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HSE - Introduction to Project Finance

This document provides an overview of project finance and public-private partnerships. It discusses key definitions, including distinguishing project finance from corporate finance. Project finance relies on the cash flows generated by a single project to repay lenders, rather than relying on corporate sponsors. The document outlines the contractual structure of project finance deals and industries amenable to limited recourse financing. It also notes benefits and drawbacks of the project finance model compared to corporate finance. Public-private partnerships are defined as cooperative ventures between public and private sectors to meet public needs through shared resources.

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Project Finance, Public-Private Partnerships and Emerging Markets L.S.P. Prabhu, BCom MPhil CA CPA Managing Director Interstice Consulting Corporation Higher School of Economics, Moscow October, 2008
Session objectives To understand the basic characteristics of project finance as distinct from corporate finance To understand the principles of public-private partnerships To understand the analytical process of assessing viability and financeability of projects To understand the related terminology/acronyms such as SPV/SPC/SPE, EPC, O&M, BOT/BOOT, PRI, ECA, IFI, DSCR, LLCR, DSRA, IDC, MRA, Monte Carlo, cashflow waterfall, loan syndication To understand typical banking terms and conditions of limited recourse loans
Agenda Project finance Public-private partnerships Investment analysis of projects Finance raising process Emerging markets
Project finance
Some basic definitions to frame our discussion “Finance” = providing funding for a business or investment project Two principal forms of finance Equity: residual ownership Debt: senior claim on assets, including cash We will concentrate most of our discussion on the debt aspects of project finance “Infrastructure” = the services provided by the physical networks associated with energy (gas, thermal and water-based), water supply, transport, telecommunications, sanitation and waste facilities, and flood protection and drainage.
Multiplier effect of infrastructure Numerous research studies point to the relationship between income per capita and infrastructure stocks per capita Infrastructure is an environmental good – benefits cut across industries Inadequate infrastructure limits international competitiveness e.g. unreliable power or telecom infrastructure Inefficient infrastructure provides disincentives for private capital investment e.g. air conditioning in China Raises the quality of life
Definition Project finance: “a method of funding in which the lender looks primarily to the revenues generated by a single project, both as the source of repayment and as security for the exposure. This type of financing is usually for large, complex and expensive installations that might include, for example, power plants, chemical processing plants, mines, transportation infrastructure, environment, and telecommunications infrastructure. Project finance may take the form of financing of the construction of a new capital installation, or refinancing of an existing installation, with or without improvements. In such transactions, the lender is usually paid solely or almost exclusively out of the money generated by the contracts for the facility’s output, such as the electricity sold by a power plant. The borrower is usually an SPE (Special Purpose Entity) that is not permitted to perform any function other than developing, owning, and operating the installation. The consequence is that repayment depends primarily on the project’s cash flow and on the collateral value of the project’s assets.” Source: Basel Committee on Banking Supervision, International Convergence of Capital Measurement and Capital Standards ("Basel II"), November 2005. http://www.bis.org/publ/bcbs118.pdf. Key takeaways: “Project finance” (in terms of debt) = limited or no recourse to the shareholders (sponsorii), beyond their equity invested in the project Lenders look to the cash flow generated by the project for their repayment Not to be confused with “financing of projects” where lenders require guarantees from the sponsors or other forms of recourse to the sponsors’ other assets outside of the project itself Not to be confused with “asset finance” or “asset securitization” where lenders advance funds against the market value of an existing asset Not to be confused with “pre-export” financing which finances existing production and is re-paid by customer payments to offshore accounts
Corporate finance vs. project finance (cont.) Corporate Finance Project Finance Stage of business being Existing Greenfield (or brownfield) financed Use of funds General corporate purposes, Construction costs and initial acquisition of new businesses, working capital expansion projects Lenders’ security Flexible, sometimes no Shares and assets + security is required assignment of third-party contracts Minimum deal size Any $100 million Typical industries Any Infrastructure, real estate Typical tenor (final maturity) Depends on the country; in Normally, at least 10-12 years Russia typically 3-5 years Drawdown Lump sum, up front In stages, depending on documented project needs (e.g. construction contract) Repayment Lump sum, via operating cash Installments matched to the flow or re-financing with a new cash flow of the project, could debt facility require cash flow sweep
Credit risk of project finance Research summary (Standard & Poor’s, 2002) Average recovery rate for project finance loans is superior to other asset classes, including leveraged loans, senior unsecured bank loans and bonds. Why? Credit Process and Structure Nature of Projects Financed Extensive due diligence by lenders Transparency of the project’s Perfected first-priority liens on all performance (SPE) assets, shares, material contracts, funds Projects are often of national on account importance Cashflow sweeps Deep-pocket sponsors Covenant triggers – “early warning” Sponsors as contractual counterparties Step-in rights Commercial value of the project vs. Restrictions on facility drawdowns, use sponsors/off-takers of funds Size of projects; need to syndicate Mandatory pre-payments Prohibition on additional indebtedness Debt service reserve accounts (DSRA)
Industries amenable to limited recourse financing Infrastructure Natural resources: oil & gas, mining Power generation Telecoms, transportation Social infrastructure (hospitals, housing, schools) – on PPP basis Real estate Why? Superior predictability of cash flows based on contracts Construction costs/timeframe Output prices/volumes Input prices/volumes Creditworthy counterparties Cash generation profile fits with investors’ requirements Significant capital requirements Impact of market risk More conservative leverage ratios / maximum debt Hedging / partial hedging, if available (e.g. commodities)‫‏‬ Conditional access to funding (e.g. real estate pre-leases) Revenue makeup provisions by concession grantor (e.g. in PPPs)‫‏‬ Additional recourse to sponsors
Overall size of the project finance market (debt) Source: Thomson Financial
Banks, regions and industries Source: Thomson Financial
Simplified contractual structure EPC contract Sponsors Contractor Capital contribution agreement Take-or-pay contract Offtaker Project Company Funders Operator O&M contract (SPE) Financing agreements Supply contract Supplier Terminology EPC – Engineering, Procurement, and Construction O&M – Operations and Maintenance Sponsors Funders - Financial investors (debt and equity) SPV/SPC/SPE – Special-Purpose Vehicle/Company/Entity
Attractiveness of project finance vs. corporate finance Ring fencing of investment projects Limits risk to sponsors/corporate parents Appropriate for joint ventures Benefits of independent monitoring Project can have a stronger debt capacity than the sponsors Raising debt at project level will not have an impact on the parent company’s credit rating (other than the commitments it undertakes towards supporting the project) Attractive for both borrower and lender Project finance loans have had a superior recovery rate (S&P study - project finance recovery rates) Structural protection Early monitoring Flexibility of banks in responding to changing needs
Drawbacks of project finance Much more time consuming (detailed due diligence) Sizable additional transaction costs, requiring minimum deal size Limited number of financial institutions which specialize in this type of structure Operational and financial restrictions placed on the borrowing entity Generally, higher cost of borrowing than corporate facilities
Public-private partnerships
Definition Public-Private Partnership: A cooperative venture between the public and private sectors, built on the expertise of each partner, that best meets clearly defined public needs through the appropriate allocation of resources, risks and rewards. Source: Canadian Council for PPPs Key takeaways: PPPs are not a financing method, but rather a method of public sector procurement which seeks to share risks with the private sector PPPs are generally based on a limited-life concession: private sector finances and constructs the facilities, and receives revenues from the project over the life of the concession Payments can come directly from users (e.g. toll roads) or from government sources (e.g. prisons) Commonly has 2 components: availability and usage The private sector's participation in most PPP projects is funded through project finance structures
PPP is a alternative procurement method PPPs allocate risks to the party best able to bear them Source: PricewaterhouseCoopers
