Project Finance

CORPORATE FINANCE
Pre-conference Masterclass
Project Financing for Infrastructure Projects
19 August 2008
ADVISORY
Agenda
 Part 1: Introduction to Project Finance
 Part 2: Project Structures
 Part 3: Documentation
 Part 4: Project Issues
 Rail & Road Focus
1
Part 1: Introduction to Project Finance
What is “Project Finance”?

“A financing of a particular project or asset in which a
financier is satisfied to look initially to the cash flows and
earnings of project or asset as the source of funds from
which a loan will be repaid and to the assets of the project
as collateral for the loan.”
Financiers look to the cash flow of the financed asset for

repayment. Contrast with corporate finance.
2
Corporate Finance
 The balance sheet of the borrower is exposed to the project risk
 Corporate debt is often secured against the assets of the entire firm, not
just the project.
 This means that if the project fails, creditors will be able to make claims
against all assets of the borrower even those that are not related to the project
 Corporate debt is held on the balance sheet of the firm, increasing its
leverage.
 Higher leverage will affect the ability of the firm to raise further debt financing
in the future
 Seen as weakening effect on the borrower’s balance sheet
3
Project Finance
 A financing method that can help borrowers deal with
project-specific risks and limit exposure to the
downside risk of the project.
 Financier’s recourse is limited project revenues and
assets (limited recourse financing)
4
Comparisons Between Project Finance & Corporate Finance

Features
Project Finance Corporate Finance
 Financiers look at cash flows of a  Financiers look to the overall strength

Financing
single asset (the project) for of a company’s balance sheet and

repayment. projections, which is usually derived
not from a single asset but a range of
assets and businesses.
 No / limited guarantees for project  All assets of the company can be

finance debt used for security
Security
 Project contracts are usually the  Has access to whole cash flow from
main security for lenders; project spread of business as security, thus
companies’ physical assets are likely even if project fails, corporate lenders
to be worth much < the debt can be repaid.
5
Features
Project Finance Corporate Finance
Duration
 Project has a finite life as such the debt  Company assumed to remain in
must be repaid by the end of this life business for an indefinite period and
losses can be rolled over.
 Lenders exercise close control over

Control
activities of Project Company to ensure  Leaves management of company to run

value of project is not jeopardise. business as they see fit
6
Project Finance
 A method of mobilizing corporate finance through a newly organized
company, partnership or contractual joint venture, called a project vehicle.
 Co. loans are generally non-recourse or limited recourse to the sponsors of
the project.
 The funding for the Project Company has 2 elements:

1. Equity; and
2. Project-Financed debt
7
Typical Project Contractual Structure
SPV typically includes a

Procuring • Construction investor
Direct Agreement Entity • Facilities Management investor
• Equity Investor/ Project Manager
Periodic Receives
Payments Services
Equity
Loans Returns
Debt Project Co. Equity
Providers (Special Purpose Vehicle) Equity Providers
Debt
Service Stake
Subcontracts
Subcontractors (infrastructure builders,

equipment suppliers, O&M contractors etc.)
8
Why Project Finance?

 Benefits for Investors
 Projects are highly leveraged  leads to a higher return on equity (ROE).
 Risk spreading – enables risk of investment to be divided up between
investors
 Limited ‘risk contamination’ between the project and the rest of the investor’s
business (risk is quarantined to invested equity)
 Increased borrowing capacity of investors with the reallocation of project risks
to other contracting parties
 Avoids restrictive covenants on the corporate balance sheet arising from a
project’s debt financing.
 Small amount of equity commitment required enables parties with different
financial strengths and skills to work together.
 Matches each commercial undertaking with the specific assets and skills
required to build and operate it.
9

 Benefits for Investors
 Off balance sheet financing where equity represents a minority investment
10

 Benefits for the Public Authority (PA)
 The increase in investor’s financial capacity creates a more competitive
market for projects, to the benefit of the PA.
 Involvement of 3rd parties (lenders and advisers) would mean that a rigorous
review of the risk transfer is carried out and any weaknesses exposed
(independent due diligence undertaken by financiers)
 Highly leverage inherent in a project-finance structure helps to ensure the
lowest cost to PA.
 There is transparency as project financing is self-contained and the true costs
of the service can more easily be measured/monitored.
11
3 Main Sectors Using Project Finance

