1 Project_Finance course introduction to

The Project Finance Problem
 Cost in short term – returns only in long term
 Project can not proceed without financing
 It becomes problem for other organisations
 The project finance problem is to obtain funds to
bridge the time between making expenditures and
obtaining revenues
 Covering this negative cash balance in the most
beneficial or cost effective fashion is the project
finance problem.

The origin & evolution of Project Finance
 Perfected in 1970s for large scale natural
resource projects – Euro Disneyland and the
Euro Tunnel, pipe lines, refineries,
 Prior to world war I huge infrastructure
projects were financed by risk taking
entrepreneurs
 Fortunes were made and lost
 Suez Canal and the Trans-Siberian Railway

The origin and evolution of Project Finance
 After WW 1 and WW 2 colonial sector lost powers,
new governments financed projects through
 Budgetary resources
 Public sector borrowings
 Sovereign borrowings
 State and public utilities become primary vehicle of
infrastructure creation
 Governments identifying needs, setting policy and
procuring infrastructure

Need for alternative model of financing
 1980s convergence of various factors led to search
for alternative ways of financing
 Continued population and economy growth
 Debt crisis – less borrowing capacity, fewer budgetary
resources
 Downturn in business for construction companies
 Stiff competition among equipment suppliers and
operators making them promoters of projects
 Outright privatization was not acceptable
 Increased sophistication of financial markets in
engineering financial packages

History of Project Finance & PPP
2000
1990
1980
1970
1960
North Sea Oil Minerals
Nat. Resources
Power & Telecoms
- - - - - Infrastructure - - - - -
“PFI”
Roads
Bridges
“PPP”
Public Services
Schools
Hospitals
Office Accom.
Govt. & Corp. Gtees
[“On “ balance sheet]
Cash-Flow / Bank, ECA & IFI Loans - - - - - - - - -- & Bond
Issues
Private Co.s - - - - - - - - - Privatisations - - - - - - - - -Services- - - - - - - - -
[“Off” balance sheet]
UK, Europe & Rest of World [excl. USA]

History of Project Finance
2000
1990
1980
1970
1960
UK, Europe & Rest of World [excl. USA]
North Sea Oil Minerals
Nat. Resources
Power & Telecoms
- - - - - Infrastructure - - - - -
“PFI” “PPP”
U.S.A. & Canada
Govt. & Corp. Gtees
Municipalities
Govt. Agencies
- - - - - - - - - - - - - - - - - - Industrial Revenue Bonds - - - -- - - - - Comm. Bk. Loans--
Cash-Flow / Bank, ECA & IFI Loans - - - - - - - - Bond Issues
Turnpikes; Power; Oil/gas Pipelines; Airports, Water- - - - - - - - - - -
Private Co.s - - - - - - - - - Privatisations - - - - - - -Services - - - - - - - -
Private Corporations, PIC’s - - - - - - - - - - - - - - - - - - - - - - - - - - - -
[“PPP”]

Recent period evolution of Project Finance
 Development of a consensus that the private sector
can play a dynamic role in accelerating growth and
development
 PF peaked up in developing nations around east
Asian financial crisis
 During post crisis downturn OECD countries
provided helping hand to project financing
 PF is approached not only for financing but for
efficiency in operations, management and technical
capabilities and for introducing competition

Exercise
 1. Trace the evolution and development of
project finance in your country
 2. What factors were responsible for
development or non-development of project
financing in your country?
 3. Enlist examples of project finance in your
country

Why project finance?
 PF method spreads and distributes risk among
various players which are able to control risk
 Improved risk control is needed for large-
scale projects
 Access to finance can be facilitated by
isolating good projects from the reduced
credit status of business corporations

What is project finance?
“Project Finance is a technique of
non-recourse or limited recourse
financing in which the project lender
principally look to the cash flow of a
single project as security for their
long-term loans.”

Characteristics of Project Finance
 Limited or non-recourse based
 Cash flow based
 Performance is the nucleus
 needs strong security structure
 little more costly / complex
 Project finance involves risk identification &
allocation
 Project finance is different from corporate finance
 Usually accompanied by Special Purpose Vehicle

Exercise
 1. Why project finance? What makes it
relevant in present period and in your
country?
 2. Define Project Finance? What are special
characteristics of project finance?
 3. How project finance is different from
corporate finance?