Models of PPPs Design-Build (DB): The private sector designs and builds infrastructure to meet public sector performance specifications, often for a fixed price, so the risk of cost overruns is transferred to the private sector. (Many do not consider DB's to be within the spectrum of PPP's). Operation & Maintenance Contract (O & M): A private operator, under contract, operates a publicly-owned asset for a specified term. Ownership of the asset remains with the public entity. Design-Build-Finance-Operate (DBFO): The private sector designs, finances and constructs a new facility under a long-term lease, and operates the facility during the term of the lease. The private partner transfers the new facility to the public sector at the end of the lease term. Build-Own-Operate (BOO): The private sector finances, builds, owns and operates a facility or service in perpetuity. The public constraints are stated in the original agreement and through on-going regulatory authority. Build-Own-Operate-Transfer (BOOT): A private entity receives a franchise to finance, design, build and operate a facility (and to charge user fees) for a specified period, after which ownership is transferred back to the public sector. Buy-Build-Operate (BBO): Transfer of a public asset to a private or quasi-public entity usually under contract that the assets are to be upgraded and operated for a specified period of time. Public control is exercised through the contract at the time of transfer. Operation License: A private operator receives a license or rights to operate a public service, usually for a specified term. This is often used in IT projects. Finance Only: A private entity, usually a financial services company, funds a project directly or uses various mechanisms such as a long-term lease or bond issue. Other terms used in the PPP field: RFEI: Request for Expressions of Interest RFQ: Request for Qualifications RFP: Request for Proposals Source: Canadian Council for PPPs
Risk transfer
Investment analysis of projects
Analytical model for projects Credit Enhancements Business & Legal Institutional Risk Sovereign Risk Transactional Structure Project Level Risks Counterparty Competition Technology, Construction, Financial Contractual Exposure Operations Risks Foundation Source: Standard & Poor’s
Risk analysis of projects Project level risks Contractual foundation Technology, construction and operations Resource availability Competitive-market exposure Counterparty risk Financial performance Financial model projections, stress tests Transactional structure Bankruptcy-remote SPE Independent trustee to manage cash Sovereign risk Business & legal institutional risk Legislation supporting security requirements Credit enhancements Political risk insurance Financial guarantees Source: Standard & Poor’s
Investment analysis - qualitative Project rationale Does it make sense? What problem is it solving? Track record of sponsors Support of government Risk analysis and mitigation Key risks Construction (e.g. tunnels)‫‏‬ Technology Resource (e.g. geothermal, mining)‫‏‬ Operating Legal/contractual Environmental Reputational Expropriation (e.g. sensitive sectors) Seek risk mitigation from party best able to manage it Some uncovered risks may be addressed by insurance
Investment analysis - quantitative Financial model Integrity of the financial model is of core importance to the investing (equity) and lending (debt) decision, since there is no existing business or historical financial information on which to base assumptions Highly complex In bidding situations (equity stage), quality of financial model and soundness of assumptions make the difference between winning and losing a project Can also lead to “winner’s curse” if the financial assumptions are deemed unrealistic by the lenders In syndicated lending situations, financial models are distributed to potential lenders and are subject to independent audit
Key differences between modeling project finance and corporate finance Construction vs. operating period Long-term projection period (e.g. 30 years) emphasizes need for consistent assumptions Multiple tranches Multiple currencies Hedging requirements Inflation has an impact on long-term project viability, if not compensated in the legal agreements Need to model reserve accounts - DSRA, MRA More sophisticated tax modeling (know specific assets being procured) Interest and fee calculations lead to circularity (interest accrues and other fees are payable during construction, but no cash to pay, so must draw more from the facility, etc., etc.) Terminal value / exit multiple may be zero, depending on concession nature
Investment analysis - quantitative (cont.) Ratio analysis (post-completion) DSCR = Cashflow Available for Debt Service / Debt Service (P+I) for a specific period (e.g. 1-year) LLCR = NPV of future Cashflow Available for Debt Service / Debt Outstanding Acceptable benchmarks depend on the industry, with the most predictable sectors, such as power generation, allowed to show the smallest DSCRs (e.g. 1.2x) Equity analysis uses standard CF-type ratios for overall investment attractiveness: NPV, IRR, payback
Investment analysis - quantitative (cont.) Monte Carlo simulation Statistical technique for modeling macro variables with a long history - e.g. exchange rates, interest rates, weather effects Uses proprietary software, can provide a 95% confidence of the upper/lower limit of the given variable However, does not apply to more specific project risks, e.g. traffic risk for a specific bridge
Financial modelling exercise – BOT container port in Russia Concession period: 15 years Construction assumptions Construction period: 3 years Construction costs: Y1=$50 million, Y2=$150 million, Y3=$100 million Total capacity: 1,000,000 TEU Operating assumptions Capacity build-up: 60% in Y4, 80% in Y5, 90% thereafter Revenue and cost assumptions Revenue per TEU = $75 per TEU Fixed operating costs = $100mm per year Variable operating costs = $40 per TEU Financing and tax assumptions Interest rate = 10% during construction, 8% post construction Require 30 days of Y1 revenue as initial working capital Financing mix: 30% equity, 70% debt Loan repayment: 1 year grace, thereafter in 8 equal annual instalments, end of period Tax rate: 25% Is this an attractive project from a purely quantitative point of view? Equity vs. debt perspective? Which measures would you use?
Risk analysis Traffic / demand Location / competing facilities Construction Foreign currency What protective measures would you seek as a loan provider? From an equity perspective, how does this project compare with a power station? Risks? Returns?
Financial model output construction period operating period Summary Y1 Y2 Y3 Y4 Y5 Y6 Y7 Y8 Y9 Y10 Y11 Y12 Operating activities Revenue 7 800 000 000 450 000 000 600 000 000 675 000 000 675 000 000 675 000 000 675 000 000 675 000 000 675 000 000 675 000 000 Direct expenses -4 160 000 000 -240 000 000 -320 000 000 -360 000 000 -360 000 000 -360 000 000 -360 000 000 -360 000 000 -360 000 000 -360 000 000 Fixed expenses -1 200 000 000 -100 000 000 -100 000 000 -100 000 000 -100 000 000 -100 000 000 -100 000 000 -100 000 000 -100 000 000 -100 000 000 Interest expense -137 216 410 -3 763 441 -9 730 347 -19 503 533 -18 948 925 -18 948 925 -16 580 310 -14 211 694 -11 843 078 -9 474 463 -7 105 847 -4 737 231 -2 368 616 Pre-tax income (loss) 2 302 783 590 -3 763 441 -9 730 347 -19 503 533 91 051 075 161 051 075 198 419 690 200 788 306 203 156 922 205 525 537 207 894 153 210 262 769 212 631 384 Taxes -467 156 182 0 0 0 -18 210 215 -32 210 215 -39 683 938 -40 157 661 -40 631 384 -41 105 107 -41 578 831 -42 052 554 -42 526 277 Net income 1 835 627 408 -3 763 441 -9 730 347 -19 503 533 72 840 860 128 840 860 158 735 752 160 630 645 162 525 537 164 420 430 166 315 322 168 210 215 170 105 107 Investing activities Capital expenditure -300 000 000 -50 000 000 -150 000 000 -100 000 000 Initial working capital -37 500 000 -37 500 000 Financing activities Equity drawdown 99 899 196 16 129 032 47 919 104 35 851 060 0 Term debt drawdown 233 098 125 37 634 409 111 811 243 83 652 473 0 Revolver drawdown (repayment) 0 Term debt repayment -236 861 565 0 0 0 0 -29 607 696 -29 607 696 -29 607 696 -29 607 696 -29 607 696 -29 607 696 -29 607 696 -29 607 696 Net financing activities 53 763 441 159 730 347 119 503 533 0 -29 607 696 -29 607 696 -29 607 696 -29 607 696 -29 607 696 -29 607 696 -29 607 696 -29 607 696 Net cashflow 1 594 263 164 0 0 0 35 340 860 99 233 164 129 128 057 131 022 949 132 917 842 134 812 734 136 707 627 138 602 519 140 497 412
Cashflow generating profile $1 800 000 000 $1 600 000 000 $1 400 000 000 $1 200 000 000 $1 000 000 000 $800 000 000 Operating cash flow $600 000 000 Cumulative $400 000 000 $200 000 000 $0 -$200 000 000 -$400 000 000 Y1 Y3 Y5 Y7 Y9 Y11 Y13 Y15
Environmental impact of infrastructure projects Historically, environmental Sample risk considerations considerations have been applied Assessment of the baseline social and environmental conditions using each bank’s own standards Consideration of feasible “Equator Principles” (voluntary) environmentally and socially preferable alternatives were introduced in 2003, based on Requirements under host country laws IFC standards and regulations, applicable international treaties and agreements Created global standards for Protection of human rights and commercial banks community health, safety and security (including risks, impacts and Level playing field: most major management of project’s use of international PF banks have security personnel) subscribed to common principles for Protection of cultural property and heritage categorizing environmental and social risks in project financing Protection and conservation of biodiversity, including endangered Applies to all projects over $10 species and sensitive million Ecosystems in modified, natural and critical habitats, and identification of Projects are categorized in A/B/C legally protected areas depending on risk assessment Category A projects, and as appropriate, for Category B projects, require appointment of an independent environmental and/or www.equator-principles.com social expert
