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Transcript of Project and Infrastructure Finance Slides Module1_Ver3
R.Kannan
MODULE - 1
BASICS OF PROJECT FINANCE
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BASICS OF PROJECT FINANCE
• Investment - Investor, IRR, NPV (Land, Working
capital)
• Project Finance – Process of raising finance for
gross root projects.
• How Bankers look at project for financing.
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Project Finance Objectives1. Identify key risks in the project through due
diligence and develop risk mitigate structures 2. Risk allocation to the various participants who are
best capable of handling it through structured contracts – This depends upon negotiating power and risk premiums (lower tariff for offtake contract) – Risk trade off skills; No point in allocating risk to a party who cannot sustain the financial consequences.
3. (a) Quantifying and considering the acceptability of the residual risks that remains with the company / lenders (Mitigation, Impact). Transferring all risk – not possible(b) Increasing interest rate is not risk mitigation
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4. Development of security structures to protect lenders’ interest.
5. Financial Modelling6. The project should be structured for risk and
priced and pricing should not be on risk alone7. Security and Documentation
Project Finance Objectives
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Why Risk is important
• Huge upfront cost / Earnings back ended over long term.
• No recourse to promoters • No adequate tangible / saleable security• If we de-risk the project, raising funds
from banks is not difficult.
Invt. Bankers,
Technical & Legal
Advisers
Concession/Licence
Agreement
Insurance
Companies
O&M
Operator
EPC
Contractor
Government
Sponsors
Invt. Bankers,
Technical & Legal
Advisers
Financial
Investors
Users
TRA/Escrow
Agent
Lenders
Project SPV
Advisers
Insurance Policies
O&M
Contract
EPC Contract
Equity
Equity/
Sub-debt
Offtake
contracts
TRA/Escrow
Agreement
Debt
Substitution
Agreement
(Assignment of interests, rights etc.)
AdvisersFuel Supply
Advisers/Experts
Rating agency
Deal Diagram
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RAS LAFFAN LIQUIFIED NATURAL GAS COMPANY LTD (RASGAS)
Risk Case Study
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1. 25 year take or pay agreement with Korea Gas2. Mobil to guarantee minimum price of LNG linked to crude
oil price of $10.40 per barrel3. Maximum liability of Mobil $200 million4. Maximum period of guarantee – 2009 (10 years)
Risks - Price
Qatar Govt. Mobil Itochu Nissho Iwai
66.5% 26.5% 4% 3%
Equity
LNG project
Security Trustee
Bond Trustee
Exim facilities
Bond holders
Offshore contractorOnshore contractorDrilling contractor
Offtake agreement
Minimum price guarantee
Trustee agreement
Project coordination agreement
Korea Gas
RAS LAFFAN LNG
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Project
Production of 10 million tonnes of LNG from North field which is world’s largest non associated gas field – 9% of world gas reserves
Project Cost $ millionDrilling 239Offshore facilities 453Onshore facilities 1670Interest during construction 593Other costs 380
-------3335-------
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Project (cont’d)
Financial PlanEquity $ millionQatar Petroleum Company 651 (19.9%)Mobil 260 ( 8.0%)Itochu 39 ( 1.2%)Nisso Iwai 29 ( 0.9%)
979 30%DebtCommercial Banks 382 (11.7%)ECA (US Exim, UKECGD Italy-Sace) guaranteed loans 703 (21.5%)Bonds redeemable in 2006 400 (12.3%)Bonds redeemable in 2013 800 (24.5%)
2285 70% 3264 100%
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• Korean Gas, offtaker has an option to take 5% equity- Bonds were considered because of long duration debt
and long moratorium requirement (6-8 years)Long term bond yield - 8.294% (U.S. Treasury + 1.875%)
- International investors 20%- US Investors 80%
- Lead manager – Goldman Sachs
Project (cont’d)
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Project detailsRAS LAFFAN LIQUIFIED NATURAL GAS COMPANY LTD
(RASGAS)
State of Qatar
Mobil Corporati
on
Itochu/ Nisso Iwai
Facility agent
Bond Trustee
Qatar Petroleu
m Corporati
on
Mobil QM Gas Inc
Banks ECA
Bonds
Ras GasRepublic of Korea
Korea Electric Power
Corporation
Regional Governmen
ts
Korea Gas Corporation
(Kogas)
Korea Electric Power Corporation
(Kepco)
100% 100%
71% 29%
Equity 28%
Equity 2%
Debt 70%
Offshore Trust Account (Industrial
Bank of Japan)
Kogas, Kepco enjoy Korea sovereign rating – AADefault probability – 1.07%
LNG Supply
50% 34.7% 15.3%
47.4% 52.6%
Operating Cost
Other LNG Buyers
Condensate Buyers
Royalt
ies &
ta
xes
Div
iden
ds
Deb
t serv
ice
LNG
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a) Offtaker: Korea Gas (Kogas) offtakes 75% of gas and supplies to Korea Electric Power Corporation (Kepco)
b) Shareholding of Kogas - Republic of Korea 50.0%- Kepco 34.7%- Regional Governments 15.3% ----------- 100.00% -----------
Kogas and Kepco enjoy Korea Sovereign rating AA according to Standard and Poor
Project details (cont’d)
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c) Risks in the projectAssets are of little value because of dedicated use and
location- Spot sales of LNG world over forms only 2% of sales- Heavy front end investment in dedicated facilities- Lack of transportation capacity / lack of alternative
markets- Demand risk for power (Kogas reduced offtake by 22%
during Asian crisis in 1998)- Price risks- Quantity risks
Credit spread depends on firm specific contractual structure.
