Management Engineering - Financing complex projects

Resuming notes of the course

Complete course

Financing Complex Projects Easy Recap Notes 2022 -2023 1 Fin a n c in g C o m pl e x P ro jec ts 1. lntroduction • Why infrastructures are an attractive asset class for investors? o Long term and long economic life (>10 years) o Stable and predictable operating CF (no volatility, easy forecasting) o Low technological risk (at least in the majority, the market is mature) o Provision of public services (Street, railways&) o Rigid demand (if the price increase, the demand remains the same) o Typically is a monopoly or something very similar o High barriers to entry (due to monopoly and high capex) o High regulated market (the price is fair for all the parties) o Natural hedge against inflation (price adjustments) o Higher return compared to government bonds, due to a lower interest rate • Alternatives for financing infrastructures? o Corporate finance = project developed inside the existing company , that uses its assets/liabilities and equity as collaterals for the project. The structure and risk profile of the company consider also this investment. Usually a company has a portfolio of investments. o Project finance = here there is the creation of a SPV (legal and financial entity) that has the only purpose so deliver the project. It has its own assets and liabilities and it’s tailor made for the project, it has its rules and constraints. Through the SPV the sponsors won’t be touched in case of default etc. The CF generated will be used for operating cost and repay the debt, then if there is room they will be divided to shareholders/sponsors. CORPORATE PROJECT Guarantees Company’s assets Assets of the SPV Effect on financial elasticity Reduced for borrower Untouched Accounting ON BS of the company OFF Balance Sheet Variables to find fund sources Customer relation, solidity of BS, profitability, rating & Future CF of the SPV Leverage utilizable Depends on the BS of the company According just to Cash generated in the project (very high leverage usually) • Project financing key features: o Industrial/infrastructural project financed OFF balance sheet through an SPV , that has around a network of contractual agreements with key counterparties. o SPV is legally -financially independent from sponsors (shareholders and owner of SPV) → lenders have no complain on sponsors. Sponsors won’t be touched by negative consequences of the project. They give collateral for inflows and assets for managing the project. o Consequences are only attributable to SPV , designed to secure cash. o The project risks are distributed among all the counterparties, the lower part remains within the SPV. Many counterparties can be involved and can play different roles. o The CF generated first will repay the debt and operating costs ! Only condition to receive funds is that the Operating CF > Debt service , in operations years!! 2 • Why we talk about a contractual framework ? o The SPV is an empty box and need all the things necessary to deliver the project, so many contracts with several external actors have to be signed. o The contracts are necessary to share rights but above all obligations and risks . o On avg we have 15 counterparties and 40 contracts. • PROs of PF: o Very good risk allocation among all the actors involved, in this way the D/E (leverage) can be very high , unsustainable otherwise o Higher returns on avg , thanks to financial leverage o Not all the accounting items appear always on Sponsors’ statements as off BS items o Sponsors completely isolated , they can use their assets only in case for further collaterals o Lenders can count always on securities interest and the SPV facilitate the valuation. • CONs of PF: o Higher costs respect to the corporate financing (5−10% more), mainly due to transaction costs: ▪ Advisor, legal and technical consultants need more time to value the project ▪ Higher number of contracts so higher negotiation costs ▪ Higher cost for monitoring ▪ Higher risk for lenders = higher costs • How is the SPV from a SPONSOR P.O.V? o Financial flexibility is intact o Limited losses but also responsibilities o Less risk contamination o Possibly cheaper cost of funding • How is the SPV from a LENDER P.O.V? o Full control on CF o Easier monitoring (there is just a project to look) • What type of sponsors can we have? o Industrial = they participate in the project because is something related to their core business ; they can act as client, supplier or lenders. o Contractors/sponsor = they are motivated to participate in the finance deal to supply assets and services to the SPV (initial phase or in the last phase), they can act also as small shareholders. o Public = they want to participate to realize public works (satisfactory and efficient service to the community) with private money . Usually they are the concession agreement creator. o Financial investors = they have the single goal to invest capital to gain high returns (propensity to risk). 