Finance raising process
Raising equity finance Sponsors Typically, sponsors would be a JV between international and local partners Common issues with local sponsors Have the requisite political connections to secure the project, but no cash Provide “in-kind” contributions towards the equity Leads to valuation issues and may have a negative impact on debt capacity of the project Equipment suppliers may also be considered more as sponsors than as equity investors since they typically have technical or operating experience to contribute Financial investors Equity - increasing number of hedge funds dedicated to infrastructure, since the returns are more predictable for fund investors than in private equity funds focused on the corporate sector. Fund investors are typically pension and insurance funds, who seek a premium over a the benchmark fixed income rate of return
Raising debt finance Financial advisor typically coordinates the process Competitive process - information memorandum Due diligence Use of technical specialists Feasibility study Insurance Independent review Underwriting commitment Syndication Road show Monitoring
Sources of debt finance Commercial banks Primary source of non-recourse debt International (e.g. Citigroup, ABN-Amro, Calyon, SocGen, HSBC, etc.) Domestic (e.g. Vnesheconombank, Gazprombank, Sberbank, VTB, etc.) Capital markets 144A project bonds (SEC) Institutional funds TLCs
Sources of debt finance (cont.) Official agencies Critical source of financing in emerging markets Export credit agencies (ECAs) Support export of goods and services from a specific country, eg. US Eximbank, ECGD, EDC, EDC, K-Exim Can provide up to 85% of export contract value Provide a measure of informal political risk insurance (PRI) as they are generally government owned International Financial Institutions (IFIs) Seek developmental impact as well as financial returns Are generally AAA-rated (owned by multiple governments)‫‏‬ e.g. EBRD, IFC, World Bank, Asian Development Bank MIGA – political risk insurance
Terms of limited recourse debt financing Typical covenants Affirmative Financial Debt Service Coverage Ratio Debt-Equity Tangible Net Worth Non-financial Cash flow waterfall Debt reserve account Cash sweep Monitoring and reporting provisions Negative Additional indebtedness Distributions Maintain assets, existence Conditions to release of completion guarantees Events of default Payment obligations Covenant violations Material Adverse Change (MAC) / force majeure Step-in rights
Application of funds (real example)‫‏‬ $$$ All revenue $$$ $$$ All revenue $$$ Trustee general account (NYC) Trustee general account (NYC) Dollar operating account Tax payment account Debt service account Major maintenance reserve account Debt service reserve account General O&M reserve account Distribution account
Emerging markets
Emerging markets defined No single universally accepted definition Typically defined in terms of World Bank categories of Middle and Low income per capita (GNI) Morgan Stanley - as of June 2007 the MSCI Emerging Markets Index consisted of the following 25 emerging market country indices: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Jordan, Korea, Malaysia, Mexico, Morocco, Pakistan, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey Big Emerging Market (BEM) economies are Brazil, China, Egypt, India, Indonesia, Mexico, Poland, Philippines, Russia, South Africa, South Korea and Turkey
International credit ratings S&P Moody’s Investment grade AAA Aaa Sample Country Ratings AA (+/-) Aa1, Aa2, Aa3 Brazil BBB- India BBB- Russia BBB+ A (+/-) A1, A2, A3 China A+ BBB (+/-) Baa1, Baa2, Baa3 South Africa BBB+ Taiwan AA- Tunisia BBB Speculative grade BB (+/-) Ba1, Ba2, Ba3 Turkey BB- Ukraine B+ B (+/-) B1, B2, B3 Thailand BBB+ CCC (+/-) Caa1, Caa2, Caa3 CC Ca C C D
Emerging market characteristics Lack of precedents, legal framework Weak domestic capital markets Weak local partners Currency instability Corruption Expropriation risk Political instability Rule of law?
Project finance in the emerging markets Emerging markets are where the needs are greatest, but… Country rating is generally less than investment grade - reduced pool of lenders/investors Cross-currency risks - project revenues are derived in local currency, but local capital markets are not generally deep enough to fund projects, so must seek funding in international markets Re-patriation risk - currency restrictions imposed in future may prevent repayment Expropriation risk – e.g. Venezuela, Russia? Lack of appropriate legislation, legal precedent Questionable impartiality of court systems - “we own every judge in Mexico” Political climate during downturns – image of exploitation by foreign investors Implications Importance of specialized lenders ECAs - seeking to support export of goods and services IFIs - concessionary lenders seeking developmental impact Reduces political risks (indirectly) Tighter restrictions on project companies Increased reliance by lenders on “relationships” with key project sponsors outside of the specific project being financed
Case studies BTC pipeline (Azerbaijan, Georgia, Turkey) Ariawest International (Indonesia)
BTC pipeline – project overview Baku-Tbilisi-Ceyhan (BTC) oil pipeline built to transfer oil reserves of the Caspian Sea Basin to world markets, avoiding the congested Bosphorus Straits and also bypassing Russia British Petroleum (BP), the consortium manager, (30.1%), SOCAR (25%), Unocal (8.9%), Statoil (8.7%), Turkish TPAO (6.5%), ENI (5%), Total (5%), ConocoPhillips (2.5%), Amerada Hess (2.35%), Itoku (3.4%) and Inpex (2.5%). The opening of the pipeline had been delayed on several occasions. Initially expected at the end of 2004, delivery of the first litres of crude from the Caspian to oil tankers in Ceyhan did not begin until May 29 2006. One of the most complex project financings ever – 11 The 1,774-kilometer pipeline has sponsors, crossing 3 countries, 2 years to conclude capacity to hold 10 million barrels of financing package. financing package includes 208 oil, stretching across 449 kilometres of finance documents, with over 17,000 signatures from 78 Azerbaijan, 235 kilometres of Georgia different parties and 1,059 kilometres of Turkey, before reaching the Turkish port of Ceyhan. Main driver: to transport crude from the $12 billion Azeri, Chirag and Deepwater Gunashli Fields (ACG Field) without going through Russia
BTC pipeline - financing US$3.65 billion project cost Debt package (~70%): IFC/EBRD A/B loans US$500mm ECAs (JBIC, NEXI, US Exim, ECGD, 766mm Hermes, Coface and SACE) JBIC overseas investment loan 300mm OPIC covered loans 100mm Sponsor senior loans 923mm TOTAL DEBT US$2,589mm EBRD - $125 million 12-year A Loan; $125 million 10-year B Loan 12- 10- MLAs: SocGen, Mizuho, Citi, ABN-Amro + 11 others in syndicate – BNP Paribas, Credit Agricole Indosuez, Natexis Banque MLAs: SocGen, Citi, ABN- Populaire, ING, Banca Intesa, Sanpaolo IMI, HypoVereinsbank, WestLB, Dexia, KBC, Royal Bank of Scotland Populaire, Intesa, HypoVereinsbank, WestLB, Dexia,
BTC financing – structural features Cayman Islands SPE (BTC Co) – receives payments from shippers Construction completion guarantees by sponsors (several) + milestones related to ACG Field development Transportation agreement Shippers must transport all their ACG field crude production through BTC Ship-and-pay (not ship-or-pay) Main bank accounts held in New York
Ariawest International PT Ariawest International SPE owned by U S West (now AT&T) – 35%, Asian Infrastructure Fund – 12.5%, and local partner PT Artimas Kencana Murni – 52.5% “Joint Operations Scheme” with PT Telkom (State monopoly provider) 5 territories Private sector invited to bid on, and operate, concessions for 15-year period, under a BOT scheme Employees seconded from PT Telkom Financial terms: 30% revenue sharing with PT Telkom Minimum Telkom Revenue (gross amount) Investor’s commitment to build a minimum number of new land lines (500,000 in West Java), for a population of 25 million with 1.4% penetration rate for fixed lines US$614 million project financing was 1996 the largest ever in Indonesian Euromoney telecoms sector; 40 international Deal of the banks participated in the syndicate Year
Key risks and mitigants Risk Mitigant(s) Inflation Revenues are not directly Ability to raise tariffs linked to inflation, thus long- term viability of the project could be eroded Foreign exchange Revenues are denominated in Government commitment to raise local currency, while funding is tariffs if IDR depreciates more than in offshore currency 10% p.a. Capital expenditure Additional hedging requirements in (equipment) largely the financing agreements denominated in foreign currency Construction Potential for construction cost Turnkey construction contract with overruns and delays Siemens Demand There may not be a market for Independent market survey the total land line commitment indicates significant unmet demand
Indonesian economy (1990-96)
Indonesian economy (1997-98)
Indonesian currency (IDR) 2,112 (Oct-93) 2,482 (Jul-97) 9,551 (Oct-08) 16,475 (Jun-98)
