Presentation on theme: "Indian Institute of Management, Ahmedabad"— Presentation transcript:
1Indian Institute of Management, Ahmedabad Project FinanceSession on FinanceSidharth SinhaIndian Institute of Management, AhmedabadThe views expressed here are those of the presenter and do not necessarily reflect the views or policies of the Asian Development Bank (ADB), or its Board of Directors, or the governments they represent.
2Project Finance Objective Project vehicle Financing a single purpose capital asset usually with a limited lifeProject vehicleLegally independent project companyFinancing (debt and equity definition)Equity from one or more project sponsorsNon recourse (to sponsors) debtEquity at the minimum level to issue debt at reasonable costComparison with traditional or corporate finance
3Standard & Poor’s defines a project company as a group of agreements and contracts between lenders, project sponsors, and other interested parties that creates a form of business organization -that will issue a given amount of debt at start;will operate in a focused line of business;lenders look only to a specific asset to generate cash flow as the sole source of principal and interest payments and collateral.
4Project debt is not a permanent part of the capital structure, but is repaid in most projects according to a schedule based on the project’s useful life.Projects by design do not build up equity, but instead, use up cash quickly -First as operating expenses,then as debt service (often the most significant expense), andfinally as dividends.
5Project finance is suitable for large projects Takes a longer period of time to structure, negotiate and document a project financing than a traditional financingThe legal fees and related costs associated with project financing can be very highIt limits the risk of the sponsor to its equity investment - not the total project investment.
6Main Parties in a Project Financing VehicleSuppliersPurchasersOperatorLendersContractorShareholdersLoanAgreementConcessionOff-takeEquitySubscriptionSupplyOperation &MaintenanceConstructionSpecial PurposeAuthority
7Project Financing Participants Sponsor/Developer. The sponsor(s) or developer(s) of a project financing is the party that organizes all of the other parties and typically controls, and makes an equity investment in the project company.Additional Equity Investors. In addition to the sponsor(s), there frequently are additional equity investors in the project company.These include government, sponsors, contractors, insurers, suppliers, off-takers, etc, giving them a vested interest in the success of the project
8Project Financing Participants (continued) Lender. The lender in a project financing is a financial institution or group of financial institutions that provide a loan to the project company to develop and construct the project and that take a security interest in all of the project assets. Lenders can also include bond investors in capital markets
9Risk AnalysisSince lenders provide bulk of the financing, risk is usually analyzed from the lenders’ perspectiveProject-level risks - agreementsDefault by counterpartiesCountry risk - stability of economic, political, and regulatory environmentBusiness and legal institutions risk - enforceability of agreementsForce majeure risk - ‘acts of god/nature’InsuranceCredit enhancementsThe objective is to assess the risk of cash flows available for debt servicingLoan and security agreements
10Project Level Risks Quality of sponsors Experience, commitment (equity investment)Strategic importance of the projectFinancial strength to meet future obligations such as contingent equityConstruction riskConstruction agreementsQuality of contractors (could be a sponsor)Related investment requirementsOperations riskQuality of operatorOperations and maintenance contract
11Project Level Risks Supply risk Availability Agreements for variability of input pricesOfftake, demand & market riskOfftake agreementMay not offer adequate protection against unfavourable market situation because of problems of enforceability of contractsCompetitive positionCost of production relative to competitorsAvailability of substitutesBetter competitive position implies lower demand risk
12Construction Contract Price. Most project financing construction contracts are fixed-price contracts although some projects may be built on a cost-plus basis. If the contract is not fixed-price, additional debt or equity contributions may be necessary to complete the project, and the project agreements should clearly indicate the party or parties responsible for such contributions.Completion Date. If construction is not finished by the completion date, the contractor typically is required to pay liquidated damages to cover debt service for each day until the project is completed. If construction is completed early, the contractor frequently is entitled to an early completion bonus.