3 2. Theory of project finance For Modigliani and Miller, corporate financing decisions do not affect firm value under perfect and efficient market, while the Project financing provides the opposite (Financing structure do matter). • Negative aspect of PF: o It’s longer and more expensive o Often more expensive cost of debt, due to a non -recourse nature (the only assets that the lender can take are the one specified as guarantees before the loan) o Less managerial flexibility due to high leverage and many contracts o Operating synergies are hard to obtain o Higher disclosure of information (not always a good thing) o Less likelihood of using interest tax shield. • So , why firms use PF? To avoid an huge risk for the company and shareholders, that is the Contamination risk : o The project is very large compared to the size of the company o The degree of risk is higher than the avg of the company’s portfolio o Directly link with the core business of the company Example of Contamination risk: if we have a new project to insert in an existing portfolio (lower market value, risk and so return) and we compute the new Expected return of the portfolio we can see an increase in the Return of the portfolio → GOOD; but we can also identify an increase in the risk of the portfolio (both in the case the correlation is = 1 or 0) → NOT GOOD. The higher risk has to be compensated with an higher cost of debt and equity ; now if the variation of WACC (calculated with Ke and Kd) is higher than the variation of the Expected return → the corporate finance will lead to a reduction of the company value !! Moreover since the size of the project > size of the company, in case of default the company will go to bankruptcy! Therefore, PF is the best solution to avoid the contamination risk for the company. • How is seen PF from the standpoint of creditors ?? In this case PF is a problem because there is the absence of the Coinsurance effect (the fact that the project can balance the losses and vice versa). Example of coinsurance effect : two projects financed by debt, one already in place (100) and one new (100), and 6 different CF generations. In the corporate finance, there is the possibility to use the CF of both the project to repay both the debts (if something remains can be given to shareholders), there is default of the company in scenario 1,2,3 (scenario 2 is due to contamination effect). In Project finance the CF of the project new are used just to repay its debt, then if something remains can be used for the existing company, there is default of the project in scenario 1,3,5 but also default of the company in scenario 1,2. (Scenario 5 default is due to absence of coinsurance effect). RESULTS: o Scenario 2 = the project finance is better because avoid contamination risk (default just for the existing project) o Scenario 3 = the project finance is better because avoid contamination risk (default just for the new project) o Scenario 5 = PF is better just in the eyes of company (higher dividends), but not for the lenders of the SPV (the SPV is in default because there is not a coinsurance effect ). There is always a trade -off to consider , between the benefits from coinsurance and contamination risk!!! 4 • To Summarize the PF: o Reduce costly agency conflicts , between shareholders and managers (thanks to same incentives = in PF the time horizon is until the completion of the project, no future growth, so there is not willingness to invest money in other projects ). But also between shareholder and debtholders (Thanks to the easy verifiability of CFs and because debt has to be repaid first ). o Reduce information costs (asymmetric info ) = thanks to the higher level of disclosure , that allow a reduced gap between insiders and lenders: close monitoring . o Reduce costly underinvestment = because with PF the project is separated from the company that can have a rigid structure, risk adverse and asymmetric information , that could lead to a reduction of new investments . PF allow to use non−recourse contracts. • Historically PF involved just the private sector, but nowadays also the public sector play a key role → PPP = Public Private Partnership , definitions: o Durable cooperation to jointly develop goods and services, sharing risks, costs and resources. o Developing of a public infrastructure by a private actors based on long term contracts. • PPP key features : o The public sector decides only the output of the project, doesn’t prescribe a method. o Private sector has the right to finance, design and construct the infrastructure , performing some services, it bears also the risk related (construction risk ) o The public sector pays a fee to the private to deliver the project, only at the end of the works after some tests o At the end to the contract the infrastructure is handed back to the government • There are two types of PPP : o Institutional = public sector is also a shareholder of the SPV, the ownership is shared between public and private actors o Contractual = there is just a contractual agreement between them, there is not the obligation to create and own an SPV. The construction always to the private partner while the management can be done also by the government . • Type of contractual schemes : o O&M = the public body (contractor) negotiates with the private one the management and maintenance of a public infrastructure . o DB = the public body negotiates with the private one the design and construction of a facility that must be compliant with min performance stds, after the construction the ownership is retain by the public . o TK = the public provides funding but all the rest is up to the private that has to finish before a certain date . The owner is the public . o Temporary privatization = temporary transfer of ownership to the private to work on the infrastructure, when the public terminate to pay the works the ownership can turn back to it. o BOT = Built Operate and Transfer for the concession period by the private, during this period the private partner should be able to repay its investment . The ownership remains always with the public. 