8 - Project Finance Flashcards

1
Q

Project Finance: definition/characteristics

A

Proj. Finance is a LARGER SCALE, sometimes, HIGHLY LEVERAGED, financing facility established for a SPECIFIC UNDERTAKING whose credit worthiness and economic justification is based primarily on that undertaking’s EXPECTED CASH FLOWS and ASSET COLLATERAL
-Lenders look initially to the project’s cash flow for repayment and its assets for collateral

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2
Q

Project Finance: definition/characteristics (2)

A
  • Debt terms are not based on the sponsor’s credit support of the value of the physical assets of the project, but on the technical and economic factors
  • Level of leverage is higher than for a normal project
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3
Q

Recourse vs non-recourse finance

A
  • Recourse: lender can recover debt by selling OTHER assets of the sponsor
  • Limited recourse: if project is nearly finished, lender has right to assets to finish the project
  • Non recourse: lender has right ONLY to the CFs and assets of the project (not the company)
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4
Q

Completion test

A

-Companies often move from recourse to non-recourse throughout the project
-Based on expected CFs which is based on assumed technological details
-Details include design engineering and construction risks
Tests include: capacity, daily production rate, output specification, banks will have done sensitivity analyses

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5
Q

Financial consequences of recourse/non recourse

A
  • Recourse is an important consideration, because it affects balance sheet ratios:
  • Higher recourse causes D/E ratio to deteriorate
  • Affects ratings
  • Affects borrowing covenants
  • Once a loan becomes non-recourse, interest costs/borrowing amounts become OBS (not included in ratios)
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6
Q

Financial convenants

A
  • A range of financial ratios which must always be observed: e.g., current assets ratio (2:1), debt service ratios (1.5:1), debt/equity ratio (40/60)
  • A breach of ratio can result in immediate payback of principal, and also cross-default clauses (default in one agreement = default in ALL agreements)
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7
Q

PF: greater economic efficiency

A
  • Project financings are designed to avoid uncertainty

- Extensive feasibility/engineering/due diligence takes place so that CF projections can be relied upon

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8
Q

Types of risks: Development phase

A
  • Developers and contractors usually take an equity position (i.e. become a partner in the project)
  • Risks include: technology risk (assumed by sponsors through equity contribution), credit risk (often enhanced through letters of credit), bid risk (will the bid be successfully made)
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9
Q

Types of risks: Construction phase

A
  • Completion risk: risk that project may never reach operating stage, contractors therefore allocate segments of completion risk to equipment and material suppliers; sponsors favour turnkey projects where engineering/construction contractors assume responsibility for completion
  • Cost overrun risk: fixed price contracts may be difficult to obtain, may offset by including price escalation clauses
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10
Q

Types of risks: Construction phase (cont.)

A
  • Sponsor’s performance risk: may not meet quality standards or deadlines by failing to provide specified goods or services on time; completion and performance guarantees help cover this risk
  • Political risks: legislative and regulatory changes which occur during project construction
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11
Q

Types of risks: Operations phase

A

Project has been successfully completed, the following risks remain:

  • Cost overrun risk: labour and materials used during operation may turn out to be more expensive than anticipated
  • Off-take risk (marketing): risk that the project may not meet revenue projections because of price or demand changes (manage through fixed price agreements, or derivatives)
    • take-or-pay: guarantee if company produces nothing, pay certain amount back (fixed costs)
    • take-and-pay: if company can’t produce goods, will only pay back what has been delivered
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12
Q

Types of risks: Ongoing risks

A
  • Equity resale risk: contractors and other sponsors may be unable to sell their share in a project upon completion because secondary market may be limited
  • Ongoing risks: interest rate and FX risks
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13
Q

Ownership Structure: key aspects (3)

A

1) To avoid parent company direct involvement
2) Legal liability: due to size of most projects covered by project finance
3) Tax: timing of deductions for CAPEX, which affect deductions against taxable income and hence timing of tax payable and cash flow effects

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14
Q

Partnerships

A
  • Direct access to write-offs
  • Recourse limited to partnership assets
  • BUT unlimited liability for partners
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15
Q

Corporations

A
  • Special purpose company may be formed
  • Will own the assets of the project, but not other assets
  • If a single sponsor: access exists to initial tax write offs through the grouping provisions
  • If dual sponsor: tax claims are deferred until the project generates taxable income
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16
Q

Joint ventures

A
  • Sponsors are only liable to the extent of their investment and advances to the project
  • Each party holds an undivided interest (e.g. 1/3) in the property of the joint venture
  • Sponsors may sue each other for breach of contract
17
Q

Example of BHP

A
  • 50:50 iron ore joint venture operation in Brasil with Vale
  • Neither Vale nor BHP were operators of the Samarco mine, a separate company called Samarco was formed, overseen by a Board with BHP and Vale representation
  • BHP is now trying to unwind mining ventures that it, or its partners, have no operational control in
18
Q

Other aspects of Project Financing

A
  • Info Asymmetry: PF involves considerably more due diligence than traditional finance. Due to size of facilities as well as the number of participants and risk sharing
  • Pricing basis: basis points fee over the base rate is considerably higher on a project loan than a corporate loan (due to higher risk)
  • Traditionally, PF debt raised via large bank loan syndications, however more recently funding has been raised in capital markets