What went wrong? Financing structure: Currency hedge not available when markets are dysfunctional Impractical to raise tariffs in response to devaluation Acrimonious labour relations; former State employees Political unrest Developments: 1988: Banks declared MAC, froze credit lines after company drew US$284 million; shareholders forwarded extra $120 million to make up for shortfall 1990: US$284 million debt restructuring completed 1999: Ariawest files a US$1.3 billion arbitration claim against PT Telkom with the head office of the International Chamber of Commerce in Paris 2002: Senior executives of Ariawest (seconded AT&T reps), named as suspects in a corruption case worth a reputed IDR 74 billion 2002: Project was re-acquired by PT Telkom for US$185 million, plus assumption of debt of US$270 million
Project finance in Russia Source: Thomson Financial
Specific issues in Russia Capacity of Rouble capital markets Tenor Up to 15 years, but thin market Currency hedging Cross-currency swaps are available for up to 10 years, up to $1 billion transaction size But… at what cost? Impact on project economics? Quantum of funding available Infrastructure spending plans vs. capitalization of Russian banking system Goes back to the lack of development of the Russian banking system Legal risks Contractual enforcement Predictability of courts “Ability, incentive, and obligation” to perform under contracts (e.g. Stockmann) Expropriation risks Insurance limits Construction risks (permits) Impact of graft on project economics Ability to obtain political risk insurance? Corporate concentration/lack of alternative service providers in case of disputes (e.g. road construction)
PPPs in the Russian Federation Institutional framework Federal Law “On Concessions” adopted in 2005 (amended in July 2008) Investment Fund Vnesheconombank
Does Russia Need PPPs? Record budget surplus, Risk transfer foreign exchange reserves Capital cost overruns Operating cost overruns Government has a lower cost of capital than the Cost savings / value for money Private sector skills, innovation, private sector management Trend towards increasing Concentrate on service outcomes rather than assets state involvement in key Evidence from UK research studies – economic sectors cost savings of 15-17% Mobilize private capital Public funds can be invested in other areas of priority, such as pensions, healthcare, debt repayment
Typical PPP participants Land owners Private investors Grantor’s Grantor Expropriation (concessionaire Agent / partners) Services Department Company Land lease Government shareholder agreement financing Dividends Concession Concession Concession agreement transfer monitoring Private funds State control Concession agencies monitoring Concessionaire – Loans Construction Special Purpose Company Private/ multilaterals Bank or • Environmental Payments funds (invest. contracts) • Taxes Financiers • Customs (imports) • Land plan Company activities • Etc. Debt Roles of the SPC repayment Turnkey contract Commercial / Maintenance Construction Public Works works Administration Other sub-contractors business Income (Toll) Management Management Ex-post operation Users Ex-ante operation Management payments Management contract Relation Road building Participation in creation Contractual relation Outsourcing Services & Financial flows contracts Management Activity lines
Investment Fund of the Russian Federation Established in 2006 with funds primarily from Stabilization Fund Managed Vnesheconombank Annual capacity of the US$14.25 billion up to 2009 Investment Fund Potential private investment mobilization 2-8x (US$28.5 - US$114 billion) 5 Applications for funding must be supported by an investment 4 advisor, and involve a private investor US$ 3 Has approved 12 projects to date (approximately 1 out of 10 bn 2 applications) Investment Fund endorsement 1 plays critical role, especially in transport sector May invest equity of up to 75% of 0 project’s cost, or provide a 2006 2007 2008 2009 guarantee for 60% of financing obtained from private sector
Road PPPs approved by the Investment Fund Expected Investment Fund Projected Total Project Sector Investment Fund Contribution (% of Cost Contribution Total Cost) Construction of the Western High-Speed Diameter Transport RUR 82.2 bn RUR 26.5 bn 32.2% (WHSD) motorway (USD 2.9 bn) (USD 1.0 bn) Construction of the Moscow – St. Petersburg high- Transport RUR 53.0 bn RUR 25.2 bn 47.5% speed motorway (from 15km to 58km mark) (USD 2.0 bn) (USD 0.95 bn) Construction of “Orlovsky” tunnel under the Neva Transport RUR 25.7b RUR 8.0b 31.1% river in St. Petersburg (USD 0.97 bn) (USD 0.37 bn) Construction of a new exit to the Moscow Outer Transport RUR 17.0b RUR 9.8 bn 57.6% Ring Road (“MKAD”) from the motorway M1 (USD 0.65 bn) (USD 0.37 bn) “Byelorussia” Moscow-Minsk Expressions of interest from EBRD, EIB, NIB, IFC, VEB
Kupol Mine Chukotka Mining and Geologic Corporation ("CMGC") BEMA Gold (Canada) 75%; Government of Chukotka (25%) Considered the best gold discovery in the world in the last two decades Robust economics
Key risks Resource risk: mine life (12 years) Remote location (above the Arctic Circle): Transportation Construction Country risk Ambiguous mining laws Legal system untested Commodity price risk Environmental and social risk
Financing structure US$470 million estimated project cost Sponsors’ equity: $70 million, excluding sub debt Debt package: $400 million project loan + $25 million corporate loan to CMGC Completion guarantee by BEMA + cost overrun facility Political risk insurance by MIGA (expropriation, political violence, transfer and inconvertibility) Offshore account structure, linked to gold exports Debt service reserve account Automatic cash sweep Reporting and monitoring: monthly, with annual mine life update; semi-annual financial projections with forward-looking tests Tranche 1 senior (MLAs: HVB, SocGen) – 6.5 US$250mm year term Tranche 2 senior (Caterpillar Finance, EDC, 150mm 2005 Mining IFC, Mitsubishi) – 7.5 year term Deal of the Non-recourse subordinated loan (IFC) – 8.5 25mm Year year term back by warrants to purchase common stock of BEMA TOTAL DEBT US$425mm
Current state of the market Project finance market expected to be driven by needs for financing PPPs Prominent PPPs in Russia Western High-Speed Diameter Toll Road Pulkovo Airport BOOT concession Moscow-St. Petersburg Toll Road Orlovski Tunnel Nadzemny Light Rail
Western High-Speed Diameter 46.6 km high-speed city highway with multi- level exits, mostly eight lane, with a planned average speed of 120 km per hour and a maximum capacity of 94,000 vehicles per day Project timeline Nov 2006: Concession tender announced Jun 2008: Preferred bidder selected; negotiations in progress Project cost estimated at $6.5 billion (double initial estimates)‫‏‬ According to the president of Strabag, “This is not only the largest project of this type in the world, but probably the most complicated in terms of execution. Tunnels and bridges make up about half of the Diameter‘s length, and the highway passes through established city infrastructure.” Opposed by environmental groups Current status: final selection of preferred consortium occurred on 6 June 2008 (BasEl, Strabag, Hochtief, Bouygues, Egis, Mostootryad 19) (big surprise!)‫‏‬ Financing plan Russian investment fund direct subsidy St Petersburg city direct subsidy IFIs - letters of interest EBRD EIB NIB IFC Equity
Western High-Speed Diameter motorway in St. Petersburg Grantor: Russian Federal Government and City of St. Petersburg Initial project analysis: Project: To build a new high-speed, 46 Project rationale? km long toll motorway along the Gulf of Finland coast, connecting the northern, Project economics? central and southern parts of St. Sponsors? Petersburg Concession: DBFO, 30-year period Experience? Funding: Country risk? 1. Public: 33% - Investment Fund; 17% - St. Petersburg municipality 2. Private: 50% of project costs paid by investor funds Letters of Interest from EBRD, IFC, and EIB Structure: “Real toll”, not shadow Toll collection risk to be borne by concessionaire Traffic risk mitigation by City of St. Petersburg Certain land risks to be borne by grantor Early termination compensation by grantor Some form of foreign exchange protection by grantor Detailed risk allocation to be set out in draft concession agreements; subject to negotiation
Careers in project finance Commercial banks Core skills Financial advisory Financial modelling (Excel) Credit analysis Credit analysis Loan syndications Legal IFIs Writing Concessional lenders Negotiating ECAs Presenting MLAs Business development Big 4 Feasibility studies Financial advisory Law firms Drafting of contracts Advising on legislation Rating agencies Project developers Equity investors Pension funds Specialist infrastructure funds
For further references Periodicals Project Finance International Infrastructure Journal The Journal of Structured and Project Finance Harvard Business School portal (www.people.hbs.edu/b esty/projfinportal/) - links to research, data and information services
Session objectives To understand the basic characteristics of project finance as distinct from corporate finance To understand the principles of public-private partnerships To understand the analytical process of assessing viability and financeability of projects To understand the related terminology/acronyms such as SPV/SPC/SPE, EPC, O&M, BOT/BOOT, PRI, ECA, IFI, DSCR, LLCR, DSRA, IDC, MRA, Monte Carlo, cashflow waterfall, loan syndication To understand typical banking terms and conditions of limited recourse loans
Contact details L.S.P. Prabhu lsp.prabhu@mail.ru

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HSE - Introduction to Project Finance

  • 1.
    Project Finance, Public-Private Partnerships andEmerging Markets L.S.P. Prabhu, BCom MPhil CA CPA Managing Director Interstice Consulting Corporation Higher School of Economics, Moscow October, 2008
  • 2.