5 o BOOT = Built Own Operate and Transfer. Similar to the BOT but here the ownership is of the private partner that need to find also fundings . At the end of the concession the public sector takes the ownership. • How the Public party can participate in a PPP? It can use Grants (there are many types of grant), Availability -based payments (payments when the facility is available), Credit enhancement tools , Direct provision of debt and equity capital, Other possible measures. Regulated revenues (guarantee by the government to a monopoly) = they cover Opex + Depreciation + Return on Invested capital. ROI = WACC*Regulatory Asset Based (RAB). These revenues are then gathered through a tariff (€*citizen → no volume risk; or €*unit → volume risk). The Outflows are represented by Capex, Opex and Corporate taxation, Sustainable interest on debt, and Dividends. 6 3. Risk analysis and Management In PF , the risks are a key factors to consider , they need to be analyzed carefully (at the beginning, in the planning phase) because they can generate unexpected changes in the CF generation (CF shortfall), so in the repayment strategy ! • Risk allocation : o Retain = the risk is internalized because allocate it to third parties is too expensive compared to possible effects. o Transfer to counterparties = the risk is transfer to the most able and interested actor o Transfer to professional agent = risk managers or insurers. • Categorization of Risks: o Pre completion (till the end of the construction) risk = where the project absorb cash because it doesn’t generate any CF. ▪ Planning = linked to design activities and possible issues, especially linked to delays. ▪ Technological = bad performances due to a wrong technology or a wrong development of it (because is unfamiliar or new). ▪ Construction = all the risks related to the construction: delays, overruns, lower performances. Mitigation : A TKCC (Turn Key Construction Contract) is useful in these cases because the SPV can transfer almost totally the risk to the contractor (EPC) in exchange for a fee . (no extra cost for the SPV, penalties in case of delays, bad performances&); the risks not under the control of the contractor will be typically transfer to an insurer . The process : after the Commercial Operating Date, there is a test on the facility where the facility must > Min Performance Std to receive a Provisional Acceptance Certificate (PAC). If it is > the MPS but not at 100%, the contractor can BUY DOWN (reimburse for the losses due a lower performance) or MAKE GOOD (invest to try to bring it to 100% before a certain data); at the end a new test will be done with a Final Acceptance Certificate and the facility is given back to the SPV . If the MPS are not meet LIQUIDATE (but in reality is not the correct way to proceed), there is a negotiation between the contractor and the SPV to avoid the default of the project, obviously at the end with penalties for the contractor. o Post completion (after the construction, so during operation mainly) risk = where the project starts to generate cash , so first it recovers the deficit and then generate a surplus. ▪ Supply = risk of shortage of raw materials or higher prices, needed for operations. The SPV can sign PUT or PAY agreements , where the SPV pre agrees on prices and quantities with a supplier . If something is lacking, the supplier has to find a way to supply all the things at its expenses . Another possibility can be an Indexation on prices , in order to transfer the risk to the final user . ▪ Operational = risk of bad procedures and maintenance, creating malfunctioning . The SPV can sign O&M agreements with some operators in order to transfer the risk and set penalties if it’s below the Service Level Agreement (SLA ). There are two types of contract : FIXED price (the operator receive every year a certain amount of money, the risk of higher prices is allocated to him) or PASS - THROUGH contract (there is a fixed part, but also penalties or rewards related to the performances). 