Risk and Project Phases
Engineering &
Construction Phase
Start-up
Phase
Operation
Phase
Physical
Completion
Full Scale
Production

Project Finance Life Cycle
Operations &
Monitoring
Drafting of financing documents
Implementation &
Monitoring
Resolution of due
Diligence issues
Preliminary project assessment Due diligence
Issue of LOI
Issue of term sheet
Term sheet
negotiations
Term sheet signing
Financial closure Project completion
Project identification
Debt servicing

Basic Project Finance Structure
At Risk:
No Risk:
Equity
Debt
Hotels & tourism = 50/50
Industrial projects = 70/30
Infrastructure [e.g. roads & power] = 80/20
PPP’s : hospitals/schools = 90/10
Typical Debt/Equity Ratios:
• Grants and subventions
Cost of
Capital

Conventional Government Structure
PROJECT COMPANY
Contractor
Govt.
Lenders
[ECAs; IFIs; banks]
(Inter-credit. Aggt.)
EPC
Contract
“Equity”
Grant / Subvention Loan Aggts.
The
Engineer
Govt. Guarantee
Returns /
Dividend

Public Capital Market Model
PROJECT COMPANY
Contractor
Government through budgetary
resources
Lenders
[ECAs; IFIs; banks]
(Inter-credit. Agreement)
EPC
Contract
“Equity” or Grant (capital
subsidy) or Subvention Loan Agreements
The
Engineer
Government Guarantee
Returns /
Dividend
Capital Debt Market
Raising funds through
Bonds/ Debt Instrume
Capital Equity Market
For Raising Equity

Capital Subsidy Model
PROJECT COMPANY
Contractor
Govt.
Lenders
[ECAs; IFIs; banks]
EPC
Contract
Capital Subsidy
one time or
recurring
Loan Aggts.
The
Engineer
Govt. Guarantee

Conventional Corporate Structure
PROJECT COMPANY
Contractor
Parent
Company
Lenders
[ECAs; IFIs; banks]
EPC
Contract
“Equity”
Grant / Subvention Loan Aggts.
The
Engineer
Corporate Guarantee
Returns /
Dividend

Revenue Sharing Model
PROJECT COMPANY
Contractor
Parent Company 2
Lenders
[ECAs; IFIs; banks]
EPC
Contract
“Equity”
Grant / Subvention Loan Agreements.
The
Engineer
Corporate Guarantee
Parent Company 1
Revenue
Sharing
Revenue
Sharing

Co-operative Model
PROJECT COMPANY
Setting Milk Dairy, Sales Store,
Contractor
Milk Producers, Artisans,
group of people
Lenders
[ECAs; IFIs; banks]
(Inter-credit. Agreement)
EPC
Contract
Subsidy / Grant Loan Agreements.
The
Engineer
Collateral, Mortgage
Government
Dividend
Equity

Exercise
 1. Explain Different Financing Models
 2. Which financing model is associated with
your project?
 3. Out of the non-project finance models
explained earlier which mode

Project Finance Structure
PROJECT COMPANY
Contractor
Investors
Lenders
[ECAs; IFIs; banks]
Construction
Contract
Share
Subscription
Agreement
Loan Aggts.
Purchasers
Escrow
Acct.
Sales Contract.
Revenues
Debt
Service
Payments (2)
O & M
Payments(1).
Surplus(3)
Dividends
Supplier
[raw materials; fuel]
Operator &
Maintenance
Supply
Contract
O & M Contract
3rd Party
Gtees.
The
Engineer

1. Project Beneficiary
2. Shareholders / Owners
3. Lenders : banks, bonds,
etc.
4. Guarantors
1. Designers & Engineers
2. Contractors
3. Operators & Maintainers
4. Purchasers
5. Insurers
6. Financial Advisers
7. Lawyers
8. Regulators [if public sector
service]
9. Environmental Regulators
Sponsors Participants
Project Finance Sponsors & Participants

Project Agreements for Cash-Flow Financing
1 : Implementation
Agreement.
2 : Concession Agreement
3 : Construction Contract
4 : Operations Contract
5 : Maintenance Contract
6 : Raw Materials Supply
Contract
7 : Sales Purchase
Contract
08: Special-Purpose Company
Documents
09: Share Subscription Contracts
10: Loan Agreements
11: Inter-creditor Agreement
12: Escrow Account / Trustee
Arrangements
13: Insurance
14: Licences; Permits; Bills &
Decrees;

PPP - Concept
 Private sector creates assets (financed and operated)
and delivers to public sector agent or to public at
large in return for payment linked to service
delivered
 Sometime private sector shares market risk, no
payment assured
 Three categories of PPP
 Ownership of asset by private sector
 Management Contract
 Joint Venture

PPP- Objectives, Relevance
 Maximising efficiency
 Enhancing Govt.’s ability to implement multiple
projects
 Resource crunch
 Increasing need in quantity & quality terms for
infrastructure
 Allows each partner to concentrate on activities that
best suit their respective skills
 Public Sector – developing policies, distributional issues
 Private sector – producing and delivering in most cost
effective way

