Summary Project finance Class notes

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Summary - Project finance Class notes

  • 1398117600 Class notes project finance

  • Asset Finance
    1. Asset finance: - Using balance sheet assets (such as accounts receivable, short-term investments or inventory) to obtain a loan or borrow money - the borrower provides a security interest in the assets to the lender. This differs from traditional financing methods, such as issuing debt or equity securities, as the company simply pledges some of its assets in exchange for a quick cash loan.

    This type of financing is typically used for short-term borrowing or working capital. Companies using asset financing commonly pledge their accounts receivable, but the use of inventory assets is becoming more frequent.

  • Amortization
    1. Amortization. The paying off of debt in regular installments over a period of time
  • Bankability
    1. "Bankability": - Project or proposal that has sufficient collateral, future cash flow, and high probability of success, to be acceptable to institutional lenders for financing.
  • Financeability
    1. "financeability" Capable of being financed.
  • BOO
    1. B-O-O (Build-own-operate): - These are projects whose ownership remains with the project company throughout its life-e.g. a power station in a privatized electricity industry or a mobil phone network. The project company therefore gets the benefit of any residual value in the project. (Project agreements with the private sector also normally fall into this category.) note: clearly a project company would always prefer to own the project assets, but weather or not the ownership of the project is transferred to the public sector in the short or the long term, or remains indefinitely with a private sector company, or is never held by the private sector company, makes little difference from the project finance point of view. This is because the real value in a project financed in this way is not the ownership of its assets, but in the right to receive cash flows from the project. But although these different ownership structures are of limited importance to lenders, any long-term residual value in the project (as there may be in a BOO but not a BOOT/BOT/BTO project) may be of relevance to the investors in assessing their likely return.
  • BOOT
    1. B-O-O-T (Build-own-operate-transfer projects) {Off-take contracts or a concession agreement, such project agreements with the public sector, which provide a basis for project finance, can take several different forms one of which is BOOT projects} In BOOT projects, the project company constructs the project and owns and operates it for a set period of time, earning revenues from the project in this period, at the end of which ownership is transferred back to the public sector.

    e.g. the project company may build a power station, own it for 20 years during which time the power generated is sold to an offtaker (eg a state-owned electricity distribution company), and at the end time ownership is transferred back to the public sector. {note: other type of project similar to BOOT is BOT i.e. Build-own-Transfer}

  • BOT
    1. B-O-T [build-operate-transfer] {also known as design-build-finance-operate “DBFO” projects} In this type of project, the project company never owns the assets used to provide the project services. However the project company constructs the project and has the right to earn revenues from its operation of the project. {It may also be granted a lease of the project site and the associated buildings and equipment during the term of the project- this is known as build-lease-transfer (‘BLT’) or build-lease-operate-transfer(BLOT).} This structure is used where the public nature of the project makes it inappropriate for it to be owned by a private-sector company—e.g. a road, bridge, or tunnel—and therefore ownership remains with the public sector.
  • BTO
    1. B-T-O [Build-Transfer-operate] projects: - These are similar to a BOT project, except that the public sector does not take over the ownership of the project until construction is completed
  • Cash Flow
    1. Cash flow (i) A revenue or expense stream that changes a cash account over a given period. Cash inflows usually arise from one of three activities – financing, operations or investing. Cash outflows result from expenses or investments. Cash flow can be attributed to a specific project, or business as a whole. Cash flow can be used as an indication of a company’s financial strength. Cash flows are essential to solvency. 
  • Commercial Operation Date
    1. "COD" (commercial operation date) The date on which the project is complete and the project company is ready to begin operations.
  • Concession agreement
    1. Concession agreement It is a project agreement with the government or another public authority, which gives the project company the right to construct the project and earn revenues from it by providing a service either to the public sector (e.g., public building) or directly to the general public (e.g., a toll road, a mobile phone network)
  • Corporate finance
    1. Corporate finance A division or department that overseas the financial activities of a company. Corporate finance is primarily concerned with maximizing shareholder value through long-term and short-term financial planning and the implementation of various strategies. 
  • Deel Creep
    1. "Deal creep" Gradual increases in the originally agreed Tariff or Unitary Charge by the sponsors during project agreement negotiations, usually caused by the project requirements not being initially specified in enough detail by the offtaker or contracting authority. See 4.6.3
  • Force Majeure
    1. Force majeure A natural or political event that affects the ability of one party to fulfill its contract, but that is not the fault of, and could not reasonably have been foreseen by, that party. See 9.2
  • GSA (Government Support Agreement)
    1. GSA (Government Support Agreement): A project contract that establishes the legal basis for the project, or under which the government agrees to provide various kinds of support or guarantees. See 7.5
  • GSA (Government Support Agreement)
    1. GSA (Government Support Agreement): A project contract that establishes the legal basis for the project, or under which the government agrees to provide various kinds of support or guarantees. See 7.5
  • Host country
    1. Host country The country in which the project is located (usually used in connection with a cross-border investment) See 10.2
  • Input supply contract
    1. Input supply contract It is a type of project contract under which fuel or other raw material for the project will be provided on a long-term pricing formula in agreed quantities
  • Leverage