7 ▪ Demand/Revenues = it’s the risk that our forecast are > actual revenues, due to lower demand or prices. This risk on the retail market cannot be totally covered. The SPV can use TAKE or PAY agreements (similar to put or pay), or OFF -TAKE agreements , that are long term contract with an off taker that has to pay even if it’s not able to withdraw (the price can be fixed or indexed). In the case the SPV is not able to deliver, it bears the risk to find an alternative for the off−taker. *Special cases: POWER PURCHASE AGREEMENT (PPA is a long term contract with the public sector for selling electricity; it’s used especially with renewable energies and allows to cover not only the production costs: Fixed part (that covers Fixed cost, debt and dividends), variable part (fuel cost, variable operating cost and O&M)). TOLLING (it’s no more used, but consists in avoid any cash outflows from the SPV, because it receives for free the fuel, in addition to a fee to cover all the costs. The SPV will give for free the electricity to the Off−taker that will pay directly to the toller. In order to maximize the leverage. There are two approaches Industrial and Financial). SHADOW TOLL (used in transport sector. Here there is a contract between public and private sectors, in order to transfer money to cover the loss of revenues of a tariff according to the number of vehicles and service performances. The payments are done in 3 layers : 1. To cover Senior debt and O&M costs 2. To cover Subordinated debt + variable O&M costs 3. the last one to cover dividends. o Risks common to both the phases = risk that systematically arises with different intensity ▪ Force majeure = we can use insurance policies or implement strategy to increase the adaptability of our system (resiliency). ▪ Political events = very expensive risk insurances, involvement of international agencies, export credit agencies or share with counterparties. ▪ Expropriation = government guarantees, government’s equity ownership. ▪ Legal = support by gov, include this risk ex ante in the price. ▪ Interest rate = interest rate swaps, interest rate caps or forward contacts. ▪ Exchange rate = similar to the previous one but for currency. ▪ Inflation = swap contract with hedging banks, hedging contracts& 4. lnfrastructure sector Infrastructures are Strategic , Scarce in nature and High visible . Some sectors can be: Transportation, Energy and Utilities, Communication networks, Social facilities. Key characteristics of this asset class: • Provides essential goods and services • Tangible assets , so high capex needed • High barriers to entry , often the market is a monopoly • Stable CF backed by contracts • Revenues usually linked with inflation 8 6. Contracts and Legal aspects • A negotiation about contracts is needed for PF because there are many actors involved; so Rights, Obligations and Risks have to be allocated. Key success factors of negotiation: o Understand what are you doing and the whole project o Understand the problems and implications → Risk assessment (identification, mapping and allocation) o Ensure alignment among parties o Work with qualitative counterparties (experts, that don’t come cheap, but avoid additional costs) o Rely on experts and advisors (we don’t know everything) o Remember that exists a trade -off between Risk and its costs o Remember that Megaprojects have an impact on Territory and People → stakeholder management. During negotiation remember: o Residual risks remain within the SPV and the Equity investors o Conflicts of interest are always present (especially if shareholders play a dual role) o Contractors very often underestimate risks and overestimate opportunities → they want to sell o Apply the best practices in the market because it save time and you can leverage on them to exploit some opportunities, don’t be too innovative. • Types of contracts : o Transactional agreements = ▪ Investment agreement = regulation of investment by sponsor ▪ Share Purchase agreement = exchange of money x shares. This contract is needed to ensure that what he’s getting is what is paying for (list of assets, rights, contracts&); if there is something different he can decide to exit or to have some adjustments. The SPA sets the price to be purchased through two types of contracts (The different time between the two contracts is named Interim): • Locked box mechanism : higher risk for the buyer because we take all the things (gains or losses) after the Reference date (when you ask for the statements of the company). It’s easier and more used now. • Price adjustment mechanism : here the risk is for the seller, because it sets the price just at the end of the closing period (after reference date and signing). The SPA includes also some contractual tools : • Covenants (obligations) and Condition precedent (CPs): conditions to be satisfied in order to conclude the deal, set by the buyer (approvals of any kind: banks, government, third parties&). • Representation and Warranties : they are subscribed by the seller and in case of breach there is an indemnification for the purchaser, like compensations or reduce costs (for instance some taxes that are not actually paid). 