UNIVERSITY OF DAR ES SALAAM

BUSINESS SCHOOL

FN306: LENDING MANAGEMENT

CORPORATE LENDING:
PROJECT FINANCE
Tobias Swai, PhD
taswai@protonmail.com

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Credit execution and
administration
 Loan Decision
 Individual officer decision
 Committee
 Centralized underwriting
 Loan Agreement (loan package)
 Formalizes the purpose of the loan
 Terms of the loan
 Repayment schedule
 Collateral required
 Any loan covenants
 States what conditions bring about a default
Documentation

 Perfecting the bank's security interest in collateral

 When the bank's claim is superior to that of other
creditors and the borrower
 Methods to perfect collateral interest
 Require the borrower to sign a security agreement
 Obtain title to equipment or vehicle
 Insurance (life, equipment, fire and causality)

 Loan Covenants
 When a bank makes a loan, they in effect put their
profitability and solvency on the line
Parts of Typical Loan Agreement
Parts of a Typical Loan agreement
Parts of a Typical Loan agreement
Parts of a Typical Loan agreement
Parts of a Typical Loan agreement
Parts of a Typical Loan agreement
Loan Review
Conditions under which a loan is made are subject
to change due to changes in the borrowers
environment. Things like fluctuations different
sectors of the economy, loss of employment, poor
health are some unforeseeable events that may
affect the ability of the borrower to repay their
loans. The loan department must be sensitive to
the occurrence of such events and review loans
periodically until they reach maturity.
Loan Review

1. Lenders falling under the jurisdiction of the BOT are

required to prepare a loan aging schedule
categorizing the loan portfolio in terms of current and
late payments. Classification of the loan portfolio is
made in the following categories:
(i) Current--- one percent provision
(ii) Especially Mentioned---three percent provision
(iii) Substandard–-- twenty percent provision
(iv) Doubtful---- fifty percent provision
(v) Loss---- one hundred percent provision
Loan Review

Structuring the loan review process carefully to make sure the most
important features of each loan are checked, including
a. The record of borrower payments to ensure that the customer is not
falling behind the planned repayment schedule.
b. The quality and condition of any collateral pledged behind the loan.
c. The completeness of loan documentation to make sure the lender has
access to any collateral pledged and possesses the full legal authority to
take action against the borrower in the courts if necessary.
d. An evaluation of weather the borrower’s financial condition and forecasts
have changed, which may have increased or decreased borrower’s need
for credit.
Loan Review
 2. Reviewing the largest loans  4. Accelerating the loan review
most frequently because the schedule if the economy slows
default rate on these credit down or if the industries in
agreements could seriously which the lending institution
affect the lender’s own financial has made a substantial portion
conditions. of its loans develop significant
problems (e.g., the appearance
 3. Conducting more frequent of new competitors or shifts in
reviews of troubled loans with technology that will demand
the frequency of review new products and delivery
increasing as the problem methods
surrounding any particular loan
increase
Handling problem loans
Indicators of a troubled loan
 Irregular loan repayments

 Poor loan renewal record ( little reduction in the

principal amount when the loan is renewed).
 Unexpected build up of the borrowers accounts

receivables or inventory
 Rising debt-net worth ratio

 Missing documentation
Handling problem loans
 Poor quality collateral
 Reliance on reappraisal of assets to increase net
worth of the borrower
 Reliance on non recurring sources of funds to
meet loan repayments eg sale of assets.
 Indicators of inadequate/Poor
lending policies
 Poor selection of risks among borrowing

customers.
 Lending money contingent on possible future
events e.g. mergers, promise of large deposits by
a customer
 Failure to specify plan for loan liquidation
 Incomplete credit files
 Substantial self dealing clients
Indicators of inadequate/Poor
lending policies
 Tendency to overreact to competition
 Lending money to support speculative purposes
 Lack of sensitivity to changing economic
conditions.
Loan workout-the process of
recovering funds from a problem
loan situation
Loan workout
Loan workout
 Project Finance

 Definition: A form of financing projects, primarily

based on claims against the financed asset or
project rather than on the sponsor of the
project.
 However, there are varying degrees of recourse
possible. Repayment is based on the future cash
flows of the project.