1. Natural Resources Sectors
 Mining, oil & gas
2. Energy Sectors
 Independent power projects (IPPs) in the electricity sector,
primarily for power generation using BOO/BOT structures, gas
for power  gas pipelines & liquefied natural gas
3. Infrastructure Sectors
 Public Private Partnerships  Public Infrastructure (eg. toll
roads, schools, hospitals etc)
12
The Project Finance Market

Total Private Investment Size (US$m) for Deals reached Financial
Close before Dec 2007
110,000
90,000
Private Investments
Other
Telecommunications
70,000
Roads & Transport
PPP
50,000 Pow er
Petrochemicals
Oil & Gas
30,000
Mining
Leisure and Property
10,000 Industrials
Philippines Thailand Singapore Indonesia Malaysia Vietnam

-10,000
Country
13
Programme for Project Financing

Project Weeks
Test/Event/Milestone 1-4 5-8 9-12 13-16 17-20 21-24 25-28 29-32 33-36 37-40 41-44 45-48 49-52
• Sponsors approve Project Feasibility Study
• Appoint project legal counsel and financial advisor
• Appoint other advisors (e.g. Insurance environmental)
• Agree borrowing structure
• Negotiate additional equity
• Establish project vehicle
• Agree project documents with contractors/ operators/
suppliers/ offtakers
• Develop financing term sheet
• Prepare information memorandum
• Select arrangers/banks
• Agree loan documentation
• Agree security and other documentation
• Obtain all consents and permits for project
• Obtain sponsor board/shareholder approval
• Bank’s technical advisor to approve technical aspects of
project
• Bank’s insurance advisor to approve project insurances
• Agree financial model
• Agree legal opinions
• Finalise conditions precedent
• Signing and financial close 14
• First drawdown
Parties to a Project Financing

Typical participants in a project financing structure (Figure 1)
include:
 Project Sponsor (typically the equity providers)
 Procuring Entity/Off-taker
 Lenders/Financiers
 Subcontractors (infrastructure builders, equipment suppliers, O&M
contractors etc.)
 Insurers
 Advisers – legal, technical and financial
15
Typical Project Contractual Structure
SPV typically includes a

Procuring • Construction investor
Direct Agreement Entity • Facilities Management investor
• Equity Investor/ Project Manager
Periodic Receives
Payments Services
Equity
Loans Returns
Providers (Special Purpose Vehicle) Equity Providers
Debt
Service Stake
Subcontracts

16
Parties to a Project Financing

Fig. 1
17
Source: Key Project Parties, A Guide to Project Finance (Denton Wilde Sapte)
KPMG’s Role in Project Finance
GIPG product offerings
Post-
Strategy Execution
completion
Structuring Procurement Closure
 Thought leadership
 Secondary markets
 Policy & legislation  Procurement strategy  Debt raising
 Valuations
 PPP/PFI models  Prequalification
 Tendering  Funding competitions
 Commercial structure  Financial modelling  Commercial and
 M arket entry  Refinancing
 Consortia formation  Bid evaluation financial close
 Negotiation  Final business case
 Value for money  Competitive dialogue
 Risk analysis  Corporate/asset M &A
 Programme definition  Initial business case  Restructuring
& governance
GIPG aw ards
Private sector
Public sector
KPM G
2007 H1 Top PPP Financial Adviser for
Education, Transport, Defence and KPM G KPM G KPM G
Waste Sectors (Closed Deals)
2007 H1 overall Top PPP Financial Corporate Finance Deal of the Year – EM EA Pow er Deal of the 2006 European PPP Deal
Adviser (Closed Deals) Westinghouse Deal Year – Falck Deal of the Year –
Limerick Tunnel Deal
2006 Global Deal of the Year –
Golden Ears Bridge Deal
18
Agenda
19
Part 2: Project Structures
Contents
 Sources of Project Finance
 Bank Debt
 Capital Markets
 Investment Funds
 Government
 Multilateral Agencies
 Islamic Financing
 Project Finance Arrangements

