PROJECT FINANCE September 2016 1 PROJECT FINANCE What
PROJECT FINANCE September 2016 1
PROJECT FINANCE What is Project Finance • The financing of a specific project, the revenues from which will be used to repay the Lenders and will pay the investors a return on their investment. • The Lenders thus expect to take security over all the assets of the Project to secure repayment of their loans. • It is critical to balance the interests of all the Parties involved. • Project Finance is all about allocating risk inherent in the Project to the Party best able to bear it. All Project Finance deals with risk to ensure the project is “bankable”. • A “bankable” project is one which is attractive to Lenders to fund. 2
PROJECT FINANCE Why we use it It is limited recourse finance and so it enables the Project Sponsors to shed risks to the Lenders and frees up their balance sheets to do other developments. 3
PROJECT FINANCE Parties 1. The Sponsors/Shareholders • • Sponsors have expertise in developing projects (from scratch). The shareholders put the equity in and expect to earn a return on it. 2. The Project Company • A Single Purpose Vehicle (“SPV”) which typically holds the rights to the project eg – - a concession for a toll road; - a casino licence; - a generation licence and power purchase agreement; - a mining right. • The parties who lend money to the project company to develop the project. These are typically commercial banks; development fund institutions (DFIS); private equity firms. • The party who is going to pay for what the project provides 3. 4. The Lenders The Offtakers 4
PROJECT FINANCE Parties (continued) EPC Contractor • • O&M Contractor • • Engineering Procurement Construction Contractor – usually one of the experienced civil engineering companies responsible for designing all infrastructures in respect of the project, procuring all the necessary materials and equipment and constructing the project. All design and construction risk is passed through to the EPC Contractor. Operations and Maintenance Contractor usually an experienced company which can operate and maintain the Project once it has been built. All operations and maintenance risk is passed through to the O&M Contractor. 5
PROJECT FINANCE Finance Parties (Lenders, Account Bank, Facility Agent, security SPV and Hedging Counter Parties Shareholders /Sponsors Loan Agreements Security Documents Project Co (Single Purpose Vehicle) Holds the rights to Project Who provide skills and equity to the Project Company under Shareholders Agreement, Sponsor Support Agreements, equity Subscription Agreements Who pays for what the project produces through an: Offtake Agreement Power Purchaser Agreement Concession Agreement EPC Contractor Offtaker Who provides engineering, procurement and construction services through an EPC Contract Broadly speaking the agreements can be split into two categories – • Finance Documents • Project Documents Who provides operation and maintenance services through an O&M Contractor 6
PROJECT FINANCE FINANCIAL CLOSE CONSTRUCTION PHASE In the Construction Phase - • • OPERATIONS PHASE COMMISSIONING EPC Contractor builds the Project; Lenders advance money to the Project Company so it can meet its payment obligations to the EPC Contractor; The loans can only be drawn down when certain “milestones” in the construction have been achieved; Lenders usually have a “Lenders Technical Adviser” certifying that such milestones have been met. TERMINATION In the Operations Phase- • • • The O&M Contractor runs the Project so it generates revenue; The Lenders are repaid; The shareholders earn a return on equity ie the project declares and pays dividends to its Shareholders and repays Shareholder Loans. 7
PROJECT FINANCE Risk • The contracts determine the allocation of risk. • Risk can be allocated; priced; mitigated; insured. • The Project Company should retain as little risk as possible. • There are some risks which are incapable of proper assessment or analysis eg change in law risk; or which are potentially open-ended in their effect eg tax changes / special damages. These risks often remain with the Project Company. • Banks are not concerned about the probability that the risk may occur, only the possibility it may occur. 8
PROJECT FINANCE Risk (continued) • • In each project finance deal it must be assessed which is the riskiest phase - in some it is the Construction Phase eg constructing a hydro power plant involving a dam; - in some it is the Operation Phase – eg a hospital or a prison project. The margin charged on the debt will be the highest in the riskiest phase. 9
PROJECT FINANCE PROJECT DOCUMENTS (IN DETAIL) Shareholders Agreement Between the Project Companies and its Shareholders – - Capital - it is extremely important that each shareholder’s obligations to fund the Project Company are unambiguous. - Share retention obligations - shareholders will often be required to retain their equity in the Project Company for a prescribed period. - Pre-emptive rights; - Non-competition clauses 10
PROJECT FINANCE Concession Agreements (if a PPP) Between the Project Company and the Commissioning Authority Most of these are “BOT’s” Build - the Project Company has to Build the infrastructure. Operate - the Project Company has to Operate the infrastructure for a specified period. Transfer - at the end of the Concession Period the Project Company has to transfer the infrastructure to the Commissioning authority. It is critical that this agreement is “bankable” with a debt underpin for early termination. 11
PROJECT FINANCE Construction Contracts • This Agreement is between the Project Company and the EPC Contractor. • All design and construction risk in the Project should be passed to the EPC Contractor. • It is not appropriate to use FIDIC / JBIC Contracts. • Ideally these should be fixed price / fixed time contracts. • Contentious issues – - latent defects and what the time period is in this regard; - liquidated damages - level of performance guarantees; - who is responsible for insurance. Performance; Delay; 12