    Session objectives To understand the basic characteristics of project finance as distinct from corporate finance To understand the principles of public-private partnerships To understand the analytical process of assessing viability and financeability of projects To understand the related terminology/acronyms such as SPV/SPC/SPE, EPC, O&M, BOT/BOOT, PRI, ECA, IFI, DSCR, LLCR, DSRA, IDC, MRA, Monte Carlo, cashflow waterfall, loan syndication To understand typical banking terms and conditions of limited recourse loans
  • 3.
    Agenda Project finance Public-private partnerships Investment analysis of projects Finance raising process Emerging markets
  • 4.
  • 5.
    Some basic definitionsto frame our discussion “Finance” = providing funding for a business or investment project Two principal forms of finance Equity: residual ownership Debt: senior claim on assets, including cash We will concentrate most of our discussion on the debt aspects of project finance “Infrastructure” = the services provided by the physical networks associated with energy (gas, thermal and water-based), water supply, transport, telecommunications, sanitation and waste facilities, and flood protection and drainage.
  • 6.
    Multiplier effect of infrastructure Numerous research studies point to the relationship between income per capita and infrastructure stocks per capita Infrastructure is an environmental good – benefits cut across industries Inadequate infrastructure limits international competitiveness e.g. unreliable power or telecom infrastructure Inefficient infrastructure provides disincentives for private capital investment e.g. air conditioning in China Raises the quality of life
  • 7.
    Definition Project finance: “a method of funding in which the lender looks primarily to the revenues generated by a single project, both as the source of repayment and as security for the exposure. This type of financing is usually for large, complex and expensive installations that might include, for example, power plants, chemical processing plants, mines, transportation infrastructure, environment, and telecommunications infrastructure. Project finance may take the form of financing of the construction of a new capital installation, or refinancing of an existing installation, with or without improvements. In such transactions, the lender is usually paid solely or almost exclusively out of the money generated by the contracts for the facility’s output, such as the electricity sold by a power plant. The borrower is usually an SPE (Special Purpose Entity) that is not permitted to perform any function other than developing, owning, and operating the installation. The consequence is that repayment depends primarily on the project’s cash flow and on the collateral value of the project’s assets.” Source: Basel Committee on Banking Supervision, International Convergence of Capital Measurement and Capital Standards ("Basel II"), November 2005. http://www.bis.org/publ/bcbs118.pdf. Key takeaways: “Project finance” (in terms of debt) = limited or no recourse to the shareholders (sponsorii), beyond their equity invested in the project Lenders look to the cash flow generated by the project for their repayment Not to be confused with “financing of projects” where lenders require guarantees from the sponsors or other forms of recourse to the sponsors’ other assets outside of the project itself Not to be confused with “asset finance” or “asset securitization” where lenders advance funds against the market value of an existing asset Not to be confused with “pre-export” financing which finances existing production and is re-paid by customer payments to offshore accounts
  • 8.
    Corporate finance vs.project finance (cont.) Corporate Finance Project Finance Stage of business being Existing Greenfield (or brownfield) financed Use of funds General corporate purposes, Construction costs and initial acquisition of new businesses, working capital expansion projects Lenders’ security Flexible, sometimes no Shares and assets + security is required assignment of third-party contracts Minimum deal size Any $100 million Typical industries Any Infrastructure, real estate Typical tenor (final maturity) Depends on the country; in Normally, at least 10-12 years Russia typically 3-5 years Drawdown Lump sum, up front In stages, depending on documented project needs (e.g. construction contract) Repayment Lump sum, via operating cash Installments matched to the flow or re-financing with a new cash flow of the project, could debt facility require cash flow sweep
  • 9.
    Credit risk ofproject finance Research summary (Standard & Poor’s, 2002) Average recovery rate for project finance loans is superior to other asset classes, including leveraged loans, senior unsecured bank loans and bonds. Why? Credit Process and Structure Nature of Projects Financed Extensive due diligence by lenders Transparency of the project’s Perfected first-priority liens on all performance (SPE) assets, shares, material contracts, funds Projects are often of national on account importance Cashflow sweeps Deep-pocket sponsors Covenant triggers – “early warning” Sponsors as contractual counterparties Step-in rights Commercial value of the project vs. Restrictions on facility drawdowns, use sponsors/off-takers of funds Size of projects; need to syndicate Mandatory pre-payments Prohibition on additional indebtedness Debt service reserve accounts (DSRA)
  • 10.
    Industries amenable tolimited recourse financing Infrastructure Natural resources: oil & gas, mining Power generation Telecoms, transportation Social infrastructure (hospitals, housing, schools) – on PPP basis Real estate Why? Superior predictability of cash flows based on contracts Construction costs/timeframe Output prices/volumes Input prices/volumes Creditworthy counterparties Cash generation profile fits with investors’ requirements Significant capital requirements Impact of market risk More conservative leverage ratios / maximum debt Hedging / partial hedging, if available (e.g. commodities)‫‏‬ Conditional access to funding (e.g. real estate pre-leases) Revenue makeup provisions by concession grantor (e.g. in PPPs)‫‏‬ Additional recourse to sponsors
  • 11.
    Overall size ofthe project finance market (debt) Source: Thomson Financial
  • 12.
    Banks, regions andindustries Source: Thomson Financial
  • 13.
    Simplified contractual structure EPC contract Sponsors Contractor Capital contribution agreement Take-or-pay contract Offtaker Project Company Funders Operator O&M contract (SPE) Financing agreements Supply contract Supplier Terminology EPC – Engineering, Procurement, and Construction O&M – Operations and Maintenance Sponsors Funders - Financial investors (debt and equity) SPV/SPC/SPE – Special-Purpose Vehicle/Company/Entity
  • 14.
    Attractiveness of projectfinance vs. corporate finance Ring fencing of investment projects Limits risk to sponsors/corporate parents Appropriate for joint ventures Benefits of independent monitoring Project can have a stronger debt capacity than the sponsors Raising debt at project level will not have an impact on the parent company’s credit rating (other than the commitments it undertakes towards supporting the project) Attractive for both borrower and lender Project finance loans have had a superior recovery rate (S&P study - project finance recovery rates) Structural protection Early monitoring Flexibility of banks in responding to changing needs
  • 15.
    Drawbacks of projectfinance Much more time consuming (detailed due diligence) Sizable additional transaction costs, requiring minimum deal size Limited number of financial institutions which specialize in this type of structure Operational and financial restrictions placed on the borrowing entity Generally, higher cost of borrowing than corporate facilities
  • 16.
  • 17.
    Definition Public-Private Partnership: A cooperative venture between the public and private sectors, built on the expertise of each partner, that best meets clearly defined public needs through the appropriate allocation of resources, risks and rewards. Source: Canadian Council for PPPs Key takeaways: PPPs are not a financing method, but rather a method of public sector procurement which seeks to share risks with the private sector PPPs are generally based on a limited-life concession: private sector finances and constructs the facilities, and receives revenues from the project over the life of the concession Payments can come directly from users (e.g. toll roads) or from government sources (e.g. prisons) Commonly has 2 components: availability and usage The private sector's participation in most PPP projects is funded through project finance structures
  • 18.
    PPP is aalternative procurement method PPPs allocate risks to the party best able to bear them Source: PricewaterhouseCoopers
  • 19.
    Models of PPPs Design-Build (DB): The private sector designs and builds infrastructure to meet public sector performance specifications, often for a fixed price, so the risk of cost overruns is transferred to the private sector. (Many do not consider DB's to be within the spectrum of PPP's). Operation & Maintenance Contract (O & M): A private operator, under contract, operates a publicly-owned asset for a specified term. Ownership of the asset remains with the public entity. Design-Build-Finance-Operate (DBFO): The private sector designs, finances and constructs a new facility under a long-term lease, and operates the facility during the term of the lease. The private partner transfers the new facility to the public sector at the end of the lease term. Build-Own-Operate (BOO): The private sector finances, builds, owns and operates a facility or service in perpetuity. The public constraints are stated in the original agreement and through on-going regulatory authority. Build-Own-Operate-Transfer (BOOT): A private entity receives a franchise to finance, design, build and operate a facility (and to charge user fees) for a specified period, after which ownership is transferred back to the public sector. Buy-Build-Operate (BBO): Transfer of a public asset to a private or quasi-public entity usually under contract that the assets are to be upgraded and operated for a specified period of time. Public control is exercised through the contract at the time of transfer. Operation License: A private operator receives a license or rights to operate a public service, usually for a specified term. This is often used in IT projects. Finance Only: A private entity, usually a financial services company, funds a project directly or uses various mechanisms such as a long-term lease or bond issue. Other terms used in the PPP field: RFEI: Request for Expressions of Interest RFQ: Request for Qualifications RFP: Request for Proposals Source: Canadian Council for PPPs
  • 20.
