Unit 7: Specialised Lending- Structured Finance and Project
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Credit Skills Academy Credit Skills Academy Executive Briefing Unit 7: Specialised Lending- Structured Finance and Project Finance keith Checkley & Associates 1 Credit Skills Academy Originated and Devised by Keith Checkley & Associates London; UK Senior authors: Keith Checkley FCIB, FCIBS, Chartered Banker and Keith Dickinson FCIB The authors have taken all reasonable measures to ensure the accuracy of the information contained in this topic and cannot accept responsibility or liability for errors or omissions from any information given or for any consequences arising. © Keith Checkley & Associates, November 2013 No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means – electronic, electrostatic, magnetic tape, mechanical, photocopying, recording or otherwise, without permission in writing. keith Checkley & Associates 2 Credit Skills Academy Table of contents 1 Structured Finance Principles ............................................................................ 5 2 Project Finance Checklist ................................................................................ 11 2.1 Risks Inherent in Project Finance ..................................................................... 11 2.2 Common Causes for Project Failures .............................................................. 11 2.3 Successful Project Financing Checklist ........................................................... 11 2.4 Credit Analysis from the Viewpoint of a Term Lender ................................... 12 2.5 General Considerations for the Credit Decision ............................................. 12 2.6 Risk Mitigation Considerations: ......................................................................... 13 2.6.1 Construction and Completion Risks .................................................... 13 2.6.2 Operational Risks ............................................................................... 13 2.6.3 Financial Risks .................................................................................... 14 2.6.4 Political Risks ...................................................................................... 14 2.7 Synthetic Securitisation- with example ............................................................. 15 3 Co-operative financing ..................................................................................... 18 3.1 Types of Co-operative ......................................................................................... 18 3.2 Financing of Marketing Co-operative ............................................................... 19 3.3 Example: Medstead Potatoes Ltd ..................................................................... 21 3.3.1 Questions and Answers for a New Project ......................................... 27 3.3.2 Summary on Co-operative Financing ................................................. 29 3.4 Crop Production Lending: Cash Flow Analysis Methods .............................. 30 3.5 Example 2: ABC Farms ...................................................................................... 30 3.5.1 American Agri-Specialist Bank ........................................................... 30 3.5.2 How the Security Bank Analyses a Production Loan Request ........... 31 keith Checkley & Associates 3 Credit Skills Academy ! ! ! Welcome!to!the!Credit!Skills!Academy! There have been previous financial crises but this time it is the severity and global impacts that are very different from what we have seen before. Never have banks and lending bankers received greater criticism over the quality of their lending than at the present time. Media comment suggests that prudent lending principles have been disregarded in the quest in recent years for increased lending volumes and enhanced short term profitability. Analysts suggest that many of the prudential canons of lending have been overlooked and many lending bankers would benefit from a reconsideration and review of well tested and accredited lending principles. It is against this background that the Credit Skills Academy has been developed. The modules in this Academy have been prepared to allow you and your colleagues instant access via e-learning and may be accessed as individual topics in which you are interested. We believe that they will also make an excellent basis for discussion with colleagues for mutual benefit. We do hope that the extensive range will help you in your everyday job and also as someone interested in self development in the important area of Credit Skills. Keith Checkley and Keith Dickinson S Senior authors keith Checkley & Associates 4 Credit Skills Academy 1 Structured Finance Principles International banks are organised around the core businesses of lending, new issue underwriting, broking, sales and trading. These business areas generate repeatable business to produce what are hopefully ‘core’ profits for the organisation. Somewhere within the organisation there exist two business lines that straddle many of these core activities: Specialised Finance and Structured Finance. Specialised Finance: Repeatable business dealing with loans to finance industry-specific assets (e.g. shipping, aircraft and rolling stock finance). Structured Finance: Funding or investment transactions that exploit credit, legal, regulatory or tax arbitrages available to the entity undertaking them. Structured finance transactions: • Tend to be one-off. Therefore, arranged by negotiation on a case-by-case basis. • Business is highly relationship-orientated. Relies critically on willingness of the client to discuss its situation. • Transactions typically require bespoke documentation. • Tend to be very profitable for the bank arranging them. Can bring profits of the order of hundreds of basis points. • Highly proprietary and confidential business Structured finance tends to be counter-cyclical: During the expansionary phase of the economic cycle, business risks are relatively low and capital is readily available. The main aim of corporations is to obtain capital quickly and funding transactions that have long gestation periods will be unattractive. In this scenario, additional volumes of core business should mean additional profits for the international banks. During recession, capital is less easily available and pressures on profit margins make cost- effective forms of funding more attractive, even if the operations are more complex. Financial institutions will also be seeing a slowing down in their volume of core business, so structured finance profits are very welcome. Structured finance teams may be layered into the organisation in different ways: •With the core front office business teams, or •As separate groups interacting with the cores business areas on an ad-hoc basis. Transactions can be designed to generate profits for the organisation in their own right, or can be used to assist core businesses in winning mandates. Secured Lending The notion of lending against the security of an asset is a very old one. The asset itself and the future cash flows that are contractually receivable on it can both be used as security for the loan. The Lender normally takes a legal charge over the assets. Should the borrower fail to keep up with its payments on the loan, the lender has the right, under certain conditions, to repossess or enforce the sale of the assets. In this sense, a secured loan can be thought of as being ‘self- liquidating’. keith Checkley & Associates 5 Credit Skills Academy Legal Charge Cash Flows Interest Asset Lender Buyer/ Seller Borrower $100 $100 Debentures Larger commercial and industrial assets are often used as security, when raising funds through a special type of secured debt instrument known as a debenture. A debenture is a loan that is backed by a fixed or floating charge on one or more assets. UK Debenture market is more than 100 years old. It is important source of secured finance, especially for property companies. The secured assets can either be used within the business of the borrower or, in the case of property companies, leased out to provide an income stream. Assets tend not to be fiscally separated from the business of the borrower itself, but are simply used as security, should the borrower’s business fail. The lender has an element of control over the assets through a fixed and/or a floating charge. The main investors in debenture securities in the UK are commercial banks, pension funds and life assurance companies. The latter two are attracted to debentures because they typically have long maturities and fixed coupons, which make them ideal for funding long term liabilities. Assessing the Collateral The assets used as collateral for a loan are normally valued on the basis of: • Current market prices for similar assets (if available); or • The cash flows that will contractually arise from the assets themselves – e.g. properties that have been leased out. The market value of a property that is leased, is the present value of the future cash flows payable on the lease, plus some residual value for the property at the expiry of the lease, discounted at a rate that includes a risk premium to compensate for any uncertainties in the future cash flows. The techniques for discounting future cash flows are explained in time Value of Money – Annuities & Perpetuities. Normally in a debenture, the lender advances only a percentage of the estimated value of the secured assets: the loan to value ratio is typically around 2/3. This amount of over-collateralisation