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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].