  • 21.
  • 22.
    Analytical model forprojects Credit Enhancements Business & Legal Institutional Risk Sovereign Risk Transactional Structure Project Level Risks Counterparty Competition Technology, Construction, Financial Contractual Exposure Operations Risks Foundation Source: Standard & Poor’s
  • 23.
    Risk analysis ofprojects Project level risks Contractual foundation Technology, construction and operations Resource availability Competitive-market exposure Counterparty risk Financial performance Financial model projections, stress tests Transactional structure Bankruptcy-remote SPE Independent trustee to manage cash Sovereign risk Business & legal institutional risk Legislation supporting security requirements Credit enhancements Political risk insurance Financial guarantees Source: Standard & Poor’s
  • 24.
    Investment analysis -qualitative Project rationale Does it make sense? What problem is it solving? Track record of sponsors Support of government Risk analysis and mitigation Key risks Construction (e.g. tunnels)‫‏‬ Technology Resource (e.g. geothermal, mining)‫‏‬ Operating Legal/contractual Environmental Reputational Expropriation (e.g. sensitive sectors) Seek risk mitigation from party best able to manage it Some uncovered risks may be addressed by insurance
  • 25.
    Investment analysis -quantitative Financial model Integrity of the financial model is of core importance to the investing (equity) and lending (debt) decision, since there is no existing business or historical financial information on which to base assumptions Highly complex In bidding situations (equity stage), quality of financial model and soundness of assumptions make the difference between winning and losing a project Can also lead to “winner’s curse” if the financial assumptions are deemed unrealistic by the lenders In syndicated lending situations, financial models are distributed to potential lenders and are subject to independent audit
  • 26.
    Key differences betweenmodeling project finance and corporate finance Construction vs. operating period Long-term projection period (e.g. 30 years) emphasizes need for consistent assumptions Multiple tranches Multiple currencies Hedging requirements Inflation has an impact on long-term project viability, if not compensated in the legal agreements Need to model reserve accounts - DSRA, MRA More sophisticated tax modeling (know specific assets being procured) Interest and fee calculations lead to circularity (interest accrues and other fees are payable during construction, but no cash to pay, so must draw more from the facility, etc., etc.) Terminal value / exit multiple may be zero, depending on concession nature
  • 27.
    Investment analysis -quantitative (cont.) Ratio analysis (post-completion) DSCR = Cashflow Available for Debt Service / Debt Service (P+I) for a specific period (e.g. 1-year) LLCR = NPV of future Cashflow Available for Debt Service / Debt Outstanding Acceptable benchmarks depend on the industry, with the most predictable sectors, such as power generation, allowed to show the smallest DSCRs (e.g. 1.2x) Equity analysis uses standard CF-type ratios for overall investment attractiveness: NPV, IRR, payback
  • 28.
    Investment analysis -quantitative (cont.) Monte Carlo simulation Statistical technique for modeling macro variables with a long history - e.g. exchange rates, interest rates, weather effects Uses proprietary software, can provide a 95% confidence of the upper/lower limit of the given variable However, does not apply to more specific project risks, e.g. traffic risk for a specific bridge
  • 29.
    Financial modelling exercise– BOT container port in Russia Concession period: 15 years Construction assumptions Construction period: 3 years Construction costs: Y1=$50 million, Y2=$150 million, Y3=$100 million Total capacity: 1,000,000 TEU Operating assumptions Capacity build-up: 60% in Y4, 80% in Y5, 90% thereafter Revenue and cost assumptions Revenue per TEU = $75 per TEU Fixed operating costs = $100mm per year Variable operating costs = $40 per TEU Financing and tax assumptions Interest rate = 10% during construction, 8% post construction Require 30 days of Y1 revenue as initial working capital Financing mix: 30% equity, 70% debt Loan repayment: 1 year grace, thereafter in 8 equal annual instalments, end of period Tax rate: 25% Is this an attractive project from a purely quantitative point of view? Equity vs. debt perspective? Which measures would you use?
  • 30.
    Risk analysis Traffic/ demand Location / competing facilities Construction Foreign currency What protective measures would you seek as a loan provider? From an equity perspective, how does this project compare with a power station? Risks? Returns?
  • 31.
    Financial model output construction period operating period Summary Y1 Y2 Y3 Y4 Y5 Y6 Y7 Y8 Y9 Y10 Y11 Y12 Operating activities Revenue 7 800 000 000 450 000 000 600 000 000 675 000 000 675 000 000 675 000 000 675 000 000 675 000 000 675 000 000 675 000 000 Direct expenses -4 160 000 000 -240 000 000 -320 000 000 -360 000 000 -360 000 000 -360 000 000 -360 000 000 -360 000 000 -360 000 000 -360 000 000 Fixed expenses -1 200 000 000 -100 000 000 -100 000 000 -100 000 000 -100 000 000 -100 000 000 -100 000 000 -100 000 000 -100 000 000 -100 000 000 Interest expense -137 216 410 -3 763 441 -9 730 347 -19 503 533 -18 948 925 -18 948 925 -16 580 310 -14 211 694 -11 843 078 -9 474 463 -7 105 847 -4 737 231 -2 368 616 Pre-tax income (loss) 2 302 783 590 -3 763 441 -9 730 347 -19 503 533 91 051 075 161 051 075 198 419 690 200 788 306 203 156 922 205 525 537 207 894 153 210 262 769 212 631 384 Taxes -467 156 182 0 0 0 -18 210 215 -32 210 215 -39 683 938 -40 157 661 -40 631 384 -41 105 107 -41 578 831 -42 052 554 -42 526 277 Net income 1 835 627 408 -3 763 441 -9 730 347 -19 503 533 72 840 860 128 840 860 158 735 752 160 630 645 162 525 537 164 420 430 166 315 322 168 210 215 170 105 107 Investing activities Capital expenditure -300 000 000 -50 000 000 -150 000 000 -100 000 000 Initial working capital -37 500 000 -37 500 000 Financing activities Equity drawdown 99 899 196 16 129 032 47 919 104 35 851 060 0 Term debt drawdown 233 098 125 37 634 409 111 811 243 83 652 473 0 Revolver drawdown (repayment) 0 Term debt repayment -236 861 565 0 0 0 0 -29 607 696 -29 607 696 -29 607 696 -29 607 696 -29 607 696 -29 607 696 -29 607 696 -29 607 696 Net financing activities 53 763 441 159 730 347 119 503 533 0 -29 607 696 -29 607 696 -29 607 696 -29 607 696 -29 607 696 -29 607 696 -29 607 696 -29 607 696 Net cashflow 1 594 263 164 0 0 0 35 340 860 99 233 164 129 128 057 131 022 949 132 917 842 134 812 734 136 707 627 138 602 519 140 497 412
  • 32.
    Cashflow generating profile $1800 000 000 $1 600 000 000 $1 400 000 000 $1 200 000 000 $1 000 000 000 $800 000 000 Operating cash flow $600 000 000 Cumulative $400 000 000 $200 000 000 $0 -$200 000 000 -$400 000 000 Y1 Y3 Y5 Y7 Y9 Y11 Y13 Y15
  • 33.
    Environmental impact of infrastructureprojects Historically, environmental Sample risk considerations considerations have been applied Assessment of the baseline social and environmental conditions using each bank’s own standards Consideration of feasible “Equator Principles” (voluntary) environmentally and socially preferable alternatives were introduced in 2003, based on Requirements under host country laws IFC standards and regulations, applicable international treaties and agreements Created global standards for Protection of human rights and commercial banks community health, safety and security (including risks, impacts and Level playing field: most major management of project’s use of international PF banks have security personnel) subscribed to common principles for Protection of cultural property and heritage categorizing environmental and social risks in project financing Protection and conservation of biodiversity, including endangered Applies to all projects over $10 species and sensitive million Ecosystems in modified, natural and critical habitats, and identification of Projects are categorized in A/B/C legally protected areas depending on risk assessment Category A projects, and as appropriate, for Category B projects, require appointment of an independent environmental and/or www.equator-principles.com social expert
  • 34.
  • 35.
    Raising equity finance Sponsors Typically, sponsors would be a JV between international and local partners Common issues with local sponsors Have the requisite political connections to secure the project, but no cash Provide “in-kind” contributions towards the equity Leads to valuation issues and may have a negative impact on debt capacity of the project Equipment suppliers may also be considered more as sponsors than as equity investors since they typically have technical or operating experience to contribute Financial investors Equity - increasing number of hedge funds dedicated to infrastructure, since the returns are more predictable for fund investors than in private equity funds focused on the corporate sector. Fund investors are typically pension and insurance funds, who seek a premium over a the benchmark fixed income rate of return
  • 36.
