For the most part, the concerns of the providers of the various types of funding will be similar. They will all be concerned with the basic economic and financial soundness of the project. In addition, they will want to ensure that the project is completed on time and on budget and that the revenue stream that is the source of their debt service and dividend payments is created and maintained as expected. They will also all be concerned with country and political risk, devaluation risk and potential environmental risk and liability.
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However, shareholders and lenders also have some unique concerns which may need to be accommodated in devising a finance plan for the project. For example, they often differ on the on the debt-to-equity ratio as shareholders want to provide as little equity as possible to maximize the potential returns on their investment while lenders want as much equity as possible to ensure strong shareholder commitment and to increase their debt service coverage ratios. Shareholders will resist providing completion and overrun funding guarantees while lenders will often require them.
For lenders, the prime concern is the certainty of payment of interest and principal at every stage of the life of their loans while shareholders may have made their investment for strategic business and market reasons and be able to wait longer to receive their returns. Lenders will insist on including measures in the loan agreement and in other finance documents to enable them to control the actions of the SPV and to take security over all project assets while the shareholders may see this as a reduction in their flexibility to manage the project. In the final analysis, however, it is the lenders who generally prevail when their interests diverge with those of the providers of equity. Debt finance constitutes the majority of the funding for most project financing, and this means that satisfying the concerns of the lenders is often the most critical part of creating a viable finance plan for a project.
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I. DEVELOPING A FINANCE PLAN FOR A PROJECT FINANCING
In developing a finance plan for a major project, the sponsors and their financial advisors generally have two principal, but sometimes conflicting, objectives: (1) to obtain funding at the lowest possible blended cost over the life of the project; and (2) to avoid or minimize the need to refinance loans during the life of the project. Their ability to obtain these objectives will vary with the sector and type of project, the project’s basic economics, the quality of the participants, the nature of the lenders interested in the project, and financial market conditions at the time the funding is arranged and obtained.
The simplest type of finance plan is one in which the lenders are willing to assume both construction and operating period risks and provide a permanent, long term loan at the beginning of construction which extends into the operational period and is fully amortized by the project’s revenue stream over the life of the project. This type of loan avoids any refinancing risk but may result in higher interest costs as longer maturity loans generally have higher interest rates than shorter maturity loans. In addition, this type of plan is difficult to achieve as many longer term lenders are unwilling to assume construction period risks and some lenders that are willing to assume these risks (e.g. commercial banks) are not always able to provide long term permanent finance.
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This means that, in arranging finance, sponsors need to recognize that the activities in the different phases of a project may need to be funded by different sources of finance and take account of these differences in developing the finance plan. Different providers of debt finance have different funding sources, different motives for lending, different regulatory constraints and different areas of staff expertise. These differences may influence the risks that a particular type of lender is willing to assume and the length of the maturities on their loans.
The inevitable swings in conditions in the commercial banking and capital markets mean that bank and institutional investor lending preferences and practices may change from time to time. This makes generalizations about the lender composition of finance plans difficult. Even so, history has shown that: (1) sponsors are expected to provide the risk capital for a project financing and assume risks that lenders may be unwilling to bear;
(2) commercial banks tend to have short term funding sources and lend for shorter maturities, have staff with project finance and construction lending expertise, and are generally willing to accept some level of construction risk; (3) institutional investors have more stable, longer term funding sources and are sometimes comfortable lending for longer maturities via project bonds or private placements for major projects but are reluctant to accept construction and completion risk; and (4) MDB’s and ECA’s often accept some construction risk, are willing to lend for longer maturities, and are motivated
by development and
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export promotion objectives in their lending activities.
The potential for changes in financial market conditions and preferences of various providers of finance mean that there is no “typical” finance plan for major international projects. However, one very common model would have feasibility and preparatory stage costs funded by sponsors through provision of equity or equity bridge loans and/or by MDB’s and DFI’s willing to provide funds for project development and preparation.
Construction funding would be provided primarily by commercial banks and, to a lesser extent by MDB’s or ECA’s if they were participating in the project. The permanent operational period funding would be provided by (a) participating MDB’s, ECA’s and DFI’s and (b) commercial banks for a few years using mini-perm loans with these commercial bank loans refinanced with the longer term permanent finance coming from project bonds and, in some periods when the commercial banking markets are very liquid, by commercial banks themselves.
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CHAPTER 13