Risk Mitigation Strategies in Infrastructure Finance: A Comprehensive Guide, Schemes and Mind Maps of Finance

Download Risk Mitigation Strategies in Infrastructure Finance: A Comprehensive Guide and more Schemes and Mind Maps Finance in PDF only on Docsity!

Infrastructure Finance

Key Issues

TMB

Special Purpose Company Structure

[to control company activities]

At Risk:

Low or no Risk:

• Grants and subventions [free?]

Equity

Debt

Cost of Capital

TMB

Conclusion: project developers try to maximise amount of debt!

Mezzanine

Risk Mitigation Risk Type Mitigation Construction

• Cost over-runs
• Delays
• Site acquisition & access
• Physical asset risks (a) Use fixed price turnkey contracts (b) Negotiate penalties & incentives (c) Negotiate warranties (d) Keep project specification fixed (e) Use experienced/competent contractors [(f) Introduce bonding & retentions] (g) Usually Govt. responsibility (h) private projects require insurance Operations - Revenue forecasts
• Revenue build-up
• Operating costs
• Management failure (a) Obtain realistic revenue forecasts (b) Obtain long-term sales contracts (c) Support with long-term supply contracts (d) Use experienced/competent operators (d) Negotiate operational gtees & liq. damages (e) Support with loan covenants & DSCR triggers Technical - Performance
• Environmental
• Social issues (a) Obtain long-term technical warranties (b) Use proven technologies (c) Undertake public consultation and approval

TMB

Risk Mitigation Risk Type Mitigation Financial - Debt/equity ratio

• Return on capital
• Risk / reward ratio
• Foreign exchange
• Interest rates
• Debt service cover
• Taxation (a) No excessive leverage (b) Excessive Equity IRR?: lenders will seek early repayt. (c) Impose acceptable cover ratios (1.5-2.0)? (d) Match forex exposures, if possible (e) Use fixed interest rates (if possible) (f) lenders require escrow & reserve accounts (g) Dividend constraints & cash sweeps imposed (h) Debt service triggers imposed (i) Lenders will syndicate their loan (j) Capital markets may be used to cover risks (k) Standby funding facilities required (l) Bind-in key shareholders to project success (m)Unavoidable! Legal - Licences?
• PPP law? (a) Use experienced lawyers. (b) Insist on clear simple documents & laws (c) Use Intl. Arbitration protection Political - Regime stability
• Political stability (a) Use investment insurance (c) Obtain IFI support

TMB

SOURCES OF FUNDS Type Source Equity:

• New Investor capital
• Current & future profits of developer
• In-kind contributions [e.g. land & IP]
• Issue of new shares in Project co. [IPO] Debt: Quasi-equity / debt

TMB

Measures Used by Investors

Internal Rate of Return [ IRR ] :

IRR = the discount rate at which the NPV of the project cash-flows

period by period equals zero.

Which IRR? Used?

(a) Project IRR : Revenues v. [capex + opcosts] [? ]

(b) Economic IRR : as for Project IRR, but incl. economic costs

& benefits [i.e. Cost-Benefit Analysis].

[ NB. incl. inflation or not? ] [ yes ]

(c) Equity IRR : Shareholder equity v. dividends yes

[ NB. treatment of retained surplus/profits. ]

TMB

Equity Finance: Issues & Measures Taken TMB^10

ISSUE MEASURES TAKEN

• rate of return changes over time
• dividend policy and availability
• currency convertibility and transfer
• balance of inherent project risks
• availability of equity in the construction period
• exit strategy; does secondary market exist?
• partners and the sharing of risk
• Political risk: use of investment insurance
• Taxation and economic/political stability
• use of corporate loans : mezzanine/sub-debt
  • c alculate profit over 5, 10, 20 years
  • Lenders may impose constraints
  • use insurance / have IFI support
  • mis-allocation leads to problems
  • sources identified? Need an ILOC?
  • possible Lender / Govt. constraints
  • investors prefer consortium approach
  • important in emerging markets
  • part of investor due diligence
  • Lender constraints imposed?
  • Issues of transparency & good governance?

Sources of Funds

Type Source

Equity:

• New Capital
• Current & future profits of developer
• In-kind contributions
• Issue of new shares in Project co. [IPO] Debt: -^ Aid,^ grants^ & subsidies^ : NB covenants/conditions
• Development Banks [eg. World Bank; EBRD]
• Export credits: [eg. US Ex-Im; ECGD; Sace]
• National Development Funds [ e.g. OPIC, KfW]
• Commercial lenders
• Capital markets / bond issues
• Islamic finance
• Offset & Barter Quasi-equity / debt cost

TMB

Lenders’ Criteria

1 : Debt Service Cover Ratio: [for each period] : = Free Cash Flow

Fixed Charges

Free Cash Flow = Revenues: less: operating costs [ plus : depreciation] plus: any cash balances from previous period** less : increase in working capital less : incremental cap. expenditure less : tax [**Note: some conservative lenders do not include cash balances in their calculations] Fixed Charges = Loan repayment + interest payments [ plus : mandatory payments, e.g. leases]

TMB

LENDERS’ CRITERIA 2 : Interest Cover Ratio = Free Cash Flow Interest Payments 3: Coverage Ratios : [over remainder of project] : = PV of Current & Future Free Cash Flow [CFADS] Book Value of Outstanding Debt* [NB: discount rate? Av. Cost of borrowing? ] [* = or market or discounted value?]

TMB

The Project Process

Loan Security:

Cash-Flow Project Finance v. Corporate or Govt. Guarantee

Concept Development Preliminary Info. Memo Investor Identification Lender Identification Identify Contractor & Equip. Appoint Lead bank Outline Finance Proposals Formation of Project Co. Lender Due Diligence Investor commitment Confirmed Complete Financial Agreements Financial Close Phases Time

2 - 3mth 2 mth

3 - 6 mth 3 mth

3 mth 3 mth

3 - 6 mth 3 mth

3 - 6 mth 2 mth

Proj. Fin. Govt. & Corp

Total: 14 - 24mth 13 mth

TMB

Project Information Memorandum [“PIM”]

• Project Summary;
• Project participants / ownership;
• Project description: technical & physical;
• National / macroeconomic benefits;
• Government role and support;
• Legal framework, licensing regime, & sector regulation;
• Description of market and revenue potential;
• Corporate & financial structure;
• Cash-flow analysis: data; Base Case assumptions; sensitivity analysis; risk assessment and mitigation;
• Security structure for loans;
• Project agreements;
• Environmental & social issues.

TMB

Typical PPP Structure PPP Concessionaire [SPV, LLC, JV?] Investors Lenders [ECAs; IFIs; banks] (Inter-credit. Aggt.) Share Subscription Agreement Loan Agts. Govt. Agency or Co. Services Contract. Revenues or Availability Payts Dividends 3rd Party Gtees. Regulatory Regime. The Engineer GOVERNMENT Concession [e.g. PPP ] Construction Operations & Maintenance TMB

PSC v. PPP 100 50 0

“Whole Life Cycle”

Construction

Years

PPP PSC TMB [Note: need to introduce impact of inflation in costs].