PROJECT FINANCING

CONTENTS

INTRODUCTION AND HISTORY

OBJECTIVES
CHARACTERSTICS OF PROJECTS
STRUCTURE
RISKS INVOLVED
BASIC SCHEME
A FEW REAL WORLD CASES

INTRODUCTION
Project financing is an innovative and timely
financing technique that has been used on many
high-profile corporate projects.
It is the long term financing of infrastructure and
industrial projects based upon the projected cash
flows of the project rather than the balance
sheets of the project sponsors.
The loans are most commonly non-recourse
loans, which are secured by the project assets
and paid entirely from project cash flow.

 Financier principally looks to the assets and

revenue of the project in order to secure and
service the loan.
In this situation, the credit risk associated with
the borrower is not as important as in an
ordinary loan transaction.
The most important thing is the identification,
analysis, allocation and management of every
risk associated with the project.

HISTORY AT A GLANCE
Limited recourse lending was used to finance
maritime voyages in ancient Greece and Rome
Its use in infrastructure projects dates to the
development of the Panama Canal.
Project finance for high-risk infrastructure
schemes originated with the development of
the North Sea oil fields in the 70s and 80s.
For such investments, newly created Special
Purpose Corporations (SPCs) were created for
each project.

 Project financing in the developing world

peaked around the time of the Asian Financial
Crisis.
Project finance structures emerged primarily
in response to the opportunity presented by
long term power purchase contracts available
from utilities and government entities.
In recent years, project finance schemes have
become increasingly common in the Middle
East, some incorporating Islamic Finance

WHY PROJECT FINANCING ?

Project Owners Perspective

Size and cost of projects
Risk minimization
Preservation of borrowing capacity and
credit rating
May be only way that enough funds
can be raised

OBJECTIVES
Providing funds to a project is an important
objective in itself.
Monitoring by financial markets and
institutions brings competition in service
delivery.
To provide another mechanism for investors to
impose discipline.
Avoid any negative impact of the project on
the credit standing of the sponsors.

CHARACTERSTICS OF PROJECTS

Single purpose capital investment

Stand alone entity
Finite and long life
Large in size

BASIC ELEMENTS OF A PROJECT

FINANCING
Lenders

Raw
materials

Loan
funds

Debt
repayment

Purchase
contract(s)

Assets comprising the project

Output
Equity
funds

Equity
investors

Returns to
investors

Cash deficiency
agreement and
other forms of
credit support

STRUCTURE
Organizational Structure: Project companies
involve separate legal incorporation. SPEs
created to facilitate asset securitization share
this feature of separate incorporation.
Capital Structure: Project companies employ
very high leverage compared to public
corporations. The avj project company has a
book value debt-to-total capitalization ratio of
70% compared to 30% for similar sized
companies listed in the compustat database.

 Ownership Structure: Project companies have

highly concentrated debt and equity
ownership structure. Most of the debt comes
in the form of syndicated bank loans, not
bonds, and is nonrecourse to the sponsoring
firms.
Contractual Structure: Project finance is
sometimes referred to as contract finance.
The four major project contracts govern the
supply of inputs, purchase of outputs ,
construction, and operations.

RISK INVOLVED
The key to project financing is the
reallocation of any risk away from the lenders to
the project.

MINIMISING RISK
Step 1: Identification and Analysis.
Step 2: Risk Allocation.
Step 3: Risk Management.

TYPES OF RISKS AND WAYS TO REDUCE

THEM
Participant Risks
-Sponsor commitment to project - Reduce Magnitude of investment?
-Require Lower Debt/Equity ratio

equity

-Finance investment through

then by debt

Financially weak sponsor

sponsors
Construction/Design defects

- Attain Third party credit support for

weak sponsor (e.g.,Letter of Credit)

- Cross default to other

- Experienced Contractor
- Turn key construction contract

Process failure
warranties
Completion Risks
Cost overruns
funding

- Process / Equipment

- Pre-Agreed overrun

- Fixed (real) Price Contract

Project not completed - Completion Guarantee

Production/Operating Risks
Operating difficulty leads to - Proven technology
insufficient cash flow
- Experienced
Operator/ Management Team
- Performance warranties
on equipments
- Insurance to
guarantee minimum cash

 Political Risk
Covers range of issues from - Host govt. political risk
assurances nationalization/expropriation,
- Assumption
of debt
changes in tax and other laws, - Official insurance: OPIC,
COFACE, EXIM
currency inconvertibility, etc. - Private insurance: AIG,
LLOYDS
- Offshore Escrow Accounts
- Multilateral
Bilateral Involvement
Abandonment Risk
Sponsors walk away from project
- Abandonment test
in agreement for
banks to run project
closure based on historical
and
projected costs and revenues

BASIC SCHEME

 Acme coal Co. exports coal /Energen Inc

supplies energy.
Both form an SPC (divide the shares in
accordance with their contribution).
SPC signs contract with a construction
company.
SPC gets financing from development and
commercial banks to pay the construction
company.
Acme and Energen form another SPC to
manage the facility.

 If any disaster happens ,plaintiffs cannot sue

Acme or Energen because neither of them
own or operate the plant.
An SPA then allows trading between SPC and
Acme and electricity is delivered to Energen
using wholesale delivery contract.
The cash flow from these transaction will be
used to pay the financers.

A FEW REAL WORLD CASES

Panama Canal construction.
Gamsberg Zinc mining project in South Africa (The
largest Zinc mine in the world was financed at US
$900 million)
Australia Japan Cable. (12,500km cable from Sydney,
Australia to Japan via Guam at a cost of $520m. Key
sponsors: Japan Telecom, Telstra and Teleglobe.
Asset life of 15 years.)
Iridium LLC. (A $5.5bn satellite communications
project backed by Motorola which went bankrupt in
1999 after just one year of operations. Had partners
in over 100 countries.)

TOP BANKS IN PROJECT FINANCING :1. SBI Capital

2. Calyon
3. BNP Paribas
4. Societe Generale
5. IDBI Bank
*India topped Project Finance deals in 2010
with $30 billion (21.5% of Global Project
Finance).

BIBLIOGRAPHY

www.google.com
www.eagletraders.com
en.wikipedia.org
www.pwc.com