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 ..Further definition

 Standard & Poor’s defines a project company as a group

of agreements and contracts between lenders, project
sponsors, and other interested parties that creates a form
of business organization -
 that will issue a given amount of debt at start;
 will operate in a focused line of business;
 lenders look only to a specific asset to generate cash flow as the
sole source of principal and interest payments and collateral.
 Project Finance

 Objective
 Financing a single purpose capital asset usually with a
limited life

 Project vehicle
 Legally independent project company

 Financing (debt and equity definition)

 Equity from one or more project sponsors
 Non recourse (to sponsors) debt
 Equity at the minimum level to issue debt at reasonable
cost

 Comparison with traditional or corporate finance

 Historical Evolution
 Roman Empire dates  Characteristics on the sectors
Captive market >> Long Term
 Financing active during US 
Contracts, big financial solid buyers
Rail road 1840 to 1870  Low level of technological risks in
construction
 In 1930s Oil exploration
Extensions in 1980s and 1990s >>
drilling in Texas and 
Loans to Developing country (DCs)
Oklahoma – USA governments.
 1970s EUs – 1978  Support from credit agencies
>>EXIMs
introduction of IPPs– wide
 DCs Off-balance sheet financing
application >> off taker techniques
arrangement  Toll roads, leisure facilities, city
parking lots – less market risk
coverage

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 Historical…Evolution of Project
Finance

Preferably PPP
Arrangement
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 Why Project Finance is Needed
 Financing a JV  avoiding debt restrictions;
 carrying out a project too  maintaining a credit
big for one sponsor; rating;
 assigning risks to parties  improving corporate
that are in the best return on equity (ROE);
position to control them;  avoiding double taxation;
 insulating corporate assets  sharing ownership of
from risk; projects with employees
 keeping debt off the  establishing a business
balance sheet, venture in a foreign
 protecting borrowing country.
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capacity;
 Why Project Finance

 Public infrastructure
 Part of the Global Infrastructure
 Necessary for the functioning of the economy
 Private sector development, trade possible
 Supporting a nation’s economic and social activities
 Taxes, Trade and entrepreneurship
 Private sector cannot take account of ‘externalities’
 Competitive provision of infrastructure – equity, monopoly
 Merit on competition – underprovided – huge investment
demands
 High initial investment
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 Project Finance Participants

Many stakeholders are involved from public

perspective, which need to manage their own
objectives – Naturally
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 Project Finance Structure in PPP
Project Financing Structure

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 Project Financing Participants

 Sponsor/Developer. The sponsor(s) or developer(s) of a

project financing is the party that organizes all of the other
parties and typically controls, and makes an equity
investment in the project company.

 Additional Equity Investors. In addition to the sponsor(s),

there frequently are additional equity investors in the project
company.
 These include government, sponsors, contractors, insurers, suppliers,
off-takers, etc, giving them a vested interest in the success of the
project
 Project Financing Participants (continued)

 Lender. The lender in a project financing is a

financial institution or group of financial
institutions that provide a loan to the project
company to develop and construct the project
and that take a security interest in all of the
project assets. Lenders can also include bond
investors in capital markets
 Risk Analysis

 Since lenders provide bulk of the financing, risk is usually analyzed from
the lenders’ perspective
 Project-level risks - agreements
 Default by counterparties
 Country risk - stability of economic, political, and
regulatory environment
 Business and legal institutions risk - enforceability of
agreements
 Force majeure risk - ‘acts of god/nature’
 Insurance
 Credit enhancements
 The objective is to assess the risk of cash flows available for debt
servicing
 Loan and security agreements
 Project Level Risks

 Quality of sponsors
 Experience, commitment (equity investment)
 Strategic importance of the project

 Financial strength to meet future obligations such as

contingent equity
 Construction risk
 Construction agreements
 Quality of contractors (could be a sponsor)

 Related investment requirements

 Operations risk
 Quality of operator
 Operations and maintenance contract
 Project Level Risks
 Supply risk
 Availability
 Agreements for variability of input prices
 Offtake, demand & market risk
 Offtake agreement
 May not offer adequate protection against
unfavourable market situation because of problems of
enforceability of contracts
 Competitive position
 Cost of production relative to competitors
 Availability of substitutes
 Better competitive position implies lower demand risk
 Construction Contract

 Price. Most project financing construction contracts are fixed-price

contracts although some projects may be built on a cost-plus
basis. If the contract is not fixed-price, additional debt or equity
contributions may be necessary to complete the project, and the
project agreements should clearly indicate the party or parties
responsible for such contributions.

