Project Financing Contracts 1

8/8/2019 Project Financing Contracts 1

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Introduction to Project Finance:

Rationale, Structure and Financing

Characteristics

Scott JazynkaFebruary 26, 2007Amman, Jordan

Prepared by Gary Powell, PhD of IP3


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Project Finance

Involves the creation of a legally independentproject company financed with: Non or limited recourse debt

Equity provided by one or more sponsors

Providers of the funds look primarily to the cashflow from the project as the source of funds topay back the loans (interest & principal) and to

provide the return on the equity invested in theproject


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Project Finance

In project financing, those providing the senior debt

place a substantial degree of reliance on the

performance of the project itself.

Therefore, a project financing structure is not primarily

dependent on the credit support of the sponsors or the

value of the physical assets involved (limited purpose

assets)


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Growth in Project Financings

Dollar value of project financings grownsteadily over the past three decades

Project debt financing has surpassed $180billion in 2006 with over 540 issuances - a

30% increase in value over 2005

New project structure developing constantlyto meet investor and customer appetites


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Infrastructure Development in theMiddle East

Demand for infrastructure development inMiddle East exceeded $25 billion in 2006 is

expected to continue growing over the next 10

years

Nearly 120 infrastructure projects (excluding

petroleum-based projects) are expected overthe next 5 years in the Middle East


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Global Project Finance Volume

$139.4

$180.6

0

50

100

150

200

2005 2006

InU

.S.

DollarsB

illion

Source: Thomson Financial


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2006 Project Finance:Middle East and North Africa

Qatar15%

Oman

10 %

Saudi Arabia

51%

U A E

7%

Egypt

5%

Kuwait

8 %

Baharain4 %

US$29.4 Billion Total



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Top 2006 Project Finance Arrangers

4710$4.4Mitsubishi UFJ Fin. Grp.

279$5.4State Bank of India

368$5.4WestLB AG

327$5.8BBVA

476$5.9BNP Paribas SA

185$6.3ABN AMRO

344$7.0Societe Generale

543$7.7Mizuho Financial Group

602$8.7Calyon661$13.2Royal Bank of Scotland

Number of

Deals

RankVolume

(in US$ Billion)

Arranger



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Principle Features of Project Finance

Separate Legal Entity

Equity Sponsorship

Contractual Arrangements

Debt Financing

Non or Limited Recourse


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Traditional Debt Financing- Corporate Finance Approach -

Lender

Corporation

(Borrower)

Project

Company investsborrowed funds in project

Loan repayment securedby cash flows of company;companys assets serve ascollateral

ON-BALANCE SHEET APPROACH


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Problems with Corporate FinanceApproach

Higher risk Limits capacity to bid and undertake other

projects

Restricts ability to form consortium

Difficult to divest


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Traditional Debt Financing- Public Finance Approach -

Lender

Government

(Borrower)

Project

Government investsborrowed funds in project

Loan repayment secured

by ability of governmentto repay

ON-BALANCE SHEET APPROACH


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Problems with Public Finance Approach

Constrained public expenditures

Budget deficits in host country

Draws from other social services

Large financing needs for critical infrastructureand development projects

Reduced aid flows to developing countries

Private sector not engaged effectively

Perpetuates existing shortfalls

Government not always well suited to deal with all

project risks


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Project Finance Approach- Non Recourse -

LenderSponsor(s)

Project

Lender has no or limited recourse toother sponsor assets

Loan repayment securedby revenues from project;project assets serve ascollateral for loan

OFF-BALANCE SHEET APPROACH

equity


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Financial resourcesrequired to

execute project(Capital and O&M)

ProjectRevenues

L I N K

Allows financing of projects whose sponsors: unwilling to expose their general assets to liabilities to be incurred

in connection with the project, or

do not enjoy sufficient financial standing to borrow funds on the

basis of their general assets

Not interested in ownership

Interested in maintaining flexibility to undertake other projects


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Debt and Equity Securities

The terms of the debt and equity securitiesare tailored to the cash flow characteristicsof the project (Grace periods).

The security of project debt depends, at leastpartly, on:

the profitability of the project the collateral value of the projects assets


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Limited Recourse and Non-Recourse Lending

Non-Recourse Debt:

Project debt is non-recourse when the securities and

other borrowings are designed to be serviced and

redeemed exclusively from project cash flow.

Limited Recourse Debt:

Project debt islimited recourse

when the projectsponsors/government provide undertakings that

obligate them to supplement the projects cash flow

under certain, limited circumstances.


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Agreements and Assurances

Agreement for Project Completion

Agreement for Sufficient Cash Flow forCapital Investment and/or From Operations

Assurance Against Project Disruption

Agreement for Off-Take (Take-or-Pay)

Concession Agreement

Agreements of Funding

Operating Agreements


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Basic Elements of a Project Financing

Assets Comprisingthe Project

LendersLoanFunds

DebtRepayment

SuppliersRaw Materials

Supply Contracts

Equity Investors

EquityFunds

Returns toInvestors

Cash DeficiencyAgreement, Other Formsof Credit Support

PurchasersPurchase Contracts

Outputs

Investors/SponsorsManagementFee


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Parties Involved in ProjectFinancing

ProjectCompany

Contractors

Government

Customers Lenders

ProjectSponsors

Other

Investors

Suppliers


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Parties Involved in Project Financing Sponsors and Investors:

A controlling stake in the equity of the company will

typically be owned by a single sponsor or group of

sponsors, who will generally be involved in the

construction and management of the project.