9 • Indemnities = they give protection to the buyer , but are limited and pre agreed. If something occurs they give the risk back to the seller. o Corporate agreements = this agreements regulate the roles in the company ▪ Article of association/Bylaws : it specifies the regulations for a company's operations and defines the company's purpose. Public available contract. ▪ Shareholders agreements : contract between some or all the shareholders of the company to define their relationships in order to avoid disputes . The advantages respect to the bylaws is that is confidential (not public), impose additional obligations and is more flexible. Key elements are: • Scope of the agreement • Board of directors and rules • Resolution of the board = reserve matters, business plan, board dead−lock • Dividend and financing policies • Exit policies (tag along = obligation to protect minorities; or drag along = the majority can force the minority to sell) • Reporting o Project contracts = contracts linked to the project lifecycle: ▪ Development agreement ▪ EPC contract : common form of contracting arrangement within construction industry. One example is the LSTK (lump sum turn key), but we can have also payments split in phases in order to reduce the risk for the contractor (as can be present in LS), or the commissioning can not be done (not in case of TK contracts). Why use an EPC ? • Certain of cost, reduced stress and risks for the owner • Interface risk transfer to the contractor , because it contact all the possible subcontractors& but also commodities price (financial risk) • Single point of contact for owner , easy communication ▪ O&M contract : agreement between SPV and an operator that has to operate, maintain and manage the infrastructure, if the operator is internal the risk is retained. o Financing agreements = provision of fundings by lenders o Public concession/agreement = agreement for the Public−Private relation 10 5. lnfrastructure capital budgeting The evaluation of the CF is vital for valuing the ability of the project to repay debt, pay interest , pay dividends & since in PF the only guarantees are the CF generated into the SPV. To evaluate the ability , we have to talk about Operating CF (the difference between Inflows and Outflows before financial items (debt, interest, dividends&)). The waterfall structure of CF generation is very common in Corporate Finance but in PF we need some adjustments because the weight of each item depends on the phase in which we are (for instance, the operating CF or the changes in WC are 0 in the construction phase). Indeed, in the graph of the cash absorption we can see a negative construction phase, and a growth after the COD (testing) during the operation phase. Revenues – Raw mat and operating costs – O&M fees – Insurance costs – Taxes = Operating CF (gross) Operating CF (gross) – Increase in WC – Capex = Operating CF (net) = Unleveraged free cash flow. What we have to consider for quantifying expected future CF ? • Timing of the investment (time horizon has a major impact on IRR: the longer the better the IRR) and of the construction phase. • Total initial investment (CapEx) = it’s split in two categories: o Direct investments = costs incurred in developing the infrastructure (limited time validity) ▪ Construction cost (TKCC) ▪ Purchase of land ▪ Owners’ costs (insurance policies, start−up costs&) ▪ Development costs (for starting a PF initiative) o Indirect investments = consequences of direct investment ▪ VAT on the value of direct investment (the investment is 100 and the VAT is 20%, the total amount needed by the SPV is 120. The 20 of VAT can be compensated only during the operations with the VAT on sales, so during construction it needs to cover also it. ▪ Interests and Commitments fees (they are capitalized because we have to consider them at the end of the construction phase, when there is money to pay!). This interest have to be computed and added both in the Asset side (investment cost) and in the Liability side (value of base facility). • VAT dynamic • Public grants (if exists) = there are two possibilities: Testing Grants (at the end) or Milestone grants • Sales revenues and purchasing costs • Working Capital trends (collection periods for Receivables and Payables) • OpEX • Taxes = depending on the type of project there are various kind of taxes to consider. • Macroeconomic variables = inflation trend, interest rate trend, possible forecast of specific sector indices. The forecast of CF are vital also to understand the financing mix (how much D and E??) • EQUITY = usually it follows a milestone timeline: injection of funds after the completion of a milestone in order to advance to the following. • DEBT = it’s done in different tranches to finance specific portions. There are different types. 11 When we have understood the CF, how can we study the Profitability ? • It depends on the POV of the evaluation (the most used indicators are IRR, NPV and Payback): o Sponsors /Shareholders = the deal has to be consistent with their mandate. If sponsors play a dual role, we have to consider each different profit it has. ▪ IRR for Sponsor = the negative CF are the injection of capital, while the Positive one are represented by the dividends. The lowest acceptable IRR = WACC or higher threshold. o Lenders ▪ IRR for lenders = that is composed for the negative CF by the lending activities (loan, WIP milestones and accrued interests), and the positive one by the Principal and Interest repayment. An IRR too low work to the sponsor advantage but doesn’t involve the risk of taking a sizeable portion of the financing. An IRR too high is appealing to banks but it doesn’t jeopardize sponsors’ satisfaction. Repayment schemes : • Amortized = both principal and interest paid every year → most preferred because avoid big losses in case of