Project Finance Masterclass

DAY ONE

Characteristics of Project Finance

Project finance, or limited recourse financing, has features which render it quite different from ‘normal financings’, and these differences permeate throughout the structure.

• The limitation of recourse

• The due diligence required

• The choice of entity as the SPV

• The role of the project cash flow model

• The significance of debt risk vs. commercial risk

• The role of contract in limited recourse financings

• The role of security in limited recourse financings

• Why failed project financings don’t go into insolvency

• The rationale for selecting project finance

Contracts and Cross-Border Enforcement

Project financings involve a spider's web of contracts. These contracts are pointless unless there is an ability to enforce rights under them.  In cross-border context this is often not straightforward.  Litigation is not the answer.

• Why enforcement can be problematic

• The shortcomings of contractual litigation in limited recourse financings

• Alternative Dispute Resolution - typical structure and procedure

• Arbitration and the NY Convention

Pre-Completion

Getting a project built and working as planned is the hardest and therefore the highest risk phase of most projects. Particular care is required in structuring the rights and obligations.

• Liquidated damages

• Performance bonds and retentions

• Fixed price, lump sum, liquidity

• Variation and change orders

• Turnkey EPC structures

• Standard form contracts – e.g. FIDIC

• Completion guarantees

• Refinancing risk

• Technology, logistics, and learning curve risks

• Case Study 1: Toll Road Project

DAY TWO

Market and Operating Risks

Most projects have only one revenue source. The cash flow coming into the project needs careful structuring and due diligence.

• Offtake agreements and the errors that often occur

• Availability risk vs market risk

• Take-or-pay features

• Hidden recourse structures

• Exclusions

• Deficiency Guarantees

• Harmonisation of contracts

• Implications of market volatility

Project Cash Flow and Debt Structuring

Total dependence on a single cash flow results in structures and covenants that are not found in other financings. The analytical process can be summarised as Identification of Risks; Quantification of Risks; Management of Risks.

• Risk – solvency risk vs volatility risk

• Free cash flow – why is it fundamental to analysis

• The loan syndication process

• Cash management issues

• Liquidity – creating ‘suspension’ for the special purpose vehicle

• The six classifications for the management of Risk

• Cash Available for Debt Service (CADS)

• Loan life cover, project life cover, debt service cover (LLCR and ADSCR)

• Surplus cash flows, lock-up, cash sweeps and when appropriate

• Cashflow Waterfall/cascade, reserve accounts

• Contingency reserves

• The layout of the loan agreement, and the differences to corporate loan agreements

• Key issues for Lenders

• Key issues for SPV borrowers

• Designing structures to match cash flows

• Dealing with default – rescheduling and restructurings

• Mortgage debentures/fixed and floating charges

• Separating risk-taking and funding

• The six ‘killers’ of project financings

• Case Study 2: Telecoms Project

Day THREE

Power Projects

Power generation and transmission projects represent around 45% of global project finance, and increasingly there is a bias towards recent and new technologies as a result of the drive towards energy transition.  Power projects have characteristics that make them fundamentally different from other industry sectors.

• Types of plant – base load, peaking, non-dispatchable

• Types of market – utility, corporate, merchant

• Why Power Purchase Agreements differ from ‘normal’ offtake agreements

• Take-or-Pay versus Pay-as-Produced

• Why solar and wind have more pricing flexibility than other technologies

• Dealing with merchant risk – contracts for difference

• Corporate PPAs – direct wire, sleeved, proxy, virtual

• Capture risk, cannibalisation risk, shaping risk, imbalance risk

• Implications of Negative Pricing

• Regulatory risk

• Political risk

• Force Majeure

• Case Study 3: Financing Hydrogen Electrolysis

Sponsor Perspective

Sponsors need to have a disciplined approach to screen projects that are likely to deliver the benchmark IRR.  There are number of potential pitfalls in the analytical approach.

• The investment analysis without project finance

• The difference in approach with a limited recourse structure

• Project IRR contrasted with Equity/Sponsor IRR

• The drivers of Sponsor IRR – and implications of negotiation of the financing term sheet

• Adaptations to the evaluation of projects in emerging markets

Infrastructure Projects – Concession Agreements

DAY FOUR

The Project Finance Model

Where the financing is done with limited recourse to the company behind the project, the financing is dependent solely on the cashflows generated by the individual project itself.  It becomes critical that the modelling is done to a high standard.  In particular the model will need to test for the volatility of the cashflows.  It is not the base case that kills, but the occurrence of conditions other than the base case over the life of the project.