    1. Leverage The ratio of a company’s loan capital (debt) to the value of its common stock(equity) 

    - ie. Use borrowed capital for (an investment), expecting the profits made to be greater than the interest payable.

  • Limited recourse
    1. Limited-recourse (v. full recourse) Finance with limited guarantees from sponsors. See 8.12
  • Non recourse 
    1. Non-recourse Finance with no guarantee from the sponsors
  • Off-take contract:
    1. Off-take contract: - It is a project agreement under which the product produced by the project will be sold on a long term pricing formula. A project agreement under which the project company produces a product and sells it to the offtaker. e.g. : An off-take contract, based on which a project will be constructed to sell its output to a public-sector body (e.g, construction of a power station to sell electricity to a state-owned power company)
  • O&M contract
    1. O&M contract (operation and maintenance) It is a type of project contract under which a third party will be responsible for the running of the project after it has been built
  • Sponsors
    1. Sponsors: The investor who develop and lead the project through their investment in the project company.
  • SPV
    1. SPV (Special Purpose Vehicle): A separate legal entity with no activity other than those connected with its borrowing.
  • Turnkey EPC contract
    1. "Turnkey" EPC contract (Turnkey Engineering Procurement and Construction) It is a type of project contract under which the project will be designed and built for a fixed price, and completed by a fixed date (A contract for design and construction of a complete project)
    1. What distinguishes Project Finance from other types of lending? 

    Corporate finance

    Project Finance

    1. Financing Vehicle

    Multi-purpose organization

    Single-purpose entity

    2. Type of capital

    Permanent- an indefinite time horizon for equity

    Finite- time horizon matches life of project

    3. Dividend policy reinvestment decision

    Corporate management makes decisions autonomous from investors and creditors

    Fixed dividend policy-immediate payout; no reinvestment allowed

    4. Capital Investment decisions

    Opaque to creditors

    Highly transparent to creditors


    Financial structures

    Easily duplicated; common forms

    Highly tailored structures which cannot generally be reused

    6. Transactional cost for financing

    Low cost due to competition from providers, routinized mechanisms, and short turnaround time

    Relatively higher costs due to due diligence and customized documentation and longer gestation period

    7. Size of financing


    Might require critical mass to cover high transaction costs

    8. Basis for credit evaluation

    Overall financial health of corporate entity; focus on balance sheet and cash flow

    Technical and economic feasibility; focus on projects’ assets, cash flow, and contractual agreements