default. • Zero Coupon = all at the end (interest + principal). • Bullet = yearly payment just for interest , the principal is all at the end. 12 9. Financing l To assess the FINANCIAL SUSTAINABILITY , we have to understand the max level of debt that the project is able to sustain. We have to do an iterative process until the Capacity (Cash available for debt service) > Requirements (Debt service requirements). • Problem of circularity : the operating CF has to be used to pay the Debt Service and dividends, but we don’t know how much the Debt Service will be until we work out the financing mix; on the other hand the amount of the debt determines the total CF to cover in light of the capitalization of interest and fees → problem solved through a process of trial and error that provide a series of D/E mixes, respecting the only conditions: Operating CF (capacity) > Debt service (requirements). • Now, from the set of D/E we have to select the best one looking to IRR of Lenders and Sponsors! (Explained in the previous paragraph. • Securities for Lenders: they usually requires some guarantees to reduce the risk profile of the investment. We talk about Security packages composed by: o Mortgage on fixed assets o Pledge on SPV’s shares o Assignment of all the credits of the SPV o Covenants ( 1 or 1.2 (ADSCR = Avg DSCR). • LLCR = Loan Life Cover Ratio, is the present value of all the cash that the project is able to generate in the loan life, compared with the outstanding amount of the loan. If the SPV is not compliant with any covenants → Technical default of the SPV (different from the insolvency, because here the project can still perform well). If the a covenant is broken, the agent bank can conduct a materiality test (relevant for rights of creditors), in order to understand if it creates problems with the rights of creditors. Test Results: • YES, material breach (call for default), possibilities: o Cancellation of the available credit o Acceleration of the repayment of the loan o Loan payable on request • NO: the SPV has to pay just a fee (waiver fee). The SPV in this case can utilize a Cash Sweep (pay surplus to lenders, instead of in dividends). 13 • Funding options: o Equity = it usually covers the first part of project development and it’s contributed by sponsor (banks require a Min Initial Contribution and some Stand−by agreements = they are needed to cover alteration in the leverage when a stand−by loan is used). There are 3 possible profile to equity injection: ▪ Entirely before the loan drawdown (before construction) ▪ Entirely after the loan drawdown (convenient for sponsors because increase the IRR, but needs an higher amount of debt during construction, higher capitalization of interest = higher costs) ▪ Pro−rata clause according to E/E+D o Debt ▪ Subordinated/mezzanine = it’s in the middle between equity (high risk and high return) and senior debt (low risk and low return). It incorporate larger equity−linked components, and will be repaid before dividends. PROs: • For Shareholders = increase in ROE and avoid dividend trap • For Lenders = reduction of Loss Given Default for senior debt, because the losses are firstly absorbed here • In general = increase the financial flexibility of the project; Interest paid on subordinated debt are tax deductible; Dividend trap (that’s why usually is contributed by sponsors and not lenders): we know that dividends are distributed only when Net Income > 0 (especially during construction where the depreciation and amortization is stronger due to accelerated method; if the value of depreciation > debt service → Net income < 0). The mezzanine allows sponsors to receive the interest on it, even if the net income < 0!! Moreover, these interests are deductible and paid before taxes = increase in IRR. CONs: • Risk of equity < 0, due to the higher amount of interest expenses that increase the losses in the first year (if losses > share capital = negative equity) • Thin capitalization rules (tax deductibility is not always allowed) . ▪ Senior debt : • Base facility = it’s provided to cover the first investments (Construction, land, interests and fees accrued in construction). Its reimbursement is usually Amortized and on a time horizon similar to the duration of the operations. The SPV will pay the commitment fee on the unutilized part. It’s not a revolving credit (you can’t have infinite withdraw and repayments) • Stand by facility = represent a back−up for contingencies during construction, so usable only if specific events occur. This is the riskiest part of the loan, so the interests are higher (higher spread), because banks set them but they don’t want to use. It’s a revolving credit line! • VAT facility = this is a loan specific to cover the VAT during construction; the principal is reimbursed with cash from VAT on sales to customers, while interests are paid with operating CF. 14 • WC facility = it’s activated when the SPV enters in operational phase in order to cover the difference between receivables and payables How can be repaid? • Variable principal repayments = the repayments are set according to the CF, taking into account also future interest rate trends. However, the % may not match the CF perfectly • Dedicated