PROJECT

FINANCE
Sinsuat, Tiang, Quiambao, Ulama, and Saavedra
“An investment in knowledge
pays the best interest”

- Benjamin Franklin
 Project Finance
● involves the public funding of infrastructure
and other long-term, capital-intensive projects

● Long-term debt financing of a specific project

Understanding Project Finance
● the financing of a major new project or large project expansion
when the lenders place primary reliance on the revenues of the
new project for repayment, as well as using the assets and
contracts of the project as security.
● Project Company is a Special Purpose Vehicle
● Off balance sheet
● Non-recourse Financing
Project Company is a Special Purpose
Vehicle
- is a subsidiary created by a parent company
to isolate financial risk. Its legal status as a
separate company makes its obligations
secure even if the parent company goes
bankrupt
- bankruptcy-remote entity
Scenario:
A businessman have a good idea but he
needs 10 million in order for his idea to be
possible. Unfortunately, he only has 1 million,
thus he still needs 9 million. He go to the
bank and say I have this company which has 1
million of investment and I need 9 million
more to invest in that project.
Off Balance Sheet
Project debt is typically held in a sufficient
minority subsidiary not consolidated on the
balance sheet of the respective
shareholders.
Non-Recourse Financing

● This often utilizes a non-recourse or limited recourse

financial structure.

● Project financing is a loan structure that relies

primarily on the project's cash flow for repayment,
with the project's assets.
Traditional Corporate Financing vs.
Project Financing Structure
● Project finance refers to innovative methods of financing large,
complex projects. In project finance, a creditor’s risk and return
are largely dependent on the project’s cash flow and assets.

● Firm borrows as a whole, not primarily on the project with the

project’s assets, rights, and interests held as secondary security
or collateral.
Traditional Corporate Financing vs. Project
Financing Structure
 Recourse vs. Non-Recourse Loans
If two people are looking to purchase large assets, such as a home, and one
receives a recourse loan and the other a non-recourse loan, the actions the
financial institution can take against each borrower are different.

In both cases, the homes may be used as collateral, meaning they can be
seized should either borrower default. To recoup costs when the borrowers
default, the financial institutions can attempt to sell the homes and use the
sale price to pay down the associated debt. If the properties sell for less
than the amount owed, the financial institution can pursue only the debtor
with the recourse loan. The debtor with the non-recourse loan cannot be
pursued for any additional payment beyond the seizure of the asset.
Key Elements of Project Finance
1. The project is a separate entity and its debts are differentiated from the sponsoring
firm’s own liabilities. Recourse to the sponsor is limited.

2. Debt service is primarily on the cash flow and assets of the project. Creditors
cannot rely on the sponsor’s other cash flow sources.

3. Credit or credit support/enhancement is extended by other parties. For example,

customers may enter into long-term purchase contracts that assure project
revenues.

4. The project is highly levered. The high financial risk is in addition to the high
technical risk that may arise from the project’s new technology, remote or foreign
location, etc. Risk allocation is therefore a critical aspect of project financing.
Participants in Project Finance
● SPONSORS - They provide equity financing or subordinated loans to the
project, which they have to do before the project can receive funding from any
other source. Normally, a sponsor becomes the owner of the capital & makes a
profit either through equity participation or management contracts.
● COMMERCIAL BANKS - They have been a major source of project
finance, in terms of debt financing, and most of the large, international banks
have units that specialize in project finance.
● EXPORT CREDIT AGENCIES - Most industrialized countries have
agencies that grant credit or credit guarantees to stimulate foreign sales and
investments. These agencies’ support could be in the form of direct loans,
insurance, interest rate subsidy, etc.
Participants in Project Finance
● MULTILATERAL INSTITUTIONS - These institutions grant soft
loans, hard loans, and even equity participation. They may also give outright
grants to fund feasibility studies, technical assistance, etc.
● VENDOR FINANCING and CUSTOMER’S ADVANCES
- Vendors and Customers do this to assure their supply of a key material or the
availability of a service facility.
● HOST COUNTRY GOVERNMENT - It may provide local currency
counterpart funding, guarantees, subsidies, incentives, etc. But probably more
important than the financial contribution, is the maintenance of an environment
that is conducive to the project such as stability in regulatory policy, maintenance
of peace and order, provision of basic infrastructure, etc.
Participants in Project Finance
● Other participants:
○ Contractors
○ Operators
○ Special Purpose Vehicles (SPVs)
○ Insurance Companies
 Challenges in
Project Financing
● How to get the key players agree on the project
finance structure?
● Keeping the control over the project
● Project Management
Stages in Project
Finance and Risk
Spreading
 Stages in Project Finance & Risk
Spreading
1. Development Stage
The term "development stage" describes the initial stage of a
new company's life cycle. Companies concentrate on
establishing themselves during the development stage by
carrying out tasks including market research, product
development, and the building of new production facilities.
 Development Stage
Companies in the development stage frequently don't make any money. They
could also be spending more money as they try to expand operations at the same
time. Development-stage businesses have a high failure rate and are prone to
ongoing cash flow problems.
 Stages in Project Finance & Risk
Spreading
2. Construction Stage
It is the physical processes of building, landscaping or refurbishing
plus all the associated activities, such as demolition, site clearance,
administration and so on.
 Construction Stage
The risks involved may include cost overruns, delays and non-completion. Fixed
price contracts shift the risk of cost overruns to the contractor, the party usually
in the best position to control this risk. If the contractor is financially weak, the
risk still lies with the sponsor in spite of the fixed price contract. Some
contractors may refuse to bear the risk and opt for a cost-plus-fee arrangement.
In any case the sponsor must ensure that back-up financing to cover cost
overruns has been provided for. Delays incompletion can be controlled through
incentives for early completion, penalties for delays and performance bonds. A
turnkey arrangement is designed to shift the risk to the contractor who has to
build the facility and ensure its proper operation. All the sponsor has to do is
take over and “turn the key”.
 Stages in Project Finance & Risk
Spreading
3. Operational Stage
To develop and review financial systems, procedures and
controls to ensure that the budgeting, accounting, income and
expenditure systems operate efficiently to the highest
professional standards.
 Operational Stage
Weak demand for the project’s output may result in inadequate cash
flow. Long-term purchase contracts with fixed or minimum prices,
take-or-pay agreements, and deficiency agreements shift the risk to
the buyers. Operating cost overruns may be covered by price
escalation clauses which shift the risk to customers. On the other
hand, long-term supply contracts or supply-or-pay agreements shift
the risk to Suppliers.
Risk Involved
1. Political Risk