Benefits of PPP
 Speeds up development of infrastructure stock
 Value for money
 Transfer the risk of performance of the asset to
the private sector
 helps to reduce government debt and frees up
public capital to spend on social services
 Innovation and best practices
 Better financial decisions, cost efficiency
 Better maintenance

Prerequisites of PPP
 Political support
 Enabling legislative structure
 Expertise
 Project prioritization
 Heavy deal flow and standardization
 Regulatory mechanism
 Setting house right before PPP

PPP Structure
 Differs from project to project due to flexibility
 Creation of a SPV in which contractor,
operator and banks or financers may have share
 Cash flow of project as main security
 All obligations to be met during concession
 Similar to limited or non-recourse finance
 Allocation of risks regulated by agreements

PPP Structure
 The concession contract
 The construction contract
 The operating contract
 The offtake contract
 Identity of buyer is obvious
 Physical product which has to be sold

PPP Structure
PPP Concessionaire
Contractor
Investors
Lenders
[ECAs; IFIs; banks]
Construction
Contract
Share
Subscription
Agreement
Loan Aggts.
Purchasers
Escrow
Acct.
Sales Contract.
Revenues
Debt
Service
Payments (2)
O & M
Payments(1).
Surplus(3)
Dividends
Supplier
[raw materials; fuel]
Operator &
Maintenance
Supply
Contract
O & M Contract
3rd Party
Gtees.
Regulatory Regime
The
Engineer
GOVERNMENT
Concession
Aggt.
[e.g. PFI / PPP]

International PPP/BOOT Structure

Exercise
 1. Explain Project Finance Model and its
main characteristics
 2. Explain PPP model of project finance
 3. Compare project finance model with PPP

Different sources of project finance
Type Source
Equity: - Current & Future Profits
- Retained profits
- New equity subscription; IPOs
- In-kind contributions
Aids &
Grants
- Development Banks (IFIs);
- Governments;
- Sector Funds, e.g. environmental fund
Debt:
- Development Banks [eg. World Bank]
- Export credits: [eg. US Ex-Im; ECGD; Sace]
- Bilateral funds [OECF; OPIC; KfW]
- Commercial lenders
- Capital markets / bond issues-
Quasi-
equity /
debt
- Preference shares & shareholder loans
- Subordinated or mezzanine debt
- Debt / equity swaps.

Providers of Equity
Equity : Investors
 Equipment suppliers
 Operators & utilities
 Developers / entrepreneurs
 Private investment funds
 Development banks / institutions
 IPO’s ?

Equity Finance
ISSUES FACING INVESTORS:
 rate of return over different periods; 5, 10, 20 years?
 dividend policy and availability; Lender constraints?
 currency convertibility and transfer; Insurance / IFI support?
 inherent project risks; NB. allocation of risks
 availability of equity in the construction period; source? ILOC?
 exit strategy; secondary market; Lender / Govt. constraints?
 partners and the sharing of risk; consortium approach
 availability of investment insurance; important in emerging markets
 taxation of SPV and economic/political stability; insurance?
 corporate loans : mezzanine/subordinated debt: Lender constraints?
Transparency?

Aid & Grants
SOURCES:
 Development Banks (IFIs);
 Governments;
 Sector Funds, e.g. environmental funds

Development Bank (“IFI”) Loans [e.g.
WB; African Dev. Bank.; ADB; EIB]
Features:
 preferred creditor status of lender;
 hard currency loans
 priority access to borrower’s foreign exchange earnings;
 no impedance of foreign exchange remittances;
 sovereign guarantee often required;
 limited support for “project finance” deals [NB. IFC];
 procurement rules compliance;
 strict environmental requirements;
 can require lengthy negotiation period
 rather bureaucratic decision-making process

Export Credits [e.g. U.S. Export-Import
ECGD; Coface; JBIC]
 Terms governed by OECD Consensus
 Support for national exports of capital goods & services.
 Hard currency loans
 Usually longer term than commercial loans
 Up to 85% of export value of goods and services, plus up to 15% of local
costs;
 Balance from commercial “complementary” loan
 Fixed interest rates governed by OECD
 Insurance fee payable by buyer/borrower.
 Check differences between national schemes
 Direct and indirect loans, depending on exporter scheme
 Can be tied into aid schemes, but must be overt
 Govt. guarantee & “project finance” deals possible
Features:

Export Credits Supplier Credits Small Value
Export Credit Agency
Bank
Seller
[Exporter]
Insurance
Loans
& Gtees
Buyer
[Importer]
Export Insurance
Policy
Gtee
Credit
Export Credit
Deferred Payments