percentage/Debt sculpting = this method define a constant DSCR and so the repayment is in proportion to the CF, the higher CF the higher the amount repaid. Debt sculped * CF = Debt service. o Project Bonds = a new alternative that an SPV can use to obtain funds, because the debt is not enough anymore in infrastructure finance. It’s very similar to contract bank debt, but the bond can count on a larger base of parties interested in financing the deal. This method is more used by Institutional investors rather then retail one. PROs: ▪ Fixed pricing = with bonds the you can lock your financing cost ▪ higher tenor = bonds allow for longer maturity ▪ Diversify sources of financing ▪ Light covenants = there are lighter covenants with bonds ▪ Flexibility in amortization ▪ Rap id ex ecution (8−12 week s) ▪ Ratings • Refinancing: it’s common practice to refinance an already−granted loan or increase/reduce the sponsors’ equity commitment (usually when construction is finished because the risk is lowered and now the assets can be utilized as guarantees). It’s used to improve NPV and IRR (for sponsors) and earn new fees (for lenders). There are two types of refinancing: o Soft =it’s a renegotiation of the conditions, so no changes in the financial leverage or tenor. It’s useful to: Free up cash from debt service reserves Reduce the spreads paid on the loan ▪ ▪ ▪ Reduce restrictions of covenants o Hard = it leads to change in the level of leverage or in the tenor of the loan (that are changes in the risk profile). Methodologies: ▪ Takeover: is the acquisition on the loan by a new pool of lenders in order to replace the old one with the same conditions or changing (usually requires the approval of all creditors). If there is a regearing (changes in D/E), it needs the approval of sponsors. ▪ New financing: the debtor can repay in advance (usually helped by the new lenders) and set up a new deal. ▪ Bond issues: this method (at the end of construction) calls for a project bond issue and credit enhancement guarantee scheme collateralized by the future CF . The issue allows to have longer tenor respect to the loan of banks, less covenants, a fixed interest rate and possibility of balloon repayment (a bigger final part at the end) . 15 9. Financing ll Services offered for PF initiatives are two: • Advisory services = soft services useful to define the risk profile, the time schedule and the size of a deal (consultancy services). They don’t require huge amount of capital so can be provided by not− financial parties (sometimes also by the sponsor itself). These services include all the studies/analyses for the preliminary evaluation of the financial feasibility + initial assumption to how to finance. It’s a market still quite concentrate by the corporate finance divisions of major consulting firms. • Financing services = these are the lending activities (loans and sometimes equity), here is necessary capital so commercial banks play a leading role . This services can be also named Arranging services, when a party wins the mandate to manage the financial contracts of an SPV . This market is not concentrated as the Advisory one. Where are talk about big projects, a single bank (arranger) for the entire project is not sufficient → a syndicate is needed! Syndicate: group of banks with the goal to provide funds to the SPV. o Why is important? For Risk sharing and networking (creation of loan pools). o Issues: ▪ How many banks in the syndication? In general depends on the dimension of the PF, but there are trade−offs. • High number = risk reduction for the single bank; but higher coordination costs and confidentiality risk. • Low number = high degree of confidentiality, and lower coordination costs and decision making problems; but the each bank has to underwrite a bigger portion. ▪ Which banks? the Mandate Lead Arranger (MLA) that has to contact all the others but there are some tips: if the MLA invite someone to participate is very likely that the invited will return the favor; According to the features of the deal some specific institutions are needed; close relationships push the involvements of some banks. ▪ How much of the loan will be sold on the market? This is the final decision of the MLA (coordinator of all the underwriters) and underwriters. Selling of a huge portion of the loan → PROs (allocation of credit risk to third parties; free liquidity; increase the return on capital employed), CONs (bad signal to the market, because the MLA don’t trust the ability of borrower to repay the debt). o Actors involved: ▪ MLA = it’s the main actor, designs the operation and invites all the other ▪ Co−Lead Arrangers = they may help the MLA ▪ Participants = Arrangers, Co−Arrangers and Lead Managers/managers/co−managers (these last three grant a part of the loan, in +/− large part). ▪ Documentation banks = prepares all the finance documents ▪ Agent bank = it acts as a representative of the syndicate and control SPV’s bank accounts. o Syndication strategies: ▪ Single stage = there is just the MLA that underwrites the loan, and then contacts additional banks (if it can’t find anyone, it has to underwrite the entire amount alone → higher risk for MLA, so higher return). This method is used when the market is