Project details (cont’d)
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d) Management of risks (credit enhancement / contracts)
i) Long term take or pay agreement (25 years) between Rasgas and Kogas for 75% of production with LNG price linked to a basket of crude oil
ii) Debt contract between Rasgas and Lendersiii) Credit enhancement agreement by Mobil to
lenders. Unsecured subordinated revolving loan to meet shortage of funds for debt service.- Maximum liability $200M- Maximum period of guarantee 1999-2009- Mobil’s guarantee to be activated if crude
oil price falls below $10.4 per barrel. At 75% production level and $10.4 per barrel linked price the revenues would cover operating expenses, royalties and taxes and debt service. The oil prices in 1998 fluctuated between $12 to 14 per barrel.
Project details (cont’d)
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e) Priority of fund utilisation from offshore account
Royalties and taxes to Qatar Government(20% of revenue)
Operating Cost
Debt Service
Dividends
Project details (cont’d)
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f) Standard and Poor estimates the average crude price to be $10.15 per barrel through the project life
g) Rasgas input / output flow matrix
Assets a) Take or pay contract proceeds net of costs at NPV
b) NPV of other short term sales of products
c) Contingent debt service guarantee by Mobil
Liabilities a) NPV of royalties and taxesb) Public debt : Bondsc) Private debt : Debt from banks and
ECAsd) Equity - Private
Project details (cont’d)
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h) Unmanaged risks
Quantity - counter party risk (Kogas / Kepco)Price - Brent crude oil priceMobil guarantee - Mobil Stock priceKepco offtake risk - Kepco credit spread / rating
- Kepco stock price- High oil / LNG prices*
$ / won exchange - Kepco’s revenues in Won but debt servicing in $ risk (fixed exchange rate transformation to floating)Korea country risk - Country rating(Demand for power) - Korea composite stock price index (KOSPI)Competition - Russian exportsEmerging market risks - Kepco was downgraded from AA to B+ during
Asian crisis but subsequently upgraded to BBB**Financial risk - There is a probability that the defaults may be
over $200 million, occur after 10 years* While higher oil prices favour Rasgas it could
affect Kepco. Breakeven price for Kepco is $23 per barrel. Above this, Kepco will default (Dabhol)
** Default probability: AA – 1.07%; BBB – 4.48%
Project details (cont’d)
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Types of Financing
Finance
Corporate/Balance
sheet financing
Assets based
financing
Project
financing
(Based on company’s
financial position)
(Based on value of
Assets [Real Estate])
(Value of cash flows)
Why companies promote separate companies for large projects?
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Project Financing versus Corporate Finance
Project Financing Corporate Financing
a) Financial Plan Important; Difficult to change during the loan tenure as it is governed by contracts
Generally assumed to be independent. Can be changed at any time during the tenure of the loan
b) Repayment risk
The repayment only out of cash flows of the project. No sponsor support. The financing is off balance sheet.
Repayment out of company’s overall earnings. Sponsor support is possible
c) Security The security would include intangible assets such as rights, assets and interests.(Overbridge, Airports, Toll Road)
Normally either unsecured or security of tangible assets
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Project Financing Corporate Financing
d) Quantum and tenure of assistance
Usually large8-10 years
Variable
e) Risk levels High, because of uncertainty of project cash flows
Low as the company’s working data is available
f) Risk mitigation Through structured financing and contractual commitments
-
g) Participants Project developers, Governments Engineers, Contractors, Equipment suppliers, Fuel suppliers, Product offtakers
Only lenders and CEO
Project Financing versus Corporate Finance
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Characteristics of Project Finance
• Project is a separate legal entity / special purpose vehicle – Ring fenced
• Sometimes a Special Purpose Vehicle (SPV), where each sponsor takes his share of rewards and meets his share of expenses and project funding is availed by sponsors – Oil SPVs
• Project revenue, the only source of loan servicing, equity return – limited recourse.