Export Credits Buyer Credits Large Value
Bank
Seller
[Exporter]
Insurance
Loans
& Gtees
Buyer
[Importer]
Export Insurance
Policy
Gtee
Sales Contract
Loan Aggt.
Interest &
Repayment
Guarantor
Payments under
Sales Contract

Export Credits Line of Credit [Supply Package]
Bank
Supplier
[Exporter]
Insurance
Loans
& Gtees
Overseas Bank
Export Insurance
Policy
Gtee
Sales
Contract
Loan Aggt.
Interest &
Repayment
Buyer
Payments under
Sales Contract
Credit
Interest &
repayments

Commercial Loans
 Greater flexibility
 Complementary to ECA funding, etc.
 Floating & fixed interest rates (beware if linked to swap)
 Usually for shorter term than ECA funds;
 Arranging banks will syndicate to mitigate risks
 Possible requirement for lenders to make provisions (against
possible future loss)
 Fees comparable to ECAs
 Competition possible
Features:

Export Credit & Commercial Loans
Term Sheet
 Borrower
 Amount
 Currency
 Lender(s)
 Security & Guarantees
 Drawdown procedures
 Interest Rate:
 fixed or floating
 margins over LIBOR?
 capitalisation?
 payment dates
 Loan Repayments:
 amortisation schedule
 Fees:
 negotiation fees
 administration fees
 commitment fees on outstanding
balance
 Conditions:
 effectiveness;
 suspension; termination; prepayment
 ratios & covenants;
 reporting;
 negative pledge;
 dividend constraints

Bond Issues
 Local or foreign (hard) currency issue
 Short or long-term?
 Drawdown limitations
 Nature and location of bondholders
 Transaction costs
 Flexibility (e.g. re-negotiation)?
 Need for a “rating”
 Private placements
 Need for secondary market?
 Bond wraps (AMBAC, FCIA; etc.)
Features:

Bond Issues : Ratings
Standard & Poors Moody’s Comments
AAA
AA+, AA, AA-
A+, A, A-
BBB+, BBB, BBB-
BB+, BB, BB-
B+, B, B-
CCC+, CCC, CCC-
CC
Aaa [“Prime 1”]
Aa1, Aa2, Aa3 [“Prime 1”]
A1, A2, A3 [“Prime 2”]
Baa1, Baa2, Baa3[“Prime 3”]
Ba1, Ba2, Ba3
B1, B2, B3
Caa
Ca
Best quality; Capacity to pay
interest & principal v. strong.
V. strong capacity for repayt.
Strong capacity for repayt.
Protection of interest &
principal is moderate
Speculative grade
Highly vulnerable to adverse
business conditions
Identifiable vulnerability to
default
Highly speculative. Often in
default

Bond issues - Issues for Rating
Agencies Risk Analysis]
 Issue structure
 Company structure, e.g. position of parents & subsidiaries
 Operating & financial position e.g. shortfall deficiency support
cost overrun support
risk allocation structure
leverage
currency risks
 Management quality
 Industry & regulatory trends
 Sovereign & macroeconomic analysis
[NOTE: ratings can change over time!!]

Bond Issues
Issuer / Borrower
Lead Mgr. / Book Runner
Underwriter
Fiscal Agent / Trustee
Co - Manager Dealers
Institutional Buyers Retail Buyers
Rating

Islamic Banking
 Comply with the principles of the Sharia
 Loan must be free from interest
- Loan must aid production of goods and
services for society
- Interest makes no contribution to transaction
 Risks must be shared between borrower and lender, e.g. no pre-
determined profit
 Loan must be for benefit of society: financing of trade/commodities
prohibited under Sharia not allowed
 Uncertainty (i.e. speculative contracts) not allowed
 Culturally and politically can represent key component
 Inter-creditor agreement possible. ECA problem
[ e.g.: Equate, Kuwait; Taweelah A2 IWPP, UAE; Alba Line 5, Bahrain. ]
Features:

Quasi - Equity & Subordinated Debt
e.g. :
Reason:
Debt / Equity Swaps:
Preference shares & shareholder loans
Subordinated or mezzanine debt
 Limit shareholders exposure and liability
 Limit impact on parent Balance Sheet
 Taxation efficiency
 PR : improve equity returns
 Debt restructuring reasons
 Inflationary? Local currency
 equity

Exercise
 1. Discuss various sources of project finance?
 2. What aspects will you take into account
before selecting any source or combination of
sources for financing your project?

Project Finance
Thank You
Wishing you all the Best

1 Project_Finance course introduction to

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