Advanced Project Financing Structuring Risk Second edition Advanced Project Financing Structuring Risk Second edition Richard Tinsley E U R B O O M O O K N S E Y Published by Euromoney Institutional Investor PLC Nestor House, Playhouse Yard London EC4V 5EX United Kingdom Tel: +44 (0)20 7779 8999 or USA 11 800 437 9997 Fax: +44 (0)20 7779 8300 www.euromoneybooks.com E-mail: [email protected] Copyright © 2014 Euromoney Institutional Investor PLC 1st edition published 2000 ISBN 978 1 78137 265 4 This publication is not included in the CLA Licence and must not be copied without the permission of the publisher. All rights reserved. No part of this publication may be reproduced or used in any form (graphic, electronic or mechanical, including photocopying, recording, taping or information storage and retrieval systems) without permission by the publisher. This publication is designed to provide accurate and authoritative information with regard to the subject matter covered. 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Typeset by Phoenix Photosetting, Chatham, Kent Contents Preface to 1st edition xix Preface to 2nd edition xxiii About the author xxv List of case studies xxvii List of exhibits xxxiii List of boxes xxxvii Introduction 1 Project finance’s origins 1 Project finance defined 2 Type 1 and Type 2 project finance structuring 3 Balance sheet 5 Off balance sheet 5 Deconsolidation 5 Portfolios 5 Defeasance 6 Non-recourse 7 Completion test and option conditions 8 Limited recourse 8 Advantages 9 Capital shortage 9 Risk transfer 10 Deal sequestration 11 Ratings management 11 Securitised project financings 13 Better returns 13 Consortium control 13 Tailoring 14 Covenant busting 14 Flexibility 15 Workouts 16 Privacy 16 Project validation 17 Simple arithmetic 17 Longer term 17 Disadvantages 18 Documentation 18 Extra cost 18 Too long 19 Lender control 20 v Contents Higher insurance costs 20 Higher legal bills 21 Greater risk to lenders 21 Recourse 21 Summary 22 1 Structuring stages 24 Technical feasibility stage 24 Financial feasibility stage 29 Market feasibility stage 30 Approach to banks 30 Approach to bond underwriters 34 Board paper 35 Takeout (re)financing 35 Piercing the sovereign ceiling 36 Use in mergers and acquisitions 37 Equity/mezzanine 37 Project concept 37 Summary 38 2 Funding sources 39 Local currency funding 39 Banks 40 Bilateral agencies 40 Multilaterals 42 Multilateral political risk insurance 44 Capital markets 44 Developers 63 Mezzanine 63 Merchant financing 63 Islamic lending 63 Public-private projects 65 Leasing 65 Commodity-based lending 66 Equity 67 Summary 67 3 Cashflows 69 Modelling aspects 71 Interest bases 74 Spreads 75 Reserve styles 76 Cashflow controls 78 Operations summary 81 vi Contents Operating cashflows 82 Gross revenues 82 Opex 82 Financing reports 83 Financing costs 83 Capex 84 Modelling cashflows 84 Approaches 84 Typical sensitivities 85 Liquidated damages 87 Model periodicity 88 Input sheet 88 Model shortcomings 90 Summary 90 4 Financial advisers 91 Advantages and disadvantages 91 Need for an adviser 92 Advisory costs 92 Who are the financial advisers? 94 Summary 95 5 Credit ratios 97 Debt service cover ratio 99 Residual/tail 103 Interest cover ratio 106 Principal cover ratio 107 Present value ratios 107 Loan life ratio 108 Project life ratio 109 Residual life ratio 109 Debt:equity ratio 109 Payback 109 Discount rate 110 Leveraged internal rate of return 110 Choice of discount rate 111 Multi-tranche ratios 111 Accounting ratios 112 Telecoms 113 Summary 113 6 Risk systems 114 Insurance 117 Statistical 120 vii Contents Risk modellers 121 Benchmark 121 Checklist 122 Contractual linkage/jigsaw puzzle 123 Project finance 123 Summary 124 7 Sector profiles 126 Sector features 129 Analysis by sector 132 Power 132 Power cashflows 134 Tollways 137 Tollway cashflows 138 Railways 138 Railways cashflows 138 Resources 139 Resources cashflows 140 Telecoms 141 Telecoms cashflows 141 