Features of Project Finance 2017-11-22T05:56:44+00:00

Features of Project Finance

Common Features of Project Finance Deals

Certain features of project finance are common in all project financings. We outline those features of project finance which are common in all project financings.

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Features of Project Finance Overview

Features of project finance include that project finance provides long-term, limited recourse or non-recourse loans used to finance large commercial, industrial, infrastructure and sovereign projects in emerging market nations worldwide. The debt and repayment structure are based on the project finance model where projected cash flow of the project rather than the balance sheets of the project sponsor.

Usually, a project finance structure involves a number of equity participants, who can be project sponsors or equity investors, and a consortium of lenders that provide loans to the project. Project finance loans are almost always extended on a non-recourse or limited recourse basis and are secured by the project assets and operations. Repayment of the loans occurs entirely from project cash flow, not from the assets or credit of the borrower.

These are just some of the common elements of project finance. But we cannot provide a universal definition of project finance that is acceptable to the entire industry. Despite almost universal disagreement over the definition of project finance, there is almost universal agreement on the features of project finance that are common in every project financing and they are listed below.

Features of Project Finance

Project finance is the financing of large international projects like public infrastructure and public utility projects. But there is no single definition of project finance. Despite more than $230 billion in project finance loans being originated annually, the industry still doesn’t agree on a consensus definition of project finance. Despite almost universal disagreement over the definition of project finance, there is almost universal agreement on the features of project finance that are common in every project financing and they are listed below.

Capital-Intensive

Project financing is used for large project developments requiring a great deal of debt and equity, typically ranging from hundreds of millions to billions of dollars. Think infrastructure projects primarily in developing countries.

Risk Allocation

International project financing transactions tend to be riskier than ordinary corporate finance deals. Because of the risk exposure, allocation of the risk in the deal is often critical for approval of the project finance package.

Risk allocation, which is accomplished in the project documents, attempts to match risks and corresponding returns to the deal participants most capable of successfully managing them. For example, fixed-price, turnkey contracts for construction which typically include severe penalties for delays put the construction risk on the contractor instead on the SPE, the project sponsors or the lenders. Risks inherent in typical project financing and mitigating factors are covered in more detail below.

Project Finance Document Structure

Projects are so complex, involve such vast amounts and so many participants, projects must also involve if they are to be successful, extensive, well-organized Project Finance Documents. We have prepared a Project Finance Document summary with a brief description of each of the typical project documents.

Numerous Parties

Project development transactions, especially international project developments typically involve numerous participants. In fact, it is customary for there to be ten or more participants who play major roles in the project.

Special Purpose Entities And Finite Life

Project ownership is ordinarily held in a single-asset, Special Purpose Entity (SPE) with a limited life (sometimes referred to as Special Purpose Vehicle or Special Purpose Company) formed for the express purpose of owning a project pursuant to a Project Finance transaction by the project sponsors. They own only the underlying deal itself. In many cases, the clearly defined conclusion of the project is the transfer of the SPE.

Non-Recourse or Limited Recourse Financing

With ownership in an SPE with no credit or assets, lenders are not distracted evaluating the borrower and all underwriting is focused on the project. Non-recourse financing reinforces this paradigm. The lender will more thoroughly examine the feasibility of the project. In extreme cases, if the lender is not satisfied that the project is sufficient to repay the loan, they may require some level of limited recourse from the sponsors or investors.

Cash Flow Applied to Debt Service

Again, due to the SPE and non-recourse financing, loan documents will typically contain a contractual obligation to apply excess cash flow from the project to debt service. Thus, any excess cash flow applied in this manner will accelerate loan amortization and reduce the lender’s risk exposure.

Cost of Financing

Project finance is generally a more expensive financing structure than are typical corporate finance options. Further, project finance involves the use of highly-specialized financial structures which also drives costs higher and liquidity lower. Margins for project financings usually include premiums for emerging market risk and political risks because so many projects are located in high-risk countries. Emerging market political risk insurance is commonly factored into overall costs.

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