• No sponsor credit support; sponsors shift debt servicing to the project
• Lenders to have a high degree of confidence in the project cash flows
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• Financial package is custom built• Risk is allocated to the party that can handle
it better with negotiated rewards (through contracts), its credit worthiness, its role in the project
• Debt is of long term tenure• Financial plan takes into account taxation,
exchange controls, enforceability of claims etc.
• The borrowing structure is enforceable contract driven with covenants
Characteristics of Project Finance
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• Credit enhancement through contracts (offtake agreement, contingent guarantees)
• High cost of syndication;Syndicated loans
• Private – public partnerships / FDI• Large size loans to be viable• High leverage
Characteristics of Project Finance
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a) Competition resulting in - Price erosion- Lowering of security
requirements- Not checking enforceability of
conditions / contracts- Extension of maturities- Higher credit risk
b) Competition is not - Skill developmentadequately resulting in - Appointment of consultant
c) Increasingly becoming like corporate finance
Problems in Project Finance
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d) Higher NPA will block future project financing, lead to risk averseness as lenders’ leverage is high
e) Lenders have only downside and no upsidef) i) Syndication groups – aggressive price – no risk
perceptionii) Relationship groups – a cost & service centre; Pursuesa deal aggressivelyiii) Structured finance groups – comes with futuristic structuresignoring the core of the deal
iv) Risk groups
Departments in Project Finance
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• Blockbuster deals • Pioneer deals • Why left behind deal / take it away from
him• Market Image deal• Relationship deal
Various Deals
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Growth of Project Finance
1. Privatisation / Private Public Partnership (Private sector participation – Japan, Australia, Portugal, Italy, UK)
2. Deregulation3. Internationalization of Investments4. Growth in Power, Telecom, Infrastructure, Oil and
Roads (Portugal), Natural Resources (Mining), Gas (Brazil)
5. Project Finance is not necessarily• Privatisation• Structured financing• Securitization• Leveraged buyout• Acquisition finance
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Advantages of Project Finance (sponsors / company)
Why existing companies implement large projects in separate companies availing project finance?
a) Sponsor company can insulate itself from the credit risks of the project with only equity at risk. Even if sponsor credit support is required, it could be limited to completion guarantee, ceiling of guarantee amount, removal of guarantee in case of satisfactory D/E or DSCR
b) Project loan is off the balance sheet of the promotor company and hence doesn’t affect rating of sponsor
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c) From the lender’s angle, the project is insulated from promotor bankruptcy. This is important for lenders, suppliers and offtakers. If there is a proper contract structure, the rating of the new project could be better than the parent and can raise low interest loans.
d) The sponsor could invite equity participation from other strategic investors like product offtakers, input suppliers, technology suppliers to strengthen the project rating but at the same time without diluting their controlling interest in the sponsor company.
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e) In a similar way, the sponsors could promote larger projects by inviting public participation in equity without dilution of their control in the promoting company.i) Sponsor contribution 100
Debt 200300
ii) Sponsor contribution 100Public equity 100Debt 400
600
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f) The promotors company avoids restrictive covenants of the project lenders such as cross defaults, dividend declaration, nominee director etc.
g) Debt could be large and of long tenureh) The sponsor after ascertaining performance of
the project can always merge it into the sponsor company at a time of his choice or sell it away
i) The incorporation of a separate company may also be due to different wage levels, regulatory issues environmental issues.
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j) In many cases like power, fertilizers etc., there is a need to segment the cost of the project/operational cost for regulatory purposes. Hence there is a need for a separate entity.
k) Sharing of risks by several parties who are in a better position to handle them. For instance a good offtake contract from a buyer more creditworthy than sponsor improves project rating.
l) Limiting security to the project’s assets.
While no party assumes responsibility for the entire credit risk, a combination of guarantees and undertakings which then viewed together constitutes a bankable credit risk.
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Disadvantages of Project Finance (sponsors / company)
1. Delay due to due diligence for lenders, protracted negotiations and time for finalise risk allocation.
2. Higher risks for lenders – projected cash flow3. Generally higher fees and interest rates on non recourse
financing4. Complying with the lenders’ reporting requirements covenants,
and the reimbursement of the cost of lenders’ supervision (lenders’ engineers’ fees) could add to the cost.
