Infrastructure Infrastructure FinanceFinance

D. C. PaiD. C. Pai Prof.Prof.

PIMSR PIMSR

IMPORTANCE OF IMPORTANCE OF INFRASTRUCTUREINFRASTRUCTURE

• In the words of ADB Chairman Mr. Tadao Chino:

“Infrastructure development offers the foundation on which a country can seize and capitalise on the opportunities ushered in by globalisation and regional integration. Experiences across the region show that FDI and new technologies are most likely to bypass countries with inadequate and poor infrastructure investment climates.”

IMPORTANCE OF IMPORTANCE OF INFRASTRUCTUREINFRASTRUCTURE

• Infrastructure is defined differently by different Government agencies, but broadly includes the following sectors

- Energy- Logistics and Transportation- Telecom- Urban and Industrial Infrastructure- Water and sanitation

Multiplier effect of Infrastructure Projects is very high.

DEFINITION OF INFRASTRUCTUREDEFINITION OF INFRASTRUCTURE• RBI Definition (Nov 30, 2007)

Developing or developing and operating or developing, operating and maintaining an infrastructure facility in

- Energy- Logistics and Transportation- Telecom- Urban and Industrial Infrastructure- Agro Processing, Construction for storage

of Agro Products- Schools and Hospitals- Pipelines for Oil, Petroleum and Gas- Water and sanitation

Categories of ProjectsCategories of Projects

Brown field:• Expansion of capacity of product lines

by existing ventures.• Expansion by adding new product lines.• Investment by existing ventures for

new technologies.Green field:• Entirely new industrial venture being

established.

Methods of Financing CapExMethods of Financing CapEx

• Traditional Financing or Balance Sheet Financing

• Project Financing or Off-balance sheet Financing

Traditional FinancingTraditional Financing

In traditional financing or conventional direct financing, financing of capital expenditure is done through retained earnings and long term full recourse debt issued to the parent company by lenders where lenders look to the firm’s entire asset portfolio to generate the cash flow to service their loan.

What is Project FinancingWhat is Project Financing• According to Finnerty (1996), “….the raising of

funds to finance an economically separable capital investment project in which the providers of the funds look primarily to the cash flow from the project as the source of funds to service their loans and provide the return on their equity invested in the project.”

• According to Nevitt & Fabozzi (2000), “A financing of a particular economic unit in which a lender is satisfied to look initially to the cash flow and earnings of that economic unit as the source of funds from which a loan will be repaid and to the assets of the economic unit as collateral for the loan.”

Project FinanceProject Finance• Dependence only on Project Cash Flow

means:• Lower Tolerance for risks• Determine all risks and mitigate them• Mitigation is by allocating the risk to the

entity best placed to mitigate them.• Done through the process of contracting

with the multiple agencies involved.

• Investments Mostly through project companies (SPVs)

• Reliance on project cash flows rather than parental support.

• Highly capital intensive and has long gestation period

• Higher risks- to be evaluated carefully and proper structure for mitigation provided

How is infrastructure lending different from other project lending?

Project Finance Vs. Corporate FinanceProject Finance Vs. Corporate Finance

Project Finance Corporate Finance(Balance Sheet Funding)

Previous Track Record: Nil Previous Track Record: Yes

Recourse limited to cash flows

Recourse Limited to all borrower assets

Debt: Equity- 70:30 to 80:20

Debt: Equity- 50:50 to 66:33

DSRA: 6months DSRA: Nil

Sponsors Cost Overrun Support : Limited

Sponsors Cost Overrun Support : 100%

Types of Project Types of Project FinancingFinancing

• Project Financing – With Recourse – To sponsors– Non Recourse – Recourse only to

Project Cash Flows & Project Assets– Limited Recourse – Recourse to

sponsors under certain defined circumstances

Why a special purpose entity?Why a special purpose entity?

Lenders• Legal and structural separation (Bankruptcy

remoteness)• Ring fencing from sponsor’s cash flows• Focused entity with a limited purpose (Cash

flow protection)• restrict additional debt issuances

Sponsor• Derisk own balance sheet from high project

leverage• Creates an exit option for equity investors• Tax structuring

Concessionary Financing Concessionary Financing InstrumentsInstruments

• Rupee Term Loans – Banks /FIs/ Insurance Co’s• External Commercial Borrowings• Export Credit Agency• Suppliers Credit• Subordinated Loans• Bonds – No covenants for straight instruments,

tradable.• Soft Loans or Grants by Government- Viability Gap Funding: Loans/Grants from Govt.- Defrayment of set up costs: Grants to meet the

set up costs of setting up a Project- Combination of Soft Loans with commercial

funding so that the COC is lowered

Cost of Various Financing InstrumentsCost of Various Financing Instruments

S.No. Instrument Percentage of Project Cost

Costs/Tenor

1 Grants (if applicable)

0% - 20% Nil

2 Equity 15% - 30% 14 – 20% Equity IRR

3 Subordinate Debt

0 -20% Maturity 7 – 15 yearsTypical Cost : 12 – 15%

4 Senior Debt 50 – 80% Maturity 5 – 12 years, Typical Cost 11 -13%

Project AppraisalProject Appraisal • Adoption of a process to enable an

independent & objective assessment of the inter-relationship between Technical, Financial, Commercial, Economic, Managerial, Ecological and Social aspects of an investment proposition for arriving at a financing decision