• Model Design

• Analytical purpose – feasibility, valuation, finance-structuring, statistical probability

• Designing the Analysis Worksheet

• Determining the functionality of the model

• Structuring how inputs will be accessed and controlled

• The importance of the logic flow through the model

• The layout of the worksheets within the workbook

• The layout of the individual worksheets

• The 8 principles of modelling best practice

Procedures Upon Receiving a Model

Any analysis performed on a model is nonsense if the model itself is nonsense or if it has material errors.  There is no shortcut to model audit - to ensure that there are no errors at all - every unique formula in the model would have to be checked.  But Model Review is a procedure that allows a recipient to discover if the model has credibility within a maximum time-frame of 30-40 minutes.

• The recommended layout and inter-relationship of worksheets for a typical project finance model;

• shortcuts to determine a received model's architecture;

• The use of audit software: detecting breach of excel best practice rules;

• listing of formulas and cell references that need checking;

Tracing the logic flow;

Illustration – of scenario analysis, sensitivity analysis, breakeven analysis, dynamic graphing, model dashboards.

IRR - Modelling

The primary performance indicator for the Sponsor is the project’s IRR.  The majority of models I receive, the IRR is calculated incorrectly – often with major error margins.

• The errors usually encountered;

• What is wrong with using IRR, XIRR and NPV functions;

• The correct methodology for implementing IRR calculations;

• A better approach to NPV calculations.

Bond Financing

An increasingly important financing option, but having very distinct disadvantages as well as advantages.

• The history of bond finance for limited recourse SPVs;

• Cross-border bonds – prerequisites;

• Rule 144A – implications for emerging market projects;

• Rating agencies – approach to different sectors;

• Piercing the sovereign ceiling;

• The limited window for high yield bonds;

• Why use bond financing – advantages and disadvantages.

• Domestic bonds

• Credit enhancement – monoline insurance

Export Credit Agencies

An explanation of how ECAs and their products work, and the pluses and minuses of getting them involved in the structure.

• Buyer credits

• Political and commercial risk cover

• Concessional CIRR finance rates

• Lines of credit

• Advantages/disadvantages of ECA involvement

• Case Study 4: Project Illustrating the use of bankruptcy remote vehicles and unincorporated joint ventures

Technical Issues in Limited Recourse Financings

This section deals with a number of topics where project finance changes the conventional treatments.

• Insurances – pre-completion and operating phase

• Assignment and cut-through agreements

• The options for dealing with political risk

• Environmental risks – the limitations of insurance

• Currency exposures – optional approaches to structuring

• Financings involving multilateral agencies – implications

Training Objectives

The purpose of this course is to deliver a detailed and practical understanding of:

• How to identify, quantify and structure project risks

• Understanding the advantages, disadvantages and differences between conventional and limited recourse financing

• The Contrasting of projects with market risk/offtake and those with availability risk

• The manner in which contractual rights can be enforced or protected in complex, cross-border situations, often in emerging market locations

• Managing contracts in complex, cross-border situations

• Dealing with pre-completion risks

• The complexities of accurately assessing and evaluating cashflows

• Assessing different financing approaches and their effect on Sponsor IRR

• The role of the model in project financings, which differs in significant ways from the role of the model in other forms of financing arrangements

• How sponsors can effectively evaluate a proposed investment and its financing methodology

• The identification of the characteristics of different financing approaches – bank syndication, Rule 144A bonds, domestic bonds, leasing, export credit agency, credit enhancements

Training Course Summary

The course commences with highlighting the differences between limited recourse financing (i.e. project finance) and conventional corporate financing – esp as regards the importance of operational contracts, the financial model, and the reduced importance of security.

We then discuss why contractual litigation is inappropriate and the importance of a dispute resolution procedure in all contracts.

The project’s sole Revenue will be driven by either a Concession Agreement, an Offtake Agreement, a Power Purchase Agreement, or by the retail market in the absence of a contract.  The course deals with all four of those circumstances in separate sessions and identifies the risks and the various ways in which they can be managed.

The project’s period of highest risk is likely to be in the pre-completion phase.  A thorough examination is given to this construction period.

Turning to the financing issues, both the Lender and Sponsor perspectives are detailed.  In addition, we cover other financing options, such as project bonds and Export Credit Agency involvement.

The course’s treatment of the financial modelling topic is designed to suit people who need to use the model for analytical purposes.

Several detailed case studies are introduced throughout the course, and participants will be required to contribute their understanding of the risks that need to be addressed and their proposed solutions to the management of them.  The case studies are an important feature of the course.  They are selected to bring out particular issues and for the broad relevance they have across different sectors and geographies.