 BOT
 Forward Purchase Model
 PFI/PPP
20
Structure
 Use of special purpose vehicle (SPV).
 Project sponsor holds the project through a special purpose vehicle.
 If there is more than one participant in the project, the SPV can be
structured as:
 Incorporated Joint Venture (most typical for roads/transport projects)
 Partnership
 Unincorporated Joint Venture Partnership (resources project)
 Unit trusts
21
Sources of Project Finance
Bank Debt
Islamic Capital
Finance Markets
Sources of
Project Finance
Multilateral Investment
Agencies Funds
Government
22
 Bank Debt
 Foreign and local commercial banks.
 Foreign banks important in Emerging Market Project Finance.
 Cross-border loans to developing countries tend to be covered.
 EG: OCBC, HSBC, CIMB, RHB
 Capital Markets
 Stock and bond issuance.
 Securities markets allow finance to be raised for riskier projects.
 Bond market offers long-term fixed rate funding (which is cheaper than
bank loans).
23

 Bank Debt vs Capital Markets
 Size – Bonds used for larger projects
 Cost – Bonds typically tend to have a lower cost than bank loans (but query credit
crisis and roles of monolines)
 Term – Bonds typically have longer tenor which suits profile of certain projects
 Flexibility – Bank loans are generally more flexible as bonds have wide spread and
investors base (eg. waivers and amendments etc)
24

 Investment Funds
 Created by investment banks, multilateral banks and insurance companies.
 Channel equity and (sometimes) debt from institutional investors to power, telco
and transport projects.
 EG: Asian Giants Infrastructure Fund (AMP), Macquarie European Infrastructure
Fund 2 (Macquarie)
 Government
 Financial support for (typically) major infrastructure projects:
1. State may take on development of infrastructure integral to success of
project (EG: port or gas pipeline)
2. Grants for infrastructure development, R&D etc.
3. Compensates private sector through government availability payments
and shadow/ real toll
25

 Multilateral Agencies
 World Bank, ADB, AfDB, IsDB etc.
 Provide loans, grants, guarantees etc.
 Focus on the development/reconstruction of key infrastructure in emerging
economies.
 EG: Western Regional Road Corridor Development Project (Phase I) in Mongolia
(US$112.1m, of which US$40m is an ADB Grant)
 Islamic Finance
 Sharia Law prohibits Interest (Riba), Uncertainty (Gharar) & Gambling (Maisir).
 Sharia boards have to ascertain if transactions are Sharia-compliant.
 Can be conceptualised as Structured Finance.
 EG: US$425m Islamic project financing arranged for the US$615m construction
of a third terminal port in Jeddah, Saudi Arabia
26

 Leasing
 Most common for assets such as ships, aircrafts etc.
 Lessor typically looks to receive a guarantee or letter of credit to cover it against
any project risk that it may be exposed to.
 Intercreditor arrangements tedious to structure but may be worth it if overall tax
benefits for the project are significant.
 Forward Purchase Model

 Project lender makes advance payment for the purchase of products generated
by the project which will be deliverable to the lender following the completion of
the project.
 Project company uses these proceeds for the construction and development of
the project.
 Lender either sells the products itself or to the project company.
 EG: Oil and gas, minerals etc.
27
Project Finance and Traffic/Transport Projects
28
Public Private
Partnerships
 PPP key features

 design, build, finance, operate the infrastructure over a
specified period (>20 years)
 Private sector sets up an SPV
 Project finance structures used
 provision of end-to-end services – eg. roads/public transport
 Private sector gets a return over service term (eg. tolls, fares
or service payments)
 non-governmental income stream (third-party revenue) eg
tolls and advertising etc
 risk allocation to most suitable party (demand risk)
29
 Long-term output based contract

 for delivering a specified asset condition and service
 with appropriate incentives for performance over the life of the contract
 capital costs paid over the lifetime of the contract, revenue not capital
spending
 Private sector involvement
 in the design, build and operation of infrastructure projects . . . and they take
responsibility for performance
 to decide what is the most effective mechanism for delivering the specified
outputs
RISK TRANSFER
30
 Private sector financing (both equity and debt)

 underpins business responsibility to deliver under contracts
 improve scrutiny of contractors ability to deliver contracts
 certainty of financing through long-dated funding structures
 uses $ payment structure to incentivise correct behaviour
31
Simplified contractual structure of a PPP
Public Sector
Concession Service Fee

