Project & Infrastructure Finance Intro

• This chapter provides project and infrastructure finance information
• Details structures, relationships between stakeholders, and project risk management contracts

Introduction to Project and Infrastructure Finance

• Project and infrastructure finance are vital for lending, especially for large banks
• Project financing facilitates the execution and establishment of large-scale infrastructure projects
• Developed countries financed public sector projects with public debt and private sector projects with corporate loans
• Developing countries, such as India, financed projects through government borrowing, international banking, and institutions, such as the World Bank
• Project financing now uses public-private partnerships where "public" refers to government funding
• In India, infrastructure projects were funded by the Public Sector through government allocations and internal resources
• The private sector significantly contributes to infrastructure project finance due to growing demand in sectors, such as roads and telecom
• The Indian government established regulatory frameworks to attract private investors and banks through PPP models
• Private participation needs bank loans, so banks and financial institutions are participating in project financing

Infrastructure Finance (RBI Definition)

• Per the RBI, infrastructure finance is credit to a borrowing company (SPV) for developing, operating, and maintaining infrastructure facilities in specific sectors:
• Transport (roads, ports, airports, railways)
• Energy (electricity, oil, gas)
• Water & Sanitation (waste management, water pipelines, irrigation)
• Communication (telecom networks and towers)
• Social and Commercial Infrastructure (educational institutions, hospitals, hotels, industrial parks)
• Agriculture and social infrastructure are now priority sectors for bank lending, up to Rs. 100 crores since 2015

Infrastructure Investment Estimates by CRISIL (2017-2022)

• CRISIL estimates infrastructure investments will increase to Rs. 50 lakh crores between 2017-2022
• In the five previous fiscals, investments totaled Rs. 37 lakh crores (Rs. 7.4 lakh crores/year, 5.8% of GDP) representing a 56% increase
• Power, roads, telecom, irrigation, and railways sectors comprised 83% of past investments
• Infrastructure will account for 5.5% of GDP, with subdued private sector investment (28% of total)
• A stimulus of Rs. 7 Lakh crores is expected to boost the economy and create jobs

Project Finance Basics

• Project finance involves sourcing funds for long-term, capital-intensive infrastructure projects
• Cash flow generated repays borrowed money
• This is conceptually and structurally different from corporate finance
• Project finance extends on a limited recourse basis to a Special Purpose Vehicle (SPV), and loans are raised
• Companies and persons who invest in the equity of a project company (sponsor) form the SPV to manage funds
• A unique feature of the project financing is that liability of promoters is limited to their investment, and lenders cannot access other promoter assets

Special Purpose Vehicle (SPV)

• A SPV is a limited company or liability partnership formed for a specific project
• SPVs manage project funding during execution and insulate the sponsor from project risks

Limited Recourse Financing

• Loan repayments come from 'internally generated cash flows of the project'
• Lending recourse is limited to project cash flows after it is established
• Principal lender security is the project's future cash flows

Project Finance Features

• Project finance structures vary, but common principles include:
• Financing a "ring-fenced" project via a special purpose legal entity, like a company
• Raising funds for a new project
• High leverage, with debt to equity ratios of 70–90%
• Limited or no personal guarantees from promoters
• Lenders rely on future cash flow for debt service, not historical results or asset value
• Main security is project contracts, licenses, or rights to natural resources

Stakeholders in a Project Finance

• Sponsors, project company/SPV, procurer, government, contractors, feedstock providers/offtakers, and lenders

Sponsors

• Equity investors, promote, develop, and manage the project as their role.
• They undertake project feasibility studies
• Project finance debt may be nonrecourse, lenders consider promoter background
• Equity investors and owners of the Project Company can be a single party or a consortium
• Subsidiaries of sponsors can act as subcontractors, feedstock providers, or offtakers
• In Public Private Partnership (PPP) projects, the Government/Procurer can retain ownership
• Sponsors can attract Investment funds, Institutional investors, Shareholders in quoted equity, Governments, Local partners, and Multilateral institutions

Special Purpose Vehicle (Project Company)

• Project finance uses a systematic approach to complex tasks, including:
• Engineering and construction
• Operation
• Site acquisition, permits, contracts, loan documentation, etc.
• Accounting and tax
• Financial modeling and structuring
• Project management must coordinate activities
• Sponsors may agree to a commercially sound Project Contract, but it can be unacceptable financially for lenders
• EPC Contracts may be at a low price, but penalties may not be adequate for lenders
• Contractual and financial relationships must be contained within the SPV
• Most projects incorporate a new company to execute the project
• Borrowers corporate form (Project Company) is preferred by lenders for security
• The Project Company is typically incorporated where the project is located, but sometimes outside for tax
• The Project Company should have no assets or liabilities unrelated to the project, it also agrees with lenders not to take on extraneous assets