Other equity-holders may be companies withcommercial ties to the project including customers and

suppliers

Financial investors may also take an equity stake in theproject (Funds)


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Parties Involved in Project Financing

Lenders: A large fraction of the substantial investment needed is

usually raised in the form of debt from a syndicate of

banks Bond issues in capital markets

Project companies will sometimes enter into production

payment (revenues bonds / escrow account)arrangements instead of issuing ordinary debt


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Government: The project company will in most cases need to obtain a

concession or license from the host government in aninfrastructure investment

The government may need to establish a new regulatoryframework, guarantee currency convertibility, non-competeclause and provide environmental permits

In many cases, the project company retains ownership of

project assets (BOOs); in other cases, ownership of projectassets is transferred to the government at the end of theconcession period (BOTs)


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Contractors (Construction / OperatingCompany)

The main contractor of the plant will often holda stake in the equity of the project company

Other contractors will sometimes also hold an

equity stake, but generally to a lesser stake


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Suppliers and Customers Once the project facility has been built and becomes

operational, the project company will need to

purchase the supplies it requires and sell theproducts and services it provides.

The government is often the sole customer for some

infrastructure projects. Longer-term accounts receivable financing


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Assessing Project Risks Completion Risk (Construction)

Technology Risk Raw Material Supply & Pricing Risk

Economic and Financial Risk

Currency Risk

Political Risk

Environmental Risk Force Majeure Risk


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Distribution of Risks Among Parties

Contractual arrangements distribute riskamong the various parties

These contractual arrangements are designed toallocate the risks of the project to those partiesthat can best appraise and mitigate those risks.


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Project Sponsors: bear the risks of project design,construction, completion, operation, andmaintenance

Facility management contract (mgt fee) Working capital maintenance agreement

Cash deficiency agreement

Main contractor will usually be required to post aperformance bond.

Long term raw material purchase agreements


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Lenders: will require the usual assurances fromthe project company, including security for theirloans.

In the early stages, lenders will have recourse to theproject sponsors in the event of specific problems suchas cost overruns.

Lenders will want to ensure that cash that can be used to

service debt cannot be paid out to equity-holders(dividend restriction)

Lower risk and therefore return than equity investors


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Customers: when there are only a few

potential customers for the projects output,revenue risk is likely to be transferred to thosecustomers by means of a long-term salescontract.

Contracts may include: take-or-pay clause,throughput agreement, tolling contract.

Indexed rates

Purpose of transferring risk to customers

Rate adjustment


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Government: when a government grants a concession toa project company, there will be a concession agreementthat gives the company the right to build and operate theproject facility.

Concession agreement may require the government to

construct supporting facilities such as access roads. May require non-compete condition

Government may need to guarantee the performance ofstate-owned companies.

Government may be asked to provide guarantees forcurrency convertibility


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Requirements for Project Financing

The availability of funds depends on theability to convince providers of funds thatthe project is:

Technically Feasible

Ability to Perform

Economically Viable (incl. agreed uponsubsidies)


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Global Trends in Project Finance Private-sector participation in infrastructure projects

Build-Own-Operate (BOO)

Build-Operate-Transfer (BOT)

Risk management techniques Interest rate risk

Currency risk Raw material price/supply risk

Demand risk

Deepening of capital markets in emerging countries

Issuance of bonds in some developing capital markets


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Debt Financing

Typically fixed interest rate ==> Fixed payments Principal and interest payments

Represents a legal obligation of project company

Returns to lenders are fixed (they will not earn more thanthe interest rate on the debt)

Maximum term: usually 7-20 years (should be longer)

Interest payments on debt are tax deductible

Debt financing often represents 50% to 80% of totalproject cost


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Equity Financing

Investment with highest risk

Represents residual ownership interest in project

interest and principal payments on loans must be paid before

dividends can be paid to equity investors

Required return on equity investment (20-25%) is

always higher than interest rate on debt

Equity investment in project financing is usually 20%to 50% of total project cost


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The Institute for Public-Private Partnerships (IP3)Washington | Cairo | Jakarta | Dakar

Cairo19 Ahmed El Shattoury Street

Dokki, Giza, Egypt

Washington1010 Wisconsin Avenue, NW, Suite 250

Washington, DC 20007 USA

Tel: 1-202-466-8930 Fax: 1-202-466-8934

www.ip3.org

Jeff WuorinenRegional Representative, Middle East/North Africa

E-mail:[email protected]

Tamer ShaltoutProgram Manager, Egypt

E-mail:[email protected]

Documents

Project Financing Contracts 1