    Raising debt finance Financial advisor typically coordinates the process Competitive process - information memorandum Due diligence Use of technical specialists Feasibility study Insurance Independent review Underwriting commitment Syndication Road show Monitoring
  • 37.
    Sources of debtfinance Commercial banks Primary source of non-recourse debt International (e.g. Citigroup, ABN-Amro, Calyon, SocGen, HSBC, etc.) Domestic (e.g. Vnesheconombank, Gazprombank, Sberbank, VTB, etc.) Capital markets 144A project bonds (SEC) Institutional funds TLCs
  • 38.
    Sources of debtfinance (cont.) Official agencies Critical source of financing in emerging markets Export credit agencies (ECAs) Support export of goods and services from a specific country, eg. US Eximbank, ECGD, EDC, EDC, K-Exim Can provide up to 85% of export contract value Provide a measure of informal political risk insurance (PRI) as they are generally government owned International Financial Institutions (IFIs) Seek developmental impact as well as financial returns Are generally AAA-rated (owned by multiple governments)‫‏‬ e.g. EBRD, IFC, World Bank, Asian Development Bank MIGA – political risk insurance
  • 39.
    Terms of limitedrecourse debt financing Typical covenants Affirmative Financial Debt Service Coverage Ratio Debt-Equity Tangible Net Worth Non-financial Cash flow waterfall Debt reserve account Cash sweep Monitoring and reporting provisions Negative Additional indebtedness Distributions Maintain assets, existence Conditions to release of completion guarantees Events of default Payment obligations Covenant violations Material Adverse Change (MAC) / force majeure Step-in rights
  • 40.
    Application of funds(real example)‫‏‬ $$$ All revenue $$$ $$$ All revenue $$$ Trustee general account (NYC) Trustee general account (NYC) Dollar operating account Tax payment account Debt service account Major maintenance reserve account Debt service reserve account General O&M reserve account Distribution account
  • 41.
  • 42.
    Emerging markets defined No single universally accepted definition Typically defined in terms of World Bank categories of Middle and Low income per capita (GNI) Morgan Stanley - as of June 2007 the MSCI Emerging Markets Index consisted of the following 25 emerging market country indices: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Jordan, Korea, Malaysia, Mexico, Morocco, Pakistan, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey Big Emerging Market (BEM) economies are Brazil, China, Egypt, India, Indonesia, Mexico, Poland, Philippines, Russia, South Africa, South Korea and Turkey
  • 43.
    International credit ratings S&P Moody’s Investment grade AAA Aaa Sample Country Ratings AA (+/-) Aa1, Aa2, Aa3 Brazil BBB- India BBB- Russia BBB+ A (+/-) A1, A2, A3 China A+ BBB (+/-) Baa1, Baa2, Baa3 South Africa BBB+ Taiwan AA- Tunisia BBB Speculative grade BB (+/-) Ba1, Ba2, Ba3 Turkey BB- Ukraine B+ B (+/-) B1, B2, B3 Thailand BBB+ CCC (+/-) Caa1, Caa2, Caa3 CC Ca C C D
  • 44.
    Emerging market characteristics Lackof precedents, legal framework Weak domestic capital markets Weak local partners Currency instability Corruption Expropriation risk Political instability Rule of law?
  • 45.
    Project finance inthe emerging markets Emerging markets are where the needs are greatest, but… Country rating is generally less than investment grade - reduced pool of lenders/investors Cross-currency risks - project revenues are derived in local currency, but local capital markets are not generally deep enough to fund projects, so must seek funding in international markets Re-patriation risk - currency restrictions imposed in future may prevent repayment Expropriation risk – e.g. Venezuela, Russia? Lack of appropriate legislation, legal precedent Questionable impartiality of court systems - “we own every judge in Mexico” Political climate during downturns – image of exploitation by foreign investors Implications Importance of specialized lenders ECAs - seeking to support export of goods and services IFIs - concessionary lenders seeking developmental impact Reduces political risks (indirectly) Tighter restrictions on project companies Increased reliance by lenders on “relationships” with key project sponsors outside of the specific project being financed
  • 46.
    Case studies BTCpipeline (Azerbaijan, Georgia, Turkey) Ariawest International (Indonesia)
  • 47.
    BTC pipeline –project overview Baku-Tbilisi-Ceyhan (BTC) oil pipeline built to transfer oil reserves of the Caspian Sea Basin to world markets, avoiding the congested Bosphorus Straits and also bypassing Russia British Petroleum (BP), the consortium manager, (30.1%), SOCAR (25%), Unocal (8.9%), Statoil (8.7%), Turkish TPAO (6.5%), ENI (5%), Total (5%), ConocoPhillips (2.5%), Amerada Hess (2.35%), Itoku (3.4%) and Inpex (2.5%). The opening of the pipeline had been delayed on several occasions. Initially expected at the end of 2004, delivery of the first litres of crude from the Caspian to oil tankers in Ceyhan did not begin until May 29 2006. One of the most complex project financings ever – 11 The 1,774-kilometer pipeline has sponsors, crossing 3 countries, 2 years to conclude capacity to hold 10 million barrels of financing package. financing package includes 208 oil, stretching across 449 kilometres of finance documents, with over 17,000 signatures from 78 Azerbaijan, 235 kilometres of Georgia different parties and 1,059 kilometres of Turkey, before reaching the Turkish port of Ceyhan. Main driver: to transport crude from the $12 billion Azeri, Chirag and Deepwater Gunashli Fields (ACG Field) without going through Russia
  • 48.
    BTC pipeline -financing US$3.65 billion project cost Debt package (~70%): IFC/EBRD A/B loans US$500mm ECAs (JBIC, NEXI, US Exim, ECGD, 766mm Hermes, Coface and SACE) JBIC overseas investment loan 300mm OPIC covered loans 100mm Sponsor senior loans 923mm TOTAL DEBT US$2,589mm EBRD - $125 million 12-year A Loan; $125 million 10-year B Loan 12- 10- MLAs: SocGen, Mizuho, Citi, ABN-Amro + 11 others in syndicate – BNP Paribas, Credit Agricole Indosuez, Natexis Banque MLAs: SocGen, Citi, ABN- Populaire, ING, Banca Intesa, Sanpaolo IMI, HypoVereinsbank, WestLB, Dexia, KBC, Royal Bank of Scotland Populaire, Intesa, HypoVereinsbank, WestLB, Dexia,
  • 49.
    BTC financing –structural features Cayman Islands SPE (BTC Co) – receives payments from shippers Construction completion guarantees by sponsors (several) + milestones related to ACG Field development Transportation agreement Shippers must transport all their ACG field crude production through BTC Ship-and-pay (not ship-or-pay) Main bank accounts held in New York
  • 50.
    Ariawest International PTAriawest International SPE owned by U S West (now AT&T) – 35%, Asian Infrastructure Fund – 12.5%, and local partner PT Artimas Kencana Murni – 52.5% “Joint Operations Scheme” with PT Telkom (State monopoly provider) 5 territories Private sector invited to bid on, and operate, concessions for 15-year period, under a BOT scheme Employees seconded from PT Telkom Financial terms: 30% revenue sharing with PT Telkom Minimum Telkom Revenue (gross amount) Investor’s commitment to build a minimum number of new land lines (500,000 in West Java), for a population of 25 million with 1.4% penetration rate for fixed lines US$614 million project financing was 1996 the largest ever in Indonesian Euromoney telecoms sector; 40 international Deal of the banks participated in the syndicate Year
  • 51.
    Key risks andmitigants Risk Mitigant(s) Inflation Revenues are not directly Ability to raise tariffs linked to inflation, thus long- term viability of the project could be eroded Foreign exchange Revenues are denominated in Government commitment to raise local currency, while funding is tariffs if IDR depreciates more than in offshore currency 10% p.a. Capital expenditure Additional hedging requirements in (equipment) largely the financing agreements denominated in foreign currency Construction Potential for construction cost Turnkey construction contract with overruns and delays Siemens Demand There may not be a market for Independent market survey the total land line commitment indicates significant unmet demand
  • 52.
  • 53.
  • 54.
    Indonesian currency (IDR) 2,112 (Oct-93) 2,482 (Jul-97) 9,551 (Oct-08) 16,475 (Jun-98)
  • 55.
    What went wrong? Financing structure: Currency hedge not available when markets are dysfunctional Impractical to raise tariffs in response to devaluation Acrimonious labour relations; former State employees Political unrest Developments: 1988: Banks declared MAC, froze credit lines after company drew US$284 million; shareholders forwarded extra $120 million to make up for shortfall 1990: US$284 million debt restructuring completed 1999: Ariawest files a US$1.3 billion arbitration claim against PT Telkom with the head office of the International Chamber of Commerce in Paris 2002: Senior executives of Ariawest (seconded AT&T reps), named as suspects in a corruption case worth a reputed IDR 74 billion 2002: Project was re-acquired by PT Telkom for US$185 million, plus assumption of debt of US$270 million
  • 56.