Procurer

• Relevant only for Public-Private-Partnership (PPP) projects.
• Could be the municipality, council, or state department that tenders the project to the private sector.
• They oversee the tender competition, evaluation, and selection of the Sponsor consortium

Government

• Contractually provides undertakings to the Project Company, Sponsors, or Lenders, including credit support and permissions

Contractors

• Execute construction and operation through Engineering, Procurement, and Construction (EPC) and Operations and Maintenance (O&M) contracts

Feedstock Providers and Offtakers

• Involved in utility, industry, oil & gas, and petrochemical projects,
• Supplies feedstock in return for payment
• Takes a purchase of product/service
• Contracts are key because they affect the overall economics

Lenders

• Lenders are usually one or more commercial banks and/or multilateral agencies and/or export credit agencies and/or bond holders

Project financing structures

• Project financing structures are models used, such as BOT, BOOT, BOO, BLT, DBFO, DBOT, and DCMF

BOT (Build-Operate-Transfer)

• Common in public-private partnerships
• A government delegates rights and obligations to a private entity to design and build infrastructure
• The private party raises finance and builds the infrastructure
• Revenues are retained
• The Project Company obtains revenues through service fees charge to the utility/government
• At the end of the concession, the facility transfers to the public utility

BOOT (Build-Own-Operate-Transfer)

• Similar to BOT, but the private entity also owns the facility
• During the concession, Company recovers investment costs through means, such as toll charges
• Suitable for highways and railway transport

BOO (Build-Own-Operate)

• The project ownership remains with the company
• The private company gets the benefits of the residual of the project's benefits
• The framework works when the projects coincide with the concession period
• BOO schemes involve large amounts of finance and long payback
• Example: water treatment plants

BLT (Build-Lease-Transfer)

• The private company builds and leases to the government
• Project control is transferred to a lessee, such as the government
• Ownership stays with shareholders for operation, the facility is leased
• After the lease the ownership and operational tasks is transferred to the government at an agreed price
• This works for foreign investors taking into account the country risk, because the company maintains the property rights while avoiding operational risk

DBFO (Design-Build-Finance-Operate)

• Similar to BOOT, but there is no ownership transfer
• The contractor finances till the end of the contract
• The owner is responsible for maintenance
• DBFO can be difficult to maintain, there is possible withdrawal
• Extensively used in projects such as toll roads
• Private construction company is responsible for the design and construction for the government
• The company raises finance in construction and exploitation
• The cash flows serve to repay the investment and reward its shareholders
• Project Company pays the government for the use of infrastructure

DBOT (Design-Build-Operate-Transfer)

• Used when the client doesn't know about the project
• The company designs, builds, and operates, then transfers
• No risk of financing
• Example: refinery constructions

DCMF (Design-Construct-Manage-Finance)

• Used for prisons or public hospitals
• A private entity designs, constructs, manages, and finances based on specifications of the government
• The Project revenue is government payments
• The government owns the facility, and controls price and quality

Sectors for Project Finance

• Natural resources projects
• Independent power projects
• Public infrastructure
• Mobile telephone networks

Reasons to Choose Project Finance

• Sponsors insulate themselves from project debt and risk
• Sponsors do not want to consolidate debt
• Sharing risk in large projects
• Balance sheets may not be strong enough
• Constraints in ability to borrow funds
• Agreeing on risk-sharing basis

Project Identification, Formulation and Implementation Process

• Projects are selected and based on the infrastructure need
• Basic financial criteria include:
• Payback period (PBP): must be less than the project
• Accounting Rate of Return (ARR): must be more than the target return
• Net Present Value (NPV): NPV must be more than zero
• Internal rate of Return (IRR): This means the project gives a return equal to IRR. The Project can be accepted if the IRR is more than the cost of capital
• Benefit Cost Ratio (BCR): should be more than one
• These ratios decide on the financing acceptability
• Net Surplus is a returns
• Discount rate ensures costs and benefits are equal
• Net cash flow results after the project
• After the project is selected, financing is made

Financing Arrangement

• Two source
• Equity or Debt
• Equity consists of paid up capital, share premium, and retained earnings
• Debt consists of term loans
• With firm arrangements, project is formulated

