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Project finance has spread worldwide and includes numerous industrial projects from power stations and waste-disposal plants to telecommunication facilities, bridges, tunnels, railway networks, and now also the building of hospitals, education facilities, government accommodation and tourist facilities. Despite financial assessment of PF projects being fundamental to the lender's decision, there is little understanding of how the use of finance is perceived by individual stakeholders; why and how a financial assessment is performed; who should be involved; where and when it should be performed; what data should be used; and how financial assessments should be presented.
Current uncertainty in financial markets makes many sponsors of construction project financings carefully consider bank liquidity, the higher cost of finance, and general uncertainty for demand. This has resulted in the postponement of a number of projects in certain industry sectors. Governments have seen tax receipts drastically reduced which has affected their ability to finance infrastructure projects, often irrespective of the perceived demand. Equity providers still seek to invest, however there are less opportunities due to market dislocation. Due to the demand for global infrastructure it is believed that project financings will return to their pre-crunch levels, or more so, however lenders' liquidity costs will be passed on to the borrowers. Lenders will also be under stricter regulation both internally and externally.
The steps outlined in the guide are designed to provide a basic understanding for all those involved or interested in both structuring and assessing project financings. Secondary contracts involving constructors, operators, finance providers, suppliers and offtakers can be developed and assessed to determine their commercial viability over a projects life cycle.
Special Features
a structured guide to assessing the commercial viability of construction projects
explains economic metrics to use in the decision making process
detailed case study shows how stakeholders apply the concept of project finance
Contents
List of Illustrations xi
List of Tables xiii
About the Authors xv
Preface xvii
1 Introduction 1
1.1 The development of project finance 1
1.2 Financial assessment 6
What is financial assessment? 6
Why perform a financial assessment? 6
Who is involved in the risk assessment process? 7
Where should a financial assessment be performed? 7
When should a financial assessment be performed? 8
What data are to be used? 8
How should assessment outputs be presented? 8
1.3 Purpose of this guide 9
1.4 Scope of the guide 9
2 Project finance 11
2.1 Introduction 11
2.2 Definition of project finance 11
2.3 The key characteristics of project finance 13
Special project/purpose vehicle 14
Contractual arrangement 14
Non-/limited recourse 17
Off-balance sheet transaction 18
Robust income stream of the project as the basis for financing 19
2.4 Legal and financial considerations in project finance 20
Legal 20
Financial 22
3 Financial instruments and cash flow modelling 25
3.1 Introduction 25
3.2 Debt finance 25
Senior debt 27
3.3 Mezzanine finance 28
Subordinate debt 28
Bond finance 29
3.4 Equity finance 31
3.5 Sources of debt and equity 34
3.6 Cash flow modelling and project financing 34
4 Risk management 39
4.1 Introduction 39
4.2 Risk 39
4.3 Risk management process 41
Risk identification 42
Risk analysis 44
Risk response 47
4.4 Typical risks in project financing 49
5 The financial assessment process 51
5.1 Introduction 51
5.2 The financial assessment structure 51
SPV assessment 51
Lenders' assessment 54
SPV and lender final assessment 55
6 Case study 57
6.1 Introduction 57
6.2 Independent power project 57
6.3 Supply and offtake contracts 58
Supply contracts 60
Offtake contracts 61
Applications of supply and offtake contracts 64
6.4 Assumptions for initial assessment 65
7 Developing the base case model 69
7.1 Introduction 69
7.2 SPV's initial assessment 69
7.3 Identify the estimated activities, time, costs and revenues of the project 70
7.4 Development of the base case model 71
7.5 Identify major project risks 73
7.6 Assessment of base case model incorporating risks 74
8 Initial economic assessment by lenders 77
8.1 Introduction 77
8.2 Financial package assessment 77
Finance package (1) 78
Finance package (2) 82
Finance package (3) 83
8.3 Conclusions 87
9 Financial engineering 89
9.1 Introduction 89
9.2 Financial instruments used in financial engineering 90
Forward rates 90
Financial futures 90
Swaps 91
Options 92
Caps, floors, collars, swaptions and compound options 92
Asset-backed securities 93
9.3 Refinancing 94
9.4 Reappraising public-private partnerships 94
9.5 Techniques applied in the reappraisal of PPP concession agreement 95
9.6 Other financial engineering techniques 96
10 Final assessment to determine project commercial viability 101
10.1 Introduction 101
10.2 Detailed risk assessment 101
10.3 Financial engineering 105
Tax holiday 105
Financial collar 107
Extending the concession 107
Increasing debt 107
Grace period 108
Phasing construction and operation 108
Upfront payments 108
Existing concession revenues 108
10.4 Summary 109
11 Financial close 111
11.1 Introduction 111
11.2 Due diligence 111
Technical 113
Legal due diligence 114
Trigger step in rights 116
Model audit and sensitivity analysis 116
Risk valuation 117
Term sheet 117
Inter-creditor agreement 117
Hedge strategy 118
Letters of credit 118
Reserve account 119
Escrow and ring-fenced facilities 119
Economic indicators 120
Taxation 120
Insurance 121
11.3 Financial close 122
Credit committee approval process 123
Due diligence report 124
Technical closure 124
Financial close 124
Technical commencement 124
Execute interest rate swaps 125
12 Islamic finance and project finance 127
12.1 Introduction 127
12.2 Islamic finance 127
12.3 Shariah 129
Qiyas and Litihad 129
12.4 Core principles of Islamic finance 130
Sharing (profit/loss and risk) 130
No unfair gain 130
No speculation 130
No uncertainty 130
No investments that are not in the public interest 131
No hoarding of money 131
Deception 131
Islamic financial institutions 131
Shariah supervisory boards 132
12.5 Project finance 132
The Ijara principle 133
Ijara Mawsufah Fi Al Dhimmah (forward lease) 133
Istisna'a 133
Sukuk 134
Sukuk al Istisna'a 135
A typical SAI deal 135
Hedging 136
Swaps 137
12.6 Other Islamic finance techniques for projects 137
Musharaka (equity financing) 137
Bai salam (forward financing) 138
12.7 Risks and liabilities 138
12.8 Summary 139
13 Conclusions and recommendations 141
13.1 Review 141
13.2 Conclusions 142
13.3 Recommendations 144
Appendix 147
Glossary 159
References 161
Index 167