Political risk is a type of risk faced by investors, corporations,

and governments that political decisions, events, or conditions
will significantly affect the profitability of a business actor or
the expected value of a given economic action.
 Political Risks
Include expropriation, war damage, currency convertibility, rebellion,
cancellation or non-renewal of an export license. This may be
covered by political risk insurance or may be reduced by the
participation of multilateral and bilateral institutions. It is usually
advisable to involve the host country government in the project so it
does not feel excluded and has a stake in the project’s success.
Risk Involved
2. Financial Risk

Financial risk is the risk that a business will not be able to

meet its debt repayment obligations, which in turn could
mean that the potential investors will lose the money
invested in the company. The more debt a firm has, the
higher the potential financial risk.
 Financial Risks
It includes credit, interest rate and currency risks. Credit worthiness
may be further enhanced by guarantees issued by the sponsor, the
host government, an export credit agency, or even a commercial
bank. Interest and currency risks can be handled using techniques
like hedges, swaps, options, forwards and futures.
Risk Involved
3. Residual Equity Risk

The amount of risk that still pertains after all the risks have
been calculated, to put it in simple words this is the risk that
is not eliminated by the management at first and the
exposure that remains after all the known risks have been
eliminated or factored in.
 Residual Risks

This is a risk inherent in any venture which will remain with

the project sponsor since not all risk can be shifted.
 MODELS OF
PROJECT FINANCE
What is PROJECT FINANCE MODEL/S?

● A project finance model is a specialized financial model,

the purpose of which is to assess the economic
feasibility of the project in question. The model's output
can also be used in structuring, or "sculpting", the project
finance deal.
PROJECT FINANCE MODELS
1. TAKE-OR-BUY AGREEMENT
- a long-term purchase
agreement with fixed or
minimum price.
- The buyer guarantees a
certain cash flow to the
project that allows the
latter to service debts.
 PROJECT FINANCE MODELS
2. DEFICIENCY AGREEMENT
- requires another party to cover the shortfall in
revenues to ensure that the project can service its
debt.
PROJECT FINANCE MODELS
3. PAYMENT TRUST
- involves a trust account to ensure that the creditor is
repaid. The trustee receives payments from customers and
pays the amount for debt service directly. Only excess is
remitted to the project.
PROJECT FINANCE MODELS
4. PRODUCTION PAYMENT
SCHEME
- involves segregating or
assigning part of the project's
output to a creditor. The
creditor then sells the output
and uses the proceeds to
service the debt. The lender is
exposed to market risk if the
demand for the output is
weak.
 THANKS!
DO YOU HAVE ANY
QUESTIONS?
addyouremail@freepik.com
+91 620 421 838
yourwebsite.com

CREDITS: This presentation template was created by

Slidesgo, and includes icons by Flaticon, and infographics
& images by Freepik
Please keep this slide for attribution