Project finance cycle

• Involves the following steps and procedures: -Indentification of the project -Fixing eligibility criteria -Bidding Proccess -Finalising -Award Contract -Equity Sponsor -Total Project Cost -Project Appraisal

Technical Appraisal

• Technical appraisal involves analyzing engineering aspects and processes
• The major aspects include:
• Location: environment suitability and coverage
• Size and capacity: must be optimum
• Tech: has to exist locally or globally
• Skills available: skills required on hand to design and maintain
• Labor quality: personal admin
• Statutory laws complied: company laws, labor laws, and waste disposal
• Raw materials: inputs available
• Scaling available: whether expansion available
• Schedule prepared: work hours
• Govt policy supported: should comply to policy guidelines

Commercial Appraisal

• Commercial appraisal is about demand
• Extent of profitability
• Relationship to obligations
• Scope should be adequate
• Product needs range from benefits, comfort to essential
• Collection for Tariff, and cash
• Modernization, and diversification needed

Economic Appraisal

• Focus on Cost-Benefit Analysis
• For public sector projects
• Monetary costs are weighed up in benefits
• Maximizing the need for having competing uses
• Plank of opportunity Cost
• Matrixes used used in evaluation

Common Cost

• Present Value, Ratio of cost, Rate of returns
• IRR: Max rate a project must use
• Commonly compared to hurdle rate to test the cost of funds

Financial Appraisal

• Financial appraisal checks the accuracy of cost estimates
• Asseses of net cash
• Cash inflows, outflows, Investment cost, operating costs
• Process accurately estimates costs

Analysis

• Set realistic pricings
• Sets discount
• Analysis includes sensitivity

Managerial Assessment

• This is done to ensure the people in the project are competent and efficient
• Managerial Acumen in project
• Financial sponsor
• Skills in Leadership
• Interest in the stake
• Knowledge and Plan available
• Prospective growth in market
• Marketing strategy

Ecological appraisal

• Is done particularly for plant damage
• Analyzes damage caused by emissions, plants, irrigation etc.
• Analyzes impact it has on environment

Assumptions in Project Finance

• Project Financing - unlike a corporate borrower, has no records
• Decisions based on: completion of time, technicals operate as intended
• adequate cashflow

Factors for lenders

• Consider if loan will be repaid back
• Need to take in account of high finance risks
• Thus need high degree of confidence

Project Economics

• Need to be robust
• The evaluation of costs must happen

Project Cost Estimation Involves

• Costing Land
• Development Cost
• Structures needed
• Plant and Machinery Costs
• training
• Security deposits

Means of Finance

• Involves various elements to meet Share Capital - Equity, Term Loans, Debenture Capital
• Revenue happens based on the utilisation
• Must meet the expenses
• The project arrives at with estimates

Public Sector Debt

• Subsidy
• Happens in Commercial Markets
• Repayment is under conditions
• May be repaid only for a set return

Private Sector Debt

• From Banks, Commercial Banks
• Bond Holders, insurances
• Various legal structures are used

Sources of Debt

• A vareity of debt products are available
• Depends on jurisdiction

Phasing Project Life

Consists of three phases

• Development: project is conceived, agreements are regulated
• Construction: Finances are drawn and project is built
• Operations : Cashflow and debt is paid

Phase Initial Tender

• Provides letter of interest
• Allows sponsors to see if lenders are intrested
• Should not be taken formal
• Process steps: Request for information
• Request for quification
• Request for Proposals
• Bid submission: the cost of prices is given, and the net worth is calculated
• Bid evaluation

Contract Negotiation

• Happens after commerical agreements are finalised

Construction Phase

• Divivding roles ensures they can effectively use resources

Analysis of Risks

• Identify mitigiation reasons
• Can perform bank lawyering for certain agreements

Operation Phase

• A financial model needs to be developed for operation purposes and joint operations

Reviewing Bank Participation

They will determine project feasibility, assess its basic status They may do their own model development to work

Loan Management Responsibilites

• Summary overview
• Technical description
• Financial analysis
• List major accidents
• Project cost, and financing

Key Agreements

• Agreement for shareholders
• EPC Agreements
• Security credit managements
• Loan agreement.
• 0 and M contract

Loan Security

• Should be issued for tangible assetts mostly
• Provides to take control for certain agreements.
• Typical package includes step in agreements

Project Review

• Projects need to be reviewed periodicaly
• Useful with PERT, Commerical Path Method, help review

Glossary of terms

• Involves : BOOT, private initiative, concession, non recourse, ect.