    Project finance inRussia Source: Thomson Financial
  • 57.
    Specific issues inRussia Capacity of Rouble capital markets Tenor Up to 15 years, but thin market Currency hedging Cross-currency swaps are available for up to 10 years, up to $1 billion transaction size But… at what cost? Impact on project economics? Quantum of funding available Infrastructure spending plans vs. capitalization of Russian banking system Goes back to the lack of development of the Russian banking system Legal risks Contractual enforcement Predictability of courts “Ability, incentive, and obligation” to perform under contracts (e.g. Stockmann) Expropriation risks Insurance limits Construction risks (permits) Impact of graft on project economics Ability to obtain political risk insurance? Corporate concentration/lack of alternative service providers in case of disputes (e.g. road construction)
  • 58.
    PPPs in theRussian Federation Institutional framework Federal Law “On Concessions” adopted in 2005 (amended in July 2008) Investment Fund Vnesheconombank
  • 59.
    Does Russia NeedPPPs? Record budget surplus, Risk transfer foreign exchange reserves Capital cost overruns Operating cost overruns Government has a lower cost of capital than the Cost savings / value for money Private sector skills, innovation, private sector management Trend towards increasing Concentrate on service outcomes rather than assets state involvement in key Evidence from UK research studies – economic sectors cost savings of 15-17% Mobilize private capital Public funds can be invested in other areas of priority, such as pensions, healthcare, debt repayment
  • 60.
    Typical PPP participants Land owners Private investors Grantor’s Grantor Expropriation (concessionaire Agent / partners) Services Department Company Land lease Government shareholder agreement financing Dividends Concession Concession Concession agreement transfer monitoring Private funds State control Concession agencies monitoring Concessionaire – Loans Construction Special Purpose Company Private/ multilaterals Bank or • Environmental Payments funds (invest. contracts) • Taxes Financiers • Customs (imports) • Land plan Company activities • Etc. Debt Roles of the SPC repayment Turnkey contract Commercial / Maintenance Construction Public Works works Administration Other sub-contractors business Income (Toll) Management Management Ex-post operation Users Ex-ante operation Management payments Management contract Relation Road building Participation in creation Contractual relation Outsourcing Services & Financial flows contracts Management Activity lines
  • 61.
    Investment Fund ofthe Russian Federation Established in 2006 with funds primarily from Stabilization Fund Managed Vnesheconombank Annual capacity of the US$14.25 billion up to 2009 Investment Fund Potential private investment mobilization 2-8x (US$28.5 - US$114 billion) 5 Applications for funding must be supported by an investment 4 advisor, and involve a private investor US$ 3 Has approved 12 projects to date (approximately 1 out of 10 bn 2 applications) Investment Fund endorsement 1 plays critical role, especially in transport sector May invest equity of up to 75% of 0 project’s cost, or provide a 2006 2007 2008 2009 guarantee for 60% of financing obtained from private sector
  • 62.
    Road PPPs approvedby the Investment Fund Expected Investment Fund Projected Total Project Sector Investment Fund Contribution (% of Cost Contribution Total Cost) Construction of the Western High-Speed Diameter Transport RUR 82.2 bn RUR 26.5 bn 32.2% (WHSD) motorway (USD 2.9 bn) (USD 1.0 bn) Construction of the Moscow – St. Petersburg high- Transport RUR 53.0 bn RUR 25.2 bn 47.5% speed motorway (from 15km to 58km mark) (USD 2.0 bn) (USD 0.95 bn) Construction of “Orlovsky” tunnel under the Neva Transport RUR 25.7b RUR 8.0b 31.1% river in St. Petersburg (USD 0.97 bn) (USD 0.37 bn) Construction of a new exit to the Moscow Outer Transport RUR 17.0b RUR 9.8 bn 57.6% Ring Road (“MKAD”) from the motorway M1 (USD 0.65 bn) (USD 0.37 bn) “Byelorussia” Moscow-Minsk Expressions of interest from EBRD, EIB, NIB, IFC, VEB
  • 63.
    Kupol Mine ChukotkaMining and Geologic Corporation ("CMGC") BEMA Gold (Canada) 75%; Government of Chukotka (25%) Considered the best gold discovery in the world in the last two decades Robust economics
  • 64.
    Key risks Resourcerisk: mine life (12 years) Remote location (above the Arctic Circle): Transportation Construction Country risk Ambiguous mining laws Legal system untested Commodity price risk Environmental and social risk
  • 65.
    Financing structure US$470million estimated project cost Sponsors’ equity: $70 million, excluding sub debt Debt package: $400 million project loan + $25 million corporate loan to CMGC Completion guarantee by BEMA + cost overrun facility Political risk insurance by MIGA (expropriation, political violence, transfer and inconvertibility) Offshore account structure, linked to gold exports Debt service reserve account Automatic cash sweep Reporting and monitoring: monthly, with annual mine life update; semi-annual financial projections with forward-looking tests Tranche 1 senior (MLAs: HVB, SocGen) – 6.5 US$250mm year term Tranche 2 senior (Caterpillar Finance, EDC, 150mm 2005 Mining IFC, Mitsubishi) – 7.5 year term Deal of the Non-recourse subordinated loan (IFC) – 8.5 25mm Year year term back by warrants to purchase common stock of BEMA TOTAL DEBT US$425mm
  • 66.
    Current state ofthe market Project finance market expected to be driven by needs for financing PPPs Prominent PPPs in Russia Western High-Speed Diameter Toll Road Pulkovo Airport BOOT concession Moscow-St. Petersburg Toll Road Orlovski Tunnel Nadzemny Light Rail
  • 67.
    Western High-Speed Diameter 46.6 km high-speed city highway with multi- level exits, mostly eight lane, with a planned average speed of 120 km per hour and a maximum capacity of 94,000 vehicles per day Project timeline Nov 2006: Concession tender announced Jun 2008: Preferred bidder selected; negotiations in progress Project cost estimated at $6.5 billion (double initial estimates)‫‏‬ According to the president of Strabag, “This is not only the largest project of this type in the world, but probably the most complicated in terms of execution. Tunnels and bridges make up about half of the Diameter‘s length, and the highway passes through established city infrastructure.” Opposed by environmental groups Current status: final selection of preferred consortium occurred on 6 June 2008 (BasEl, Strabag, Hochtief, Bouygues, Egis, Mostootryad 19) (big surprise!)‫‏‬ Financing plan Russian investment fund direct subsidy St Petersburg city direct subsidy IFIs - letters of interest EBRD EIB NIB IFC Equity
  • 68.
    Western High-Speed Diameter motorwayin St. Petersburg Grantor: Russian Federal Government and City of St. Petersburg Initial project analysis: Project: To build a new high-speed, 46 Project rationale? km long toll motorway along the Gulf of Finland coast, connecting the northern, Project economics? central and southern parts of St. Sponsors? Petersburg Concession: DBFO, 30-year period Experience? Funding: Country risk? 1. Public: 33% - Investment Fund; 17% - St. Petersburg municipality 2. Private: 50% of project costs paid by investor funds Letters of Interest from EBRD, IFC, and EIB Structure: “Real toll”, not shadow Toll collection risk to be borne by concessionaire Traffic risk mitigation by City of St. Petersburg Certain land risks to be borne by grantor Early termination compensation by grantor Some form of foreign exchange protection by grantor Detailed risk allocation to be set out in draft concession agreements; subject to negotiation
  • 69.
    Careers in projectfinance Commercial banks Core skills Financial advisory Financial modelling (Excel) Credit analysis Credit analysis Loan syndications Legal IFIs Writing Concessional lenders Negotiating ECAs Presenting MLAs Business development Big 4 Feasibility studies Financial advisory Law firms Drafting of contracts Advising on legislation Rating agencies Project developers Equity investors Pension funds Specialist infrastructure funds
  • 70.
    For further references Periodicals Project Finance International Infrastructure Journal The Journal of Structured and Project Finance Harvard Business School portal (www.people.hbs.edu/b esty/projfinportal/) - links to research, data and information services
  • 71.
    Session objectives To understand the basic characteristics of project finance as distinct from corporate finance To understand the principles of public-private partnerships To understand the analytical process of assessing viability and financeability of projects To understand the related terminology/acronyms such as SPV/SPC/SPE, EPC, O&M, BOT/BOOT, PRI, ECA, IFI, DSCR, LLCR, DSRA, IDC, MRA, Monte Carlo, cashflow waterfall, loan syndication To understand typical banking terms and conditions of limited recourse loans
  • 72.