PROJECT FINANCE Operation and Maintenance Agreements • The agreement is between the Project Company and the O&M Contractor. • In this agreement all operations and maintenance risk should be placed on the O&M Contractor. • The proper performance by the O&M Contractor under this agreement is critical to ensure cash flow for servicing of debt and declaration of dividends. 13
PROJECT FINANCE Supply Contracts • This agreement is between the Project Company and the supplier(s) of raw materials critical for the operation of the project. • This agreement is necessary where project cash flows are dependent on the steady supply of components eg a coal fired power station which needs a constant supply of coal, limestone and water. • Supply risk should be passed through to the supply contractor. • Contentions issue – Price risk – if there are fluctuations in the price of the commodity who should bear this – - the Supplier? - the Project Company? - the Offtaker? 14
PROJECT FINANCE Offtake Agreements • This agreement is between the Project Company and an Offtaker (which can be a company or a utility eg Eskom). • This agreement ensures there is a buyer (the Offtaker) to buy what is produced by the Project. • Examples of Offtake Agreements - Water Purchase Agreements; - Power Purchase Agreements. • Do not have offtake agreements in all project finance deals but these agreements are necessary where what the project is producing has a limited buyer market. • Offtake Agreements are usually structured as “take or pay” agreements – if the Project Company produces the contracted amount it is paid at a fixed fee regardless of whether what is produced is used. 15
PROJECT FINANCE Finance Agreements • The Common Terms Agreement - This agreement is entered into between the Project Company and all its Lenders. - It contains provisions that are common to all lenders and all facilities. - It is usually a 200 – 400 page agreement that covers – ◦ ◦ ◦ ◦ Conditions Precedent to Financial Close; Conditions to each Drawdown; Drawdown Mechanics; Project Accounts and the cash waterfall; Mandatory Prepayments; Representations and Warranties; Undertakings - general; - negative; - financial ratios; - information. 16
PROJECT FINANCE Finance Agreements (continued) ◦ ◦ ◦ Events of Default; Boiler Plates; Margin Protection clauses - gross up; increased costs; market disruption. 17
PROJECT FINANCE Individual Loan Agreements This agreement is entered into between the Project Company and a specific Lender, for a specific facility. Deals with - pricing issues; interest; repayment in the ordinary course. 18
PROJECT FINANCE SOME UNIQUE FEATURES • Cover Ratios – All Project Finance turns on a “Financial Model”. – A Financial Model is a computer programme built by a financial adviser containing a number of assumptions as to the variables which would effect the Project’s cash flow (eg product prices, inflation, rate of taxation, foreign exchange rates) and then projecting what the Project’s net cash flow will be based on those assumptions. – The aggregate net cash flow is then discounted at a discount rate to produce a net present value ie the current value of a given future payment or payments. This takes into account the time value of money. • Typical Ratios are – – Loan Life Cover Ratio - This is the net present value of the project revenues for the period the loan will be outstanding to Bank Debt outstanding on any particular day. - This is a forward looking ratio. – Debt : Equity Ratio - The ratio of : Debt to Equity. – Annual Debt Service Cover Ratio - This relates to the Project’s historic revenues and measures the extent to which those revenues have been sufficient to meet the debt service obligations in that period. 19
PROJECT FINANCE Project Accounts • Proceeds Account: – subject to a waterfall • Maintenance Reserve Account • Debt Service reserve Account • Can also have – – distribution account; – insurance account. 20
PROJECT FINANCE Security Documents Typical Security • Cession in security of all rights under the project agreements - • Mortgage bonds. • Special Notarial Bonds. • General Notarial Bonds. • Completion Guarantees. • Pledge of shares in Borrower. • Direct Agreement. bank accounts; revenues; insurances and insurance proceeds. 21
PROJECT FINANCE Key risks in projects • Supply / traffic / reserve risk - the risk that the raw materials or inputs to a project change from those assumed / projected; - NB: in toll road projects thermal power stations, mining projects. • Material risk - the risk that demand for the product sold will dwindle or the price will decrease. • Foreign Exchange Risk - the risk that arises from a mismatch of the currency of the revenues, the operating costs and the debt. • Operating Technical - the risk that the technology is not capable of delivering at the expected level for the Project to generate cash flow. 22
PROJECT FINANCE • Operating cost - the risk that the cost of operating the project escalates so that the project is unable to pay its lenders or shareholders. • Operating Management - The risk that the project fails because the Project Company is badly managed. • Environmental Risk - the risk of economic or administrative consequences of environmental pollution. • Force Majeure - this is usually uninsurable and is problematic. 23
PROJECT FINANCE • Completion Risk - the risk that a project will not be able to pass its completion tests and be commissioned. • Engineering Risk - the risk that the project is inadequately designed so the project cannot achieve projected cash flows. • Political Risk - this is a suite of risks usually occurring as a result of actions by the Government eg expropriation. • Funding Risk - the impact on cash flows from higher funding costs. 24
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