Chapter 7 - Project Financing Flashcards
What 5 Characteristics must be present in an underlying project or business for project financing to be used?
1) Capital Intensive Project - Large-scale debt / equity capital
2) Highly Leveraged - 65-80% of capital
3) Long-term Project - 15-20 years average
4) Entity Specific Cash Flows - newly formed entities don’t have cash flows so lenders focus on specific project’s cash flows
5) Multiple Participants - Participation of numerous participants involved in the project
What are key advantages to Sponsors of high leverage?
1) Lower Initial equity injection requirements
2) Enhanced Shareholder Equity Returns through lower cost of capital being achieved due to the high degree of debt financing being utilized
3) Debt finance interest may be deductible for tax purposes, thereby further reducing the after-tax weighted, average cost of capital of the Project Company
What restricts the extent to which Sponsors can lever a Project Company?
Covenant restrictions on debt.
What are the 3 structural methods in which equity can be contributed by Sponsors?
1) Ordinary Share Capital
2) Shareholder Loans
3) Bank-funded equity bridge loan - Guaranteed by Sponsors and repaid at project completion
What are the two advantages of Shareholder Loans for Sponsors?
1) Provide a tax shield through tax deductible shareholder loan interest
2) Provide optimized returns distribution profile, where shareholder loan repayments of interest and principal are not restricted by balance sheet retained earnings.
What are the 4 points of appeal for Equity investors of Project Finance?
1) Maximize Equity Returns
2) Move Significant liabilities off a balance sheet
3) Protect key assets
4) Monetize Tax financing opportunities
What are the 2 main Covenants and rights that are in place of most project financing structures?
1) Covenants on distribution of funds to lenders and sponsors (stated distribution policy)
2) Covenants regarding operations of the business
Describe the 3 types of covenants on distribution of funds in order of the flow of funds?
1) Payment of project specific operating and capital costs
2) Payment of scheduled interest and principal payments
3) Distribution of residual profits to the project sponsors in accordance with the governing agreements
Describe Covenants regarding operations of the business.
Given multiple parties involved, it is common to set restrictions on how an asset is operated - for instance - an airport constructed using project financing will have an operating agreement in place that governs how the business can be run.
What are the 8 advantages of Project Financing?
1) Raise large amounts of long-term foreign equity and debt capital
2) Protect Sponsor’s Balance sheet (through allocating risk, and underwriting debt)
3) Strong discipline to contracting process and operations (risk allocation and private sector participation)
4) Tough Scrutiny on Capital investment decisions (de facto “political insurance”)
5) Investors have decision making power - given finite life and fixed dividend policy aspects of project finance
6) Credit Application process - limits risk as credit rating agencies have supported evaluation of project finance offerings with large institutional investors participating in these issues through private placements.
7) Protection of Key Sponsor Assets through financing structure - such as IP, Personnel, Investments in other projects, etc.
8) Tax Structuring Opportunities - particularly in monetizing tax incentives from local governments
What are the 6 Disadvantages of Project Financing?
1) Complex mechanism requiring significant lead times (unique risks, participants, constraints)
2) High Transaction costs - involved to develop special purpose financing vehicles, admin costs, lending costs, consultants, legal fees etc take off % points of loan commitment
3) Cashflow Requirements - are high, with elevated coverage ratios
4) Contractual Agreements often have more supervision of the management and operations than under a typical lending arrangement
5) Risk in investing in immobile assets, under highly unstable countries / conditions
6) Operating Restrictions on Project Company - Financing causes decrease in ability for project company to make equity distributions to sponsor prior to payment of operating expenses, debt service, and % of “sweep” of additional cash flow resulting in decision making as to whether or not to reinvest cash flow in project not resting solely with the sponsor.
What is a PPP?
Public Private Partnerships
PPP’s are a specific form of Project Finance where a public service is funded and operated through a partnership of government and the private sector
How is a PPP structured?
Typically under a long-term concession arrangement. In return, the Project Company received defined revenue stream over the life of the concession from which the private sector investors extract returns.
What is an example of PPP?
Varieties of essential infrastructure including street lighting, schools, roads, hospitals and prisons.