Deed (ongoing)
Construction
Contract Special
Construction Operations/Facilities
Contractor Purpose Manager
Vehicle Maintenance/
Performance
Facilities
Guarantee
Management
Debt
Debt/Equity Long-Term Asset
Servicing
Underwriting Management
Services
Project Parent
Financier Sponsors Company
Support
32
Agenda
33
Part 3: Documentation
Role of Documentation
 Apportionment of project risks; and
 Implement agreed risk allocation between the parties
Structure of Documentation
No standard set of documentation – but can be grouped as follows:
 Shareholder/sponsor arrangements
 Loan and security documents
 Project documents
34
Diagram
LENDING DOCUMENTS
Loan Agreements with:
Banks/ Export Credit Agencies/ Multilaterals
SHAREHOLDER/
SPONSOR
SECURITY
DOCUMENTS PROJECT/
DOCUMENTS
Pre-development SPECIAL Security
Agreements/
Shareholders’
PURPOSE Documents
VEHICLE covering all
Agreement/ Sponsor
project assets
Support Agreement
PROJECT DOCUMENTS
Construction Agreement, Operation and Maintenance Agreement,
Fuel Supply Agreement, Sales/Offtake Agreement
35
Shareholder/ Sponsor Documentation

 Shareholder agreements/ joint venture agreement
 Regulates the relationship between shareholders
 Injection of share capital; how, when and in what form;
 Funding of the project company;
 Voting rights
 Dividends policy
 Management of the SPV
 Disposal of shares and pre-emption rights
 Resolution of disputes
36
Support Agreements (tripartite agreement)

 Management and technical assistance required from
shareholders/sponsors
 Equity injection or shareholder loans that might be required
 Disposal of shares/interests
 Security requirements
37
Loan and Security Documentation

 Term Sheets
 Prepared during due diligence process
 Regulate the terms and conditions of project loan
 Subject to condition precedents
 Prepared for the purpose of agreeing financing terms
 Typically only valid for a limited period of time (three months)
 Project Loan Agreement

 Fully develop and document the terms and conditions of project loan
 Key financing document
38
Project Loan Agreement

 Disbursements and Repayment Terms
 Drawdowns
 Multiple disbursements
 Tied to construction schedule
 Subject to conditions precedent
 Repayment of Loan
 Interest capitalised during construction phase
 Typically six-monthly repayment schedule (principal + interest)
 Commencing on service availability
 Two debt service methodology:
 annuity payments; or
 equal principal payments
39
Debt Service Payment Profile under Two Payment Methods
Annuity Level principal
Interest Interest
Amount
Amount
Principal Principal
Interest Interest
-2 -1 1 2 3 4 5 6 7 8 -2 -1 1 2 3 4 5 6 7 8
Principal repayment Interest payment
Source: Project Development, Financing large Projects (M. Fouzul Kabir Khan, Robert J. Parra)
40

 Fees and Expenses
 Fees and expenses paid to lenders
 Commitment fee (25-75bps pa) calculated over the undisbursed balance lenders have
committed
 Monitoring fees (25% bps) – administrative charge for monitoring the project
(particularly over construction period)
 Conditions Precedents
 Preconditions for disbursements of loans
 Documentary CPs
 Delivery of project agreement
 Security documentation
 Legal opinions
 Non-documentary CPs
 Equity injection
 Fees and expenses paid
41

 Conditions Precedents (cont’d)
 Additional CPs required for subsequent disbursements
 Auditor to confirm project costs
 Certification of construction milestone/s
 Confirmation of Representation &Warranties
 No default on part of borrower
 No Material Adverse Change
 Representation &Warranties
 Minimises lenders’ due diligence costs
 Non-complianance with or untruth constitutes a default under the loan
 Typical R&Ws
42

