Project Financing

GREENFIELD PROJECT FINANCING
Swarup Mukherjee
PROJECT FINANCING PRINCIPLES
Financing :
A financing of a particular economic unit in which a lender looks initially to the cash
flows and earnings of that economic unit as the source of funds from which a loan will
be repaid and to the assets of the economic unit as collateral for the loan
Basic Requirements :
A proper legal entity . Independent, single purpose company formed to

build and operate the project (SPVs_)
Specified contracting norms to control project risks.
Close monitoring by the lenders of all levels of execution of the project.
Identified financial system like Escrow accounts for ensuring return to the
investors.
Normally 50-75% of project costs are covered by Debt.

PROJECT FINANCING PRINCIPLES
Financing : International Project Finance Association (IPFA) defines project
financing as:
The financing of long-term infrastructure or industrial projects and public services

based on a non-recourse or limited recourse financial structure, where debt and equity
are used to fund establishment and paid back from the cash flows generated by the
project.
Normally 50-75% of project costs are covered by Debt.

ELEMENTS OF TOTAL PROJECT COSTS
1. Capital Costs (EPC Fixed)

2. Development Fees
3. Contingencies
4. Interest During Construction
5. Initial Funding for the DSRA
6. Initial Funding for the MRA
7. Commitment Fees
8. Lenders Fees
The debt service reserve account (DSRA) is a key component in almost every project finance term
sheet and financial model. The primary purpose of the DSRA is to protect a lender against unexpected
volatility, or interruption, in the cash flow available to service the debt (CFADS
PROJECT FUND SOURCES
- Export credits
- Development funds
- Specialised asset finance
- Conventional debt and
- Equity finance
PROJECT FINANCE PROCESS
Strategic/commercial evaluation
Systematic identification and exploration of risks
Valuation (NPV of cash flows)
Design of risk bearing/sharing package
Appropriate funding package
Impact of financing package on net cash flows and sensitivity analysis
6
PROJECT FINANCING THEORETICAL ANGLE:
Portfolio Theory
Options Theory
Equity vs. Debt
Type of Debt
Sequencing
FINANCING CHOICE: PORTFOLIO THEORY
Combined cash flow variance (of project and sponsor) with joint
financing increases with:
Relative size of the project.
Project risk.
Positive Cash flow correlation between sponsor and project.
Firm value decreases due to cost of financial distress which
increases with combined variance.
Project finance is preferred when joint financing (corporate finance)
results in increased combined variance.
Corporate finance is preferred when it results in lower combined
variance due to diversification (co-insurance).
FINANCING CHOICE: OPTIONS THEORY
Downside exposure of the project (underlying asset) can be
reduced by buying a put option on the asset (written by the banks
in the form of non-recourse debt).
Put premium is paid in the form of higher interest and fees on

loans.
The underlying asset (project) and the option provides a payoff

similar to that of call option.
FINANCING CHOICE: OPTIONS THEORY
The put option is valuable only if the Sponsor might be
able/willing to exercise the option.
The sponsor may not want to avail of project finance (from an
options perspective) because it cannot walk away from the
project because:
It is in a pre-completion stage and the sponsor has provided a completion
guarantee.
If the project is part of a larger development.
If the project represents a proprietary asset.
If default would damage the firms reputation and ability to raise future
capital.
FINANCING CHOICE: EQUITY VS. DEBT
Reasons for high debt:
Agency costs of equity (managerial discretion, expropriation,

etc.) are high.
Agency costs of debt (debt overhang, risk shifting) are low due
to less investment opportunities.
Debt provides a governance mechanism.

FINANCING CHOICE: TYPE OF DEBT
Bank Loans:
Cheaper to issue.
Tighter covenants and better monitoring.
Easier to restructure during distress.
Lower duration forces managers to disgorge cash early.
Project Bonds:
Lower interest rates (given good credit rating).
Less covenants and more flexibility for future growth.
Agency Loans:
Reduce expropriation risk.
Validate social aspects of the project.
Insider debt:
Reduce information asymmetry for future capital providers.
FINANCING CHOICE: SEQUENCING
First equity expenditure.
The Loan may be drawn in several tranches usually at pre--

agreed minimum amounts based on specific progress like land
acquisition., placement of all major purchase orders and
payment of advance, construction stages( % completion).
For each drawdown, the Bank requires a certification report

prepared by a Quantity Surveyor or Valuer.
PRIMARY TERMS AND CONDITIONS AND
MAJOR POINTS OF PRINCIPLE
Major financial terms:
Loan Tenor, Interest Rate, Moratorium, etc.
Conditions on EPC and O&M Contract
Expected type of Off-take (Take or Pay)
Step-in Rights
Conditions precedent to financial close
Drawdown conditions and mechanics
Changes in circumstances
Representations, covenants and events of default
Financial covenants
Governing law and dispute resolution
STAGES IN PROJECT FINANCING
Pre financing Stage:
Identification,
Risk assessment
Feasibility analysis
Financing stage :
Equity arrangement,
Syndicate formation,
Negotiation,
Documentation and
Disbursement.
Post Financing Stage :
Monitoring,
Project Closure and
Repayment.

Project Financing

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What are the basic requirements for project financing?

What are the elements that make up total project costs?

GREENFIELD PROJECT FINANCING

A proper legal entity . Independent, single purpose company formed to

Normally 50-75% of project costs are covered by Debt.

The financing of long-term infrastructure or industrial projects and public services

Normally 50-75% of project costs are covered by Debt.

1. Capital Costs (EPC Fixed)

Put premium is paid in the form of higher interest and fees on

The underlying asset (project) and the option provides a payoff

Reasons for high debt:

Agency costs of equity (managerial discretion, expropriation,

Debt provides a governance mechanism.

First equity expenditure.

The Loan may be drawn in several tranches usually at pre--

For each drawdown, the Bank requires a certification report

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