Satellites 142 Satellites cashflows 143 Prisons/hospitals 143 Prisons/hospitals cashflows 143 Airports/ports 143 Airports/ports cashflows 144 Water/waste water 144 Water/waste water cashflows 144 Stadiums/theme parks 145 Stadiums/theme parks cashflows 145 Summary 145 8 Structures 146 Risk 146 Contract 146 Trigger 147 Financed 147 Study 148 Avoided 149 Risk division 150 Document matrix 150 Interest 153 Principal 153 Drawdown styles 154 viii Contents Certification 154 Benchmarks 154 Anticipated cost to complete 154 Up-front – banks 154 Up-front – bonds 154 Special purpose vehicle 154 Unincorporated joint venture 155 Partnership 155 Trusts 156 Mezzanine 158 Subordinated debt 160 Working capital 160 Bridge loans 160 Multi-tranche 161 Commodity funding 161 Contract structures 162 Supplier credits 162 Buyer credits 163 Pre-export financing 164 Prepayment 164 Advanced payment 164 Leasing 165 Leveraged leasing 166 Wrap lease 166 Captives 166 Double-dip 166 Hire purchase 166 Lease tranches 166 Trigger structures 172 Deferral 173 Inverse order of maturity 173 Current order of maturity 173 Banked deferral 173 Clawback 177 Mandatory prepayments 177 Equity kickers 177 Financed structures 177 Equity 177 Dividend reserve 178 Subordinated debt 178 Convertible debt/initial public offering 178 Securitisation 178 Collateralised loan obligations 178 Revenues 178 ix Contents Joint financing 179 Study structure 180 Ratings 180 Methodology 180 Default 181 Deal pricing 182 Covenants 182 Terms 183 Pricing 183 Avoided 186 Off balance sheet 186 Deconsolidation 186 Diamond deconsolidation 186 Defeasance 187 Derivatives 187 Puts/calls/indemnities 188 Comfort letters 188 Summary 189 9 Due diligence 190 Systematic review 191 The feasibility process 192 Selection of experts/engineers 195 Customary reviews 196 Traffic studies 197 Construction cost audit 204 Power 205 Resources 206 Telecoms subscriber studies 208 Common sense 209 10 Supply/inputs risk 210 Contract structures 210 Supply agreements 210 Supply undertakings 211 Tolling contracts 211 Supply assurance 212 Trigger structures 214 Insurance 214 Hedging 214 Financed structures 214 Collateral 214 Study structures 215 Supply studies 215 x Contents Traffic 215 Telecoms 216 Water 217 Oil and gas 217 Mining 218 Power 220 Processing 220 Weighting 220 Structures 221 Borrowing base 221 Physical tail 222 Depletion protection 222 Summary 223 11 Market risk 224 Market quantity 225 Sales contracts 225 Take or pay 225 Capacity contracts 226 Throughput agreements 226 Buy-back contracts 227 Minimum quantity contracts 228 Market preference contract 228 Requirement contract 229 Tolling agreements 229 Advanced sales contracts 230 Production payments 230 Contract monetisation 232 Market price hedging 233 Market price 233 Base pricing 233 Additional sales contract options 234 Force majeure 235 Priority 235 Capacity changes 235 Trading company financing 235 Customer financing 235 Trigger situations 236 Hedging 236 Contract for differences 236 Make-up/deficiency agreements 238 Insurances 238 Study techniques 238 Market forecasts 238 xi Contents Summary 240 12 Foreign exchange risk 241 What percentage to structure? 241 Contract structures 241 Forward contracts 241 Parallel loans 242 Barter 242 Trigger structures 242 Currency swap 242 Exchange rate agreements 243 Avoided 243 Natural hedge 243 Commodity lending 243 Consumer price index lending 243 Foreign exchange tariff 244 Purchasing power parity 245 Exchange rate forecasts 245 Summary 245 13 Operating risk – technical component 246 Contract structures 246 Technology management 246 Technology warranty 246 Quality assurance 247 Technology guarantee 250 Trigger structures 250 Fleet assurance 250 Business interruption insurance 251 Technology insurance 251 Financed structure 251 Performance bond 251 Study structures 251 Independent certification 251 Alternative technology 252 Technology curve 252 Summary 253 14 Operating risk – cost component 254 Contract structures