Project Finance

From Open Risk Manual

Definition

Project Finance is a method of financing in which the lender looks primarily to the revenues (cash flows) generated by a Project, both as the Source of Repayment and as security for the Exposure.

Project finance concerns typically the long-term financing of infrastructure and industrial projects. A related term is Infrastructure Finance.

Project finance involves the creation of a legally independent project company financed with non-recourse debt (and equity from one or more sponsoring firms) for the purpose of financing a single purpose capital asset, usually with a limited life.

In such transactions, the Lender (or more typically Lenders) is usually paid solely or almost exclusively out of the money generated by the contracts for the Project’s output, such as the electricity sold by a power plant.

This asset class includes all loans or equities to projects for specific purposes (i.e., with known use of proceeds) that are on the balance sheet of the financial institution. The financing is designated for a defined activity or set of activities, such as the construction and operation of a gas-fired power plant, a wind or solar project, or energy efficiency projects.

Characteristics of Project Finance

  • The initiator of a Project Finance transaction can be be either government or a corporate entity.
  • A major proportion of equity is held by project manager or contractor so provision of management and finance are linked
  • Project finance covers a range of specific sectors (see list) that might be hard to finance in traditional Banking or Capital Markets
  • The project has a well defined lifecycle
  • The client is usually a Special Purpose Vehicle that is not permitted to perform any function other than developing, owning, and operating the installation. The consequence is that repayment depends primarily on the Project’s cash flow and on the collateral value of the Project’s assets.[1]. The special purpose company is highly levered. The project might be initially sub-investment grade and gradually evolve into investment grade (post-completion)

Project Finance Financing Models

  • Loans and/or Bonds
  • Borrowing Base Model
  • "Build Operate Transfer" (BOT) Model
  • Advance Payment Facility

Project Development Lifecycle

Projects have a well developed Project Development Lifecycle with the two main components being:

  • The construction phase
  • The operation phase

Project Finance Subcategories

Project Finance typically involves large, complex and expensive installations and infrastructure that might include, for example

  • mines (metal, other ores)
  • power plants (solar, wind, fossil fuels (coal, oil and gas, biomass, nuclear)
  • oil and gas projects (extraction)
  • (petro)chemical processing plants
  • transportation infrastructure (toll roads, airports, rail infrastructure)
  • environment infrastructure (water, desalination, solid waste, waste water)
  • telecommunications infrastructure
  • social infrastructure projects (social housing, health, education, defense, sports, corrective facilities)

Structure

A Project Finance Structure is a complex nexus of involved parties and stakeholders. In summary it involves:

  • equity investors (also known as sponsors)
  • A Syndication of banks or other lending institutions that provide loans to the operation.
  • The provided credit is most commonly Non Recourse Lending which is secured by the project assets and paid entirely from project cash flow, rather than from the general assets or creditworthiness of the project sponsors
  • Project lenders are given a lien on all of the project assets and are able to assume control of a project if the project company has difficulties complying with the loan terms.

Project Finance Risks

See Also

References

  1. Basel Committee on Banking Supervision, International Convergence of Capital Measurement and Capital Standards ("Basel II")”, November 2005