 Loan Covenants
 Positive Covenants
 Negative Covenants
 Maintenance of project accounts
 Cash waterfall – priority of payments from project cashflow
 Maintain project cover ratios (LLCR/DSCR)
 Furnishing information (eg. access to inspect, financial, technical and operational
information)
 Corporate status/validity of authorisation
 Maintenance of insurance
 Payment of taxes and other statutory fees
 Compliance with environmental requirements
43
 Loan Covenants
 Cover Ratios
 Amount of debt raised is determined by the projected cashflow
 Looks at the ability of the cashflow to service debt with a “safety” margin
(ie. equity distributions)
 Annual Debt Service Cover Ratio (CADS / debt service (1.10-1.2X))
 Loan-life Cover Ratio (NPV of CADS over loan /Debt outstanding)
 Project Life Cover Ratio (NPV of CADS over project /Debt outstanding)
44

 Negative Covenants
 Restriction of use of free casflow
 No distributions (other than that allowable under the cash waterfall)
 No disposal of assets
 No further indebtedness
 No creation of additional security over project assets
 No change of business
 No amendments to material contracts
45

 Payments Waterfall
 First – to meet Operating Costs falling due
 Second – Debt service costs (interest then principal)
 Third – payment to debt service reserve account
 Fourth – payment to maintenance reserve account
 Fifth – Distribution to equity
46

Events of Default
 Relieves lenders of their commitments
 Entitles them to enforce; including
 Accelerate the loan (ie. demand that loans be made due and payable)
 Step-in rights can be exercised
 Realisation of security
 Payment defaults
 Non-payment
 Cross-default under other credit arrangements
 Representational defaults
 Misrepresentations
 Non-compliance with covenants
 Insolvency
47
Security Documentation
 Charge over project assets (fixed or floating charge)
 Direct agreements (or alternatively lenders tripartite agreement)

 Protect lenders against default by Borrower under the principal contract (eg. the Project
Agreement)
 Notice to be given to lenders of any default
 Project counterparty to suspend any termination rights
 Step in right on the part of the lenders
 Requires counterparty to make any due payments direct to Lenders
48
Part 3: Documentation - Direct Agreement
Procuring
Entity
Direct Agreement
Periodic Receives
Payments Services
Equity
Loans Returns
Providers (Special Purpose Vehicle) Providers
Debt Equity
Service Stake
Subcontracts

49
Project Agreement
 Concession Agreement
 Design, Build, Finance and Operate
 Regulates the rights/obligations of concession grantor and SPV during the concession
 Allocates the risks of the project as between concession grantor and SPV
 Typical terms:
 Grant of concession – defines term of concession
 Duties and obligations imposed on SPV/ Concession grantor
 Payment of concession fees/ retention of tolls etc
 Default/Event of Default
 Restriction of transfers and assignments
 Termination regime
50
Other Documents
 Construction Agreement
 Operating and Maintenance Agreement
51
Part 3: Security Techniques
Security Techniques
 Security
 No recourse to project company’s assets other than project assets
 Lenders looks primarily to project assets and cashflow generated by project to repay
loans
 Valid and effective security interests are crucial
 Motivation
 Ability to sell project assets and recover debt
 Defensive mechanism to prevent other creditors taking security over project assets
 Control destiny of the project should something goes wrong
 Prevents SPV from disposing secured assets without lenders’ consent
52
Security Techniques
 Scope of Security
 Project Agreement
 Subcontracts - Construction Contract, O&M Contract
 Plant and machinery
 Real property
 Project insurances
 Pledge over bank accounts
 Shares of SPV
 Enable lenders to take over management of SPV
53
Security Techniques
 Issues with respect to Security
 Selection of governing law (UK and NY law)
 Common law countries (eg. UK, Singapore, Australia) – concept of trust,
assignments well-known and well-developed
 Concept of floating charge (eg. receivables, bank accounts)
 Charge over future assets
 Restrictions on assignments (eg. Host country may prohibit creation of
security of land in favour of foreign lenders)
 Bankruptcy laws may prevent enforcing security (Chapter 11 in US)
54
Agenda
 Part 1: Introduction to Corporate Finance
55
Part 4: Project Issues
Risk Evaluation and Transfer