• Determination of the viability of a project

• Help re-shape project to enhance viability

PROJECT APPRAISAL PROCESSPROJECT APPRAISAL PROCESS

• Promoter Evaluation• Contractual Framework• Risk analysis and mitigation• Commercial Assessment• Financial Feasibility Assessment

Stages in ProjectStages in Project• Project Development Stage

• Project Construction Stage

• Project Operational Stage

• Project Termination/Abandonment Stage

Time Distribution of Project Time Distribution of Project EffortEffort

Leve

l of

effo

rt (

%)

Con

cept

ion

Sel

ectio

n

Planning & Implementation Evaluation & Termination or Transfer

Stages of Project

Development Construction & OperationalAbandonment

Stages in FinancingStages in Financing

• Identification of the market (3 – 6 months)• Technical Feasibility (6- 12 months)• Financial Feasibility ( 3-6 months)• Commitment Letter from Financiers( 2-9 months)• Mandate to financier ( 1-2 months)• Syndication Process (2-6months)• Documentation (3- 15 months)• Financial Closure ( 1 month)• Project Follow up and monitoring

Issues related to appraisalIssues related to appraisal

• High value projects: - High stakes, needs thorough understanding

of project details and risks involved.• Long gestation period & turnaround time:- Loan structuring - Assets-liability mismatch. • Multi-agency involvement i.e. Govt., nodal

agency, multiple lenders, etc. - Needs co-ordination among all the above.

Issues…..Issues…..

Complex project structure: - needs thorough understanding of project

documents, agreements, etc.- Lenders’ legal Counsel / Lenders’ independent Engineer.

- Detailed Project Report from good consultant is required.

- ALL ABOVE ISSUES EMANATE VARIOUS RISKS:

- Risks have to be mitigated.

PROJECT APPRAISAL PROCESSPROJECT APPRAISAL PROCESS

• Promoter Evaluation• Contractual Framework• Risk analysis and mitigation• Commercial Assessment• Financial Feasibility Assessment

Pre Sanction ChecksPre Sanction Checks• Bank's lending policy and other

relevant guidelines/RBI guidelines• Prudential Exposure norms• Industry Exposure restrictions • Group Exposure restrictions • Industry related risk factors • Acceptability of the promoters

Credit InvestigationCredit Investigation• Promoters

– Know your customer(KYC): Antecedents of the Promoters

– Expertise of the promoters as regards to technology, financial, marketing and general management concepts

– Experience of the promoters in the line of activity

– Track record of promoters

PROMOTER EVALUATIONPROMOTER EVALUATION• Track Record of Promoters - Net Worth / Availability of Funds• Management - Experience of Management - Ownership Pattern • Check RBI Defaulters Risk• Check CIBIL Records

STRUCTURAL/CONTRACTUAL STRUCTURAL/CONTRACTUAL FRAMEWORKFRAMEWORK

Concession AgreementConcession Agreement

• An agreement between Government ( Grantor of Concession or Permission) and Project company ( Grantee or Beneficiary) giving permission to execute a project.

Project ContractsProject Contracts• Concession Agreement - Specified Term/Period - Duties and Obligations of Project Company - Payment of Concession Fees - Technical Specifications - Force Majeur Protection -Events of default and termination, -SSA (Direct Agreement)• EPC Contract - Scope of Work, Single Point Responsibility, - Price and Payment terms, Construction Schedule, - Performance test and Guarantees and Warranties, - Agreement with EPC Contractor.• O & M Contract - Covers the term of concession, Guarantees, Termination Clause - Scope of work - Payments and Incentives

Financing FrameworkFinancing FrameworkTelecomPAST• Classical Project Finance Framework PRESENT• Corporate Finance Framework

PowerPAST• Generation Project with Long Term PPA’s with SEBS’s. – Escrow

AccountsPRESENT• Financing Based on Competitiveness of Tariff• Detailed study of supply demand scenario, assured supply of fuel

and availability of transmission lines.

Road PAST• Primarily on tolling basisPRESENT• PPP Framework including viability Gap Funding, Annuity

Framework, Projects with a right to develop real estate.

Financing FrameworkFinancing Framework

Ports• Greenfield Minor Ports with market risk• Captive Facilities• Private Berth in major ports with market risk

Airports• BOT Projects with Market Risks

Urban Infrastructure• Limited Financing Transactions based on recourse to specific

revenue streams• Pooled Financing – a single entity raising Finance to fund a group

of ULB’s

SEZ • Project with implementation risks and market risk• R & R and occupancy important elements for SEZ projects

Project StructureProject StructureA set of transaction agreements between

stakeholders

Protect Contracts Financial Agreements• Concession Agreement Lender’s agreement• EPC contract(Price, Perf. • Guarantee Shareholder’s pledge L.D, Retention Money, Defect Liability)• O&M Project Cost Comparison • Supplier contract (Supply & Transp) Successful project structure entails a win-win situation for all

Project SPVSovereign Sponsors

Suppliers Guarantor EPC

LendersO&M

Off takers

STRUCTURAL / CONTRACTUAL STRUCTURAL / CONTRACTUAL FRAMEWORKFRAMEWORK

• Concession Agreement -Rights, Responsibilities and Obligations - Operating Procedures, Specifications - User Charges, Collection Mechanism - Events of Default - Termination Compensation - Force Majeure Clause and Compensation Mechanism - Applicability of Law and Arbitration Process• EPC & O&M contract• Structure Adopted – BOO, BOT, BOOT etc• PPA• Development Agreement ( Airport, Port)• SSA ( Tripartite Agreement)• Land Lease Agreement• Loan Agreement