13Construction Contract (continued) Performance Guarantees. Such guarantees are measured by performance tests conducted by the contractor at the end of construction. If the project does not meet the guaranteed levels of performance, the contractor typically is required to make liquidated damages payments to the sponsor. If project performance exceeds the guaranteed minimum levels, the contractor may be entitled to bonus payments
14Operations and Maintenance Agreement Long-term agreement for the day-to-day operation and maintenance of the project facilitiesWith a company having the technical and financial expertise to operate the project in accordance with the cost and production specifications for the project.The operator may be an independent company, or it may be one of the sponsors.The operator typically will be paid a fixed compensationMay be entitled to bonus payments for extraordinary project performance and,Be required to pay liquidated damages for project performance below specified levels.
15Input Supply Agreements Agreements for the supply of raw materials, energy or other resources over the life of the project.Frequently, supply agreements are structured on a "put-or-pay" basis -This means that the supplier must either supply the input or pay the project company the difference in costs incurred in obtaining the input from another source.Fixed or spot price
16Product Offtake Agreements The product offtake agreements represent the source of revenue for the project.Frequently, offtake agreements are structured on a "take-or-pay" basis,The offtaker is obligated to pay for product on a regular basis whether or not the offtaker actually takes the product unless the product is unavailable due to a default by the project company.PriceFixedScheduled changesPass through of fluctuating input prices
17Country Risk Stability and predictability Economic environment Political and regulatory environmentExpropriation or creeping expropriationCurrency riskExchange rate volatility, transfer and convertibility riskCurrency of revenue, expenses, debt servicing and shareholder return
18Loan and Security Agreement Security. The project loan typically will be secured by multiple forms of collateralMortgage on the project facilities and real property.Assignment of operating revenues.Assignment of any letters of credit or performance or completion bonds relating to the project under which borrower is the beneficiary.Assignment of insurance proceeds. Assignment of all project agreements
19Loan and Security Agreement (continued) Disbursement Controls. These frequently take the form of conditions precedent to each drawdown, requiring the borrower to present invoices, builders' certificates or other evidence as to the need for and use of the funds.Progress Reports. The lender may require periodic reports certified by an independent consultant on the status of construction progress.
20Loan and Security Agreement (continued) Covenants Not to Amend. The borrower will covenant not to amend or waive any of its rights under the construction, feedstock, offtake, operations and maintenance, or other principal agreements without the consent of the lender.Completion Covenants. These require the borrower to complete the project in accordance with project plans and specifications and prohibit the borrower from materially altering the project plans without the consent of the lender.
21Loan and Security Agreement (continued) Dividend Restrictions. These covenants place restrictions on the payment of dividends or other distributions by the borrower until debt service obligations are satisfied.Debt and Guarantee Restrictions. The borrower may be prohibited from incurring additional debt or from guaranteeing other obligations.Financial Covenants. Such covenants require the maintenance of working capital and liquidity ratios, debt service coverage ratios, debt service reserves and other financial ratios to protect the credit of the borrower.
22Credit EnhancementSome third parties offer various credit enhancement products designed to mitigate project level risks, sovereign risks, and currency risks, among others.Multilateral agencies, such as the Multilateral Investment Guarantee Agency, the International Finance Corp., and ADB offer various insurance programs to cover both political and commercial risks.Project sponsors can themselves provide some type of support in mitigation of some risks - a commitment that tends to convert a non-recourse financing into a limited recourse financing.These enhancement packages cover only specified risks.
23Financial ModelingThe most important decision making instrument in the financing of a project is its financial model.The model ties up the revenue model, capex, opex, capital structure and other inputsIt provides projected multi-year financials, e.g. income statement, balance sheet and cash flow statementThe model can also be programmed to do scenario testing, sensitivity analysis and stochastic analyses of performance measures.
24Performance Measures Valuation measures Internal Rate of Return (IRR) and Net Present Value (NPV)Debt-service coverage ratios (DSCRs) as the primary quantitative measure of a project’s financial credit strength.The DSCR is the ratio of cash from operations (CFO) to principal and interest obligations.CFO is calculated strictly by taking cash revenues and subtracting expenses and taxes, but excluding interest and principal, needed to maintain ongoing operations.The ratio calculation also excludes any cash balances that a project could draw on to service debt, such as the debt service reserve fund or maintenance reserve fund.