 Project finance requires
 the examination of detailed specific risks
 the examination of the effect of the risk eventuating
 the allocation of the identified risks
 the examination of avenues to mitigate the risks
 Phases of Risks
 General risks – political risks and economic risks
 Construction phase risks – site, construction and completion risks
 Operation phase risks – operational risks
Ostregion Case
56
Risks passed to private sector

Category Examples
Site risks  Existing structure
 Site conditions
 Some Environmental risks
 Clean-up and rehabilitation
 Availability of site
Design, construction and  Design

commissioning risk  Construction (excl force majeure/government
intervention)
 Commissioning
Financial  Financing availability

 Tax changes
Operating  Inputs
 Maintenance and refurbishment
57
Risks passed to private sector

Category Examples
Operating  Operator failure
 Technical obsolescence
Market  General economic downturn

 Competition
 Demographic change
Industrial relations  Risk of strikes, industrial action
Asset ownership  Default and termination

 Technical obsolescence
58
Shared risks
Category Examples
Site Risks  Some Environmental risks (contamination)
Market  Inflation risk

 Government may redress impacts of government
subsidised competition
Legislative  Changes in law
Force Majeure  Floods, earthquakes, terrorism, etc
59
Risks retained by the public sector

Category Examples
Site risks  Some Environmental risks
 Native title
Sponsor  Probity
 Financial
 Technical and operational
Financial  Interest rates pre completion

 Further finance requirements
Operating  Changes in output specification outside agreed range
Asset ownership  Residual value on transfer to government
60
Contacts
For further details please contact:
David Ng Lieven Jacquemyn

Director, Global Infrastructure and Director, Global Infrastructure and
Projects Group Projects Group
KPMG Corporate Finance KPMG Corporate Finance

16 Raffles Quay #22-00 16 Raffles Quay #22-00
Hong Leong Building Hong Leong Building
Singapore 048581 Singapore 048581
Tel: +65 6213 2416 Tel: +65 6213 3945

Mobile: +65 8201 0096 Mobile: +65 8168 1398
Email: davidng@kpmg.com.sg Email: lieven_jacquemyn@kpmg.com.sg
61
Thank You

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CORPORATE FINANCE

 Part 1: Introduction to Project Finance

 Part 2: Project Structures

 Part 4: Project Issues

 Rail & Road Focus

What is “Project Finance”?

Financiers look to the cash flow of the financed asset for

Comparisons Between Project Finance & Corporate Finance

 Financiers look at cash flows of a  Financiers look to the overall strength

single asset (the project) for of a company’s balance sheet and

 No / limited guarantees for project  All assets of the company can be

 Lenders exercise close control over

activities of Project Company to ensure  Leaves management of company to run

 The funding for the Project Company has 2 elements:

Typical Project Contractual Structure

SPV typically includes a

Subcontractors (infrastructure builders,

Why Project Finance?

Why Project Finance?

Why Project Finance?

3 Main Sectors Using Project Finance

The Project Finance Market

Philippines Thailand Singapore Indonesia Malaysia Vietnam

Programme for Project Financing

Parties to a Project Financing

Typical Project Contractual Structure

SPV typically includes a

Subcontractors (infrastructure builders,

Parties to a Project Financing

Structuring Procurement Closure

 Part 1: Introduction to Project Finance

 Part 2: Project Structures

 Part 4: Project Issues

 Rail & Road Focus

 Project Finance Arrangements

Sources of Project Finance

Sources of Project Finance

Sources of Project Finance

Sources of Project Finance

Sources of Project Finance

Sources of Project Finance

 Forward Purchase Model

Project Finance and Traffic/Transport Projects

 PPP key features

 Long-term output based contract

 Private sector financing (both equity and debt)

Concession Service Fee

 Part 1: Introduction to Project Finance

 Part 2: Project Structures

 Part 4: Project Issues

 Rail & Road Focus

Shareholder/ Sponsor Documentation

Support Agreements (tripartite agreement)

Loan and Security Documentation

 Project Loan Agreement

Project Loan Agreement

Debt Service Payment Profile under Two Payment Methods

Annuity Level principal

Principal repayment Interest payment

Project Loan Agreement

Project Loan Agreement

Project Loan Agreement

Project Loan Agreement

Project Loan Agreement