project finance modelling course

project finance modelling course

Advanced Techniques in Project Finance Modelling

1. Introduction to Project Finance Modelling

1.2 Key Features of Project Finance The resort to project finance involves several key features. The first and most obvious result is that the use of a special purpose vehicle or “project company” allows the sponsors to have the project’s liabilities appear off-balance. Any guarantee that may be offered by the sponsor to the lenders will be kept off-balance at a cost that is substantially equivalent to the cost of funding the guarantee. The pool of assets also frequently provides more effective security to the creditors on the project’s liabilities than the usual corporate guarantee package that must be enforced in cases of financial distress. With respect to the separation of assets, this also enhances the viability of the project as an entity that is completely separate from the business activities of the sponsors’ group. It also generally leads the parties involved to draft the construction or operating contract in more precise terms than under a corporate structure for two primary reasons. First, the sharing of liability amongst different project parties is not feasible as they do not share the same parent company. Any breaches or changes to the contract must be addressed because the contract usually provides substantial protection against project financial distress. Second, the project company cannot escape contractual obligations because any difficulties will lead only to the project company’s financial distress.

1.1 Overview of Project Finance Project finance has been widely employed to finance a number of multi-billion dollar mega-projects in the power and energy sectors, as well as in other infrastructure industries such as transportation, water, telecommunications, and social infrastructure. It is also put to use far more frequently for transactions in the resources sector, such as financing mines, smelters, and other mining infrastructure. The use of project finance is not limited to big-ticket transactions. Smaller yet complex deals are also concluded with the use of project finance techniques. The main reasons for the recourse to project finance are the existence of high leverage capacity, the construction risk allocation, and the limited or non-recourse nature of the financing.

2. Key Concepts and Principles in Project Finance

The developing countries and emerging economies frequently face a lack of available skills and funding in the public sector to fund the capital necessary for utilities such as power plants, roads, transport, water supply, sanitation, electricity generation, airports, and telecommunications. The need for infrastructure in most countries generally exceeds the ability of the public sector to provide this infrastructure. Governments in some countries have turned to the private sector for the funding of infrastructure on the basis that the increased efficiency created by private sector ownership of the infrastructure will finance the increased costs of utilizing the private sector. In order to finance these commodities, governments are increasingly making use of techniques known as project finance. The term project financing became popular in the 1980s, and today many countries use the concept of project financing for infrastructure projects.

In this section, key concepts and principles of project finance are discussed. The main objective of project finance modelling is to assess project risk, determine the potential cost of debt, make decisions about capital structure, and realize the value of investment. In modelling, we analyze the cash inflows and cash outflows using a range of assumptions about the future. It is important to appreciate the degree of uncertainty associated with projects and to conduct sensitivity and risk analyses. Key concepts in project finance modelling are discussed, including asset valuation, capital structure issues, cash flow waterfall model, and risk analysis.

3. Advanced Financial Modelling Techniques for Project Finance

Because the OPIC funded reserves and NER are part of OPIC funding, it is serviced by cash received and held by the project agent to satisfy the OPIC reserve and availability test requirements.

Ring-Fencing Models allow one or more OPIC, multilateral, or bilateral facilities to be closed in separate modules, to which varying levels of senior debt and other junior debt, which are serviced by different sources of funds, can be attached. Developers, vendors, and ECAs are also separately modeled within this framework. Developers might include different sub-developers in the case of distributed energy projects. Vendors may include manufacturers and construction companies. ECAs modeled include USTDA, SGI, and others.

This type of model is rigorous in its application of allocating proceeds, servicing, funded reserves, and priority payments in accordance with the inter-creditor agreement. Ring-Fencing models are particularly useful in generating minimum coverage and distributing tests, and help in understanding the interaction of all the parties involved in the deal financing.

Ring-Fencing Models

In this section, we provide alternative financial modelling approaches. The choice of structure will depend on the nature of the deal challenges and the degree of flexibility required in the modelling of the transaction dynamics.

Advanced Financial Modelling Techniques for Project Finance

4. Case Studies and Real-World Applications

As most Project transactions, this funding was non-recourse to the Project Sponsor, with Project completion precluding the influence of the Project Owner’s financial strength on the final rating of the Project Bonds. The Rating Agencies took into account the fact that the financially lowest rated of the array of Project-related companies was the first to file for bankruptcy, and in so reflecting on the separate debt instruments and their debt service, assigned to the Senior Debt a commensurately higher investment grade. There were a number of construction, operating and market risks identified by the Lender. However, in contrast to the first wave of IPPs, the techno-economic risk was this time seen as manageable and, with the equity in the Project, inseparable from the Owner’s performance risk; the better return on the investment was made contingent on the Sponsor’s technical expertise, which was not commoditized. The three entities engaging the most number of personnel from the Sponsor’s staff were the Technical Consultant, the Operating and Maintenance Company, and the Engineering Company, tasked to design the Project in compliance with the Engineering, Procurement and Construction Contract protocols.

In this section, we illustrate the functionalities of the model by examining its real-world applications. One of the first assignments for which we used the PMT was to model the financing of a U.S. independent power project that was seeking financing in the international capital markets. Due to legal regulations on which investors the Project Sponsor could approach in its home market, the bulk of the 1994 to 1995 fund-raising activities were expected to take place in the European institutional investor market. The Lender required that the Project be financed on a long-term non-amortizing basis. The Swap Bank that was to establish a U.S. dollar/euro interest-rate cap at the low level required significant amortization of the dollar debt. The Sponsors were prepared for up to 15 percent of the Senior Debt to be repaid during the last ten years of the loan.

5. Future Trends and Innovations in Project Finance Modelling

Despite steady and often rapid growth over the last 30-40 years, the future of infrastructure finance and its tools is one of rapid change. This section discusses several trends, issues, and future innovations that will fundamentally change both the way that we practice infrastructure finance, as well as how we train students, and the types of models we construct. Some future changes are straightforward, such as the increased global use of project finance structures and the increased sophistication of the participants in project finance structures. This will, in turn, favor the development of other ancillary products including insurance products and faster secondary loan sales for NOPLAT-driven project firms. Other changes that are likely to be more subtle or unexpected in how they impact project finance include policy impacts on financial structures due to increases in trading liquidity, or the potential for taking an increased equity stake in project finance-enhanced entities through the use of potentially less transparent offshore populations into more transparent onshore REIT entities.