    9. Cost of capital

    Relatively lower

    Relatively higher

    10. Investor /lender base

    Typically broader participation; deep secondary markets

    Typically smaller group; limited secondary markets

    11. Allocation of risk

    Risk of repayment is solely borrower

    Risk spread among project parties

  • What are the advantages & disadvantages of project finance?
    • The major advantages of project finance are:
    • Allows the promoter to undertake projects without exhausting their ability to borrow amount for traditional projects.
    • Limits financial risks to a project to the amount of equity invested.
    • Enables raising more debt as lenders are sure that cash flows from the project will not be siphoned off for other corporate uses.
    • Provides stronger incentives for careful project evaluation and risk assessment.
    • Facilitates the projects to undergo careful technical and economic review.
    • Eliminates the dependency on alternative nature of funding a project.
    • Facilitates the arrangement of liability financing and credit improvement, accessible to the project but unavailable to the project sponsor.
    • Enables the diversification of the project sponsor’s investments to reduce political risk.
    • Gives more incentive for the lender to cooperate in an atmosphere of a troubled loan.
    • Enables to have prolonged credit opportunities.
    • Matches specific assets with specific liabilities.
    • Project finance[2] primarily benefits sectors or industries where, projects are structured as a separate entity, apart from their sponsors. Let us take the example of a stand-alone production plant. This is assessed in accounting and financial terms separately from the sponsors’ other activities. Generally, such projects tend to be relatively huge because of the time and other transaction costs involved in structuring, and because of the considerable capital equipment that needs long-term financing. In the financial sector, by contrast, the large volume of finance that flows directly to developing countries’ financial institutions has continued to be a part of the usual corporate lending kind.
    • All these do not mean that Project Finance is devoid of any disadvantages.
    • The major disadvantages of project finance are:
    • Complexity of the process due to the increase in the number of parties and the transaction cost.
    • Expensive as the project development and diligence process is a costly affair.
    • Litigious with regard to negotiations.
    • Complexity due to lengthy documentation.
    • Requires broad risk analysis and evaluation to be performed.
    • Requires qualified people for performing the complicated procedures of project finance.
    • Obligations regarding the trust fund account need to clearly specify.
    • Higher level of control, which might be exercised by the banks, which might bring conflict with the businesses or contracts.
  • Breakage
    1. Breakage – cost of early termination of an interest rate swap, fixed-rate loan or bond, an inflation-indexed loan or an inflation swap
  • LIBOR breakage
    1.  cost of early termination of a LIBOR rate loan
  • Swap breakage
    1.  cost of early termination of a swap, calculated based on the current value of the swap
  • Credit enhancement
    1. Credit enhancement – provision of guarantee, standby loan or other financial security for a project financing
  • Comfort letter
    1. Comfort letter - Written assurance by a subsidiary's parent company used to offer 'comfort' to the buyer as to the seller's ability or willingness to perform its obligations. Comfort letters are often used because the seller is unable or unwilling to provide a guarantee on a certain outcome, such as the performance of a security.
  • Concession agreement
    1. Concession agreement – an agreement between a project company (and the project sponsors, in some situations) and the host government, in which the project company is granted authority to develop, construct, and operate a project for a limited period of time until financing is paid and a negotiated equity return is earned; commonly used in BOT or BOOT projects
  • Countertrade
    1. Countertrade - Counter trade is an import / export relationship between nations or large companies in which good and/or services are exchanged for goods and services instead of money.
  • "Creeping" expropriation
    1. "Creeping" expropriation – a series of act which, over time, have an expropriatory effect
  • Currency swap
    1. Currency swap – a hedging contract to fix the future exchange rate of one currency against another
  • Devaluation
    1. Devaluation – a government action designed to reduce the purchasing power or value of its currency as against convertible currencies
  • Enclave project
    1. Enclave project – a project financeable by the International Bank for Reconstruction and Development (IBRD) in a country otherwise ineligible for IBRD loans because the project can generate enough foreign exchange to service the debt; guarantees or other credit enhancement exist for the benefit of the IBRD; and project revenues are capable of segregation for servicing of the IBRD loan.
  • Exchange controls
    1. Exchange controls – procedures established by a government to allow conversion of local currency to foreign, hard currency in an orderly manner that promotes policy goals
  • Force majeure
    1. Force majeure – an event outside the reasonable control of the effected party to a contract, which it could not have prevented by good industry practices or by the exercise of reasonable skill and judgment, which typically excuses certain negotiated portions of contract performance during its pendency
  • Gross-up (in context of withholding taxes)
    1. Gross-up (in context of withholding taxes) – increase a payment to compensate for tax deductions
  • Guaranteed investment contract ("GIC")
    1. Guaranteed investment contract ("GIC") – a fixed rate of interest paid by a depository bank on the proceeds of a bond issue until these are required to pay construction costs for a project
  • Hard costs
    1. Hard costs - Hard costs are direct costs incurred in relation to a specific construction project. Hard costs may be directly related to construction, including labor, materials, equipment, basic building services, shell features, interior enclosures, fit-out costs, mechanical services and electrical services. 
  • Hedge
    1. Hedge – a contract in the derivative, financial or commodity markets to protect the project company against adverse movements in interest rates, price inflation, currency-exchange rates or commodity prices
  • Hedging interest rates (interest rate swaps, caps, collars)

    1. Hedging interest rates (interest rate swaps, caps, collars) An interest rate swap is a contract in the derivative, financial or commodity markets to protect the project company against adverse movements in interest rates 
  •  interest rate cap

    An interest rate cap is a derivative in which the buyer receives payments at the end of each period in which the interest rate exceeds the agreed strike price

  • interest rate collar

    An interest rate collar is an investment strategy that uses derivatives to hedge an investor's exposure to interest rate fluctuations. The investor purchases an interest rate ceiling for a premium, which is offset by selling an interest rate floor.

  • IDC

    1. IDC (Interest During Construction) – interest during construction
  • Implementation agreement
    1. Implementation agreement - a project-specific agreement between the government and a developer that provides government assurances and guarantees to developers required for successful project development and allocation of risks that promotes equity investments and debt financing
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