 Completion Date. If construction is not finished by the completion

date, the contractor typically is required to pay liquidated
damages to cover debt service for each day until the project is
completed. If construction is completed early, the contractor
frequently is entitled to an early completion bonus.
 Construction Contract (continued)

 Performance Guarantees. Such guarantees are measured by

performance tests conducted by the contractor at the end of
construction. If the project does not meet the guaranteed levels of
performance, the contractor typically is required to make
liquidated damages payments to the sponsor. If project
performance exceeds the guaranteed minimum levels, the
contractor may be entitled to bonus payments
Operations and Maintenance
Agreement
 Long-term agreement for the day-to-day operation and maintenance of the
project facilities

 With a company having the technical and financial expertise to operate the
project in accordance with the cost and production specifications for the
project.
 The operator may be an independent company, or it may be one
of the sponsors.
 The operator typically will be paid a fixed compensation
 May be entitled to bonus payments for extraordinary project
performance and,
 Be required to pay liquidated damages for project performance
below specified levels.
Input Supply Agreements

 Agreements for the supply of raw materials,

energy or other resources over the life of the
project.
 Frequently,supply agreements are structured on a
"put-or-pay" basis -
 This means that the supplier must either supply
the input or pay the project company the
difference in costs incurred in obtaining the input
from another source.
 Fixed or spot price
Product Offtake Agreements
 The product offtake agreements represent the source of
revenue for the project.
 Frequently,offtake agreements are structured on a
"take-or-pay" basis,
 The offtaker is obligated to pay for product on a
regular basis whether or not the offtaker actually
takes the product unless the product is unavailable
due to a default by the project company.
 Price
 Fixed
 Scheduled changes
 Pass through of fluctuating input prices
Loan and Security Agreement

 Security. The project loan typically will be

secured by multiple forms of collateral
 Mortgage on the project facilities and real property.
 Assignment of operating revenues.
 Assignment of any letters of credit or performance
or completion bonds relating to the project under
which borrower is the beneficiary.
 Assignment of insurance proceeds.
 Assignment of all project agreements
 Loan and Security Agreement (continued)

 Disbursement Controls. These frequently take the

form of conditions precedent to each drawdown,
requiring the borrower to present invoices,
builders' certificates or other evidence as to the
need for and use of the funds.

 Progress Reports. The lender may require

periodic reports certified by an independent
consultant on the status of construction progress.
 Loan and Security Agreement (continued)

 Covenants Not to Amend. The borrower will

covenant not to amend or waive any of its rights
under the construction, feedstock, offtake,
operations and maintenance, or other principal
agreements without the consent of the lender.

 Completion Covenants. These require the

borrower to complete the project in accordance
with project plans and specifications and prohibit
the borrower from materially altering the project
plans without the consent of the lender.
 Loan and Security Agreement (continued)

 Dividend Restrictions. These covenants place restrictions on

the payment of dividends or other distributions by the
borrower until debt service obligations are satisfied.

 Debt and Guarantee Restrictions. The borrower may be

prohibited from incurring additional debt or from
guaranteeing other obligations.

 Financial Covenants. Such covenants require the

maintenance of working capital and liquidity ratios, debt
service coverage ratios, debt service reserves and other
financial ratios to protect the credit of the borrower.
 Credit Enhancement

 Some third parties offer various credit enhancement products designed

to mitigate project level risks, sovereign risks, and currency risks, among
others.
 Multilateral agencies, such as the Multilateral Investment
Guarantee Agency, the International Finance Corp., and
ADB offer various insurance programs to cover both
political and commercial risks.
 Project sponsors can themselves provide some type of
support in mitigation of some risks - a commitment that
tends to convert a non-recourse financing into a limited
recourse financing.
 These enhancement packages cover only specified risks.
 Related Network among various
players in the Project Finance

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 What Drives Value in the Deal
 Revenue and Competitive transaction
procedure
Revenue Growth
 Cost Reduction
(EBITDA)
 Investment
Planning (CAPEX)
 Project life (term)
 Financing (WACC)
 Residual value
Value based Management
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 Pre-Requisites of Project Finance

 Sustainable Economics
 Project financial due diligence
 Revenue risk - SPV

 Identifiable Risks
 How each risk will be mitigated e.g. Sales, feedstock
supply, O+M, Political, Cashflows (Robust Fin Model)
 Accessible Financing
 Hi Leverage, De factor tenor for Economies of Scale
 Political Stability
 Strategic sovereign default, insurance
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