5. The non recourse loans have made the sponsors totally very aggressive risk takers
6. Risk allocation leads to higher risk premium and increases cost.7. High legal bills8. Cumbersome documentation9. Lenders have a large number of covenants
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Choosing a Bank
- Cost of project vis a vis the bank size- Cost of funds of the bank and hence
pricing- Bank’s experience in project finance /
flexibility / realism- Complexity of documentation- Decentralisation of decision making
(time factor)
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Components of a Project Appraisal
1. Promotor Evaluation2. Management Aspects3. Project Details
Location Technical Implementation Raw material availability Labour issues Environmental aspects
4. Cost of Project5. Means of financing6. Profitability analysis7. Risk Evaluation8. Conditions
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Infrastructure Project TypesBOT - Build, Operate and Transfer The assets are owned by (Roads, Power, Sewage treatment) Government agency which will
take back assets after concession period
BOOT - Build, Own, Operate and TransferSame as BOT except that assetownership is with the operator andsold to the Government for either a
nominal/ preagreed fixed sum / market value with a cap
BOO - Build, Own, Operate Same as BOOT except that asset
is perpetually owned by theoperator
BOOST - Build, Own, Operate, Share and Same as BOOT except that Transfer during the concession period
revenue is shared with theGovernment agency
BOLT - Build, Own, Lease and Transfer Subleased to other tenants afterbuilding in a leased land – IT ParkTransfer to the government agencyafter concession period.
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DBFO - Design, Build, Finance and Operate Designed, financed and
operated perpetually.BTO - Build, Transfer, Operate Private operator transfers to
Government and leases it backcollects revenues.
BBO - Buy, Build, Operate Buy an existing facility,modernise, operate and collectuser fees (Old Mumbai-Pune road)
OMT - Operate, Maintain and Transfer Operated during the concession
period and transferred back tothe government agency.
Infrastructure Project Types
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Characteristics of Infrastructure Projectsa) Capital Intensive – Fixed charges form a
major part of the expenditureb) Mainly dedicated use – market analysis
is important as product has specific use at specific time and cannot be stored.
c) Cash flow is the only source of funds for loan repayment. Asset utilisation is more important than asset value
d) Usually implemented as Special Purpose Vehicles (SPV).
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e) Offtake Agreements – Long Term Agreements to purchase a minimum amount of end product at an agreed price.
f) There are different classes of investors with varying risk return characteristics.
g) Contingent funds – Equity/Debt with some commitment charges
h) Loans are usually are of long term nature – 15 to 20 years.
Characteristics of Infrastructure Projects
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Contingent Equity / Debt
- The project should be capable of repaying the debt as otherwise it cannot function.
- The quantum of loans depends on the cash flow (not profit) and volatility of cash flow (steel, cement, fashion wear, power projects).
- What should be the cash flow for a loan of Rs.100crores repayable equally over 5 years carrying 10% interest.
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Contingent Equity / Debt
Year 1 2 3 4 5
Repayment 20 20 20 20 20
Interest 9 7 5 3 1
Total 29 27 25 23 21
(Rs. in Crore)
Minimum cash – Rs.29 croresTotal cash flow – Rs.125 croresWith 60% margin = 125 x 1.6 =
Rs.200 crores(50 to 100% = Rs.40 cores / year(DSCR 1.5 – 2.0)(i.e. 40% of the total loan amount).
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Contingent Equity / Debt
Possible Scenarios
(Rs. Crores)
Contingent Equity I II
Project 100.0 110.0
Cash flow 30.0 25.0
Loan 250% of cash flow 75.0 62.5
Equity 25.0 47.5Contingent Equity = Escalation (Rs.10 crores)
Plus Shortfall (Rs.22.5 crores) in cash flow (Rs.12.5 crores)
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Contingent Equity / Debt
Contingent Debt I II
Equity 25.0 25.0
Contingent equity 22.5 12.5
Debt 62.5 62.5
Contingent debt* -- 10.0
Total 110.0 110.0
(Rs. Crores)
* Subordinated/quasi equity debt
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i) Stronger Security Structure:• Charge/assignment on assets including
intangibles, revenues, receivables, company’s rights under project documents, contracts, licenses, permits, approvals, consents and insurance polices
• Step in rights• Trust and Retention account• Pledge of equity of Promoters• L/c opening by customer for 1 to 3 month’s
estimated receivables• Debt Service Recovery Account• State Government Guarantee• Central Government Guarantee• Contingent Promoter's Support
Characteristics of Infrastructure Projects
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j) Restrictions due to contractual obligations• Recall rights if rating falls below a grade.
k) Water fall Mechanism.
Characteristics of Infrastructure Projects
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AgreementsConcession - Rights to the company to recover Agreement project costs and operating costs
through levy of fees; Fees indexing (Ports, Flyovers, Airports) / support / tax incentives
Throughput - Obligation on the part of the buyer Agreement / to pay for the quantity of product Take or Pay whether he lifts or not (LNG)
Long term pricing/Limited market (oil, toll road)Put or Pay - Supplier indemnifies the project Supply contracts company for excess cost incurred
in securing supplies from third parties for revenue cost.
Long term sales - Quantity fixed but the price at the prevailing rates
agreement (oil , minerals) with a floor price (LNG)
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Cash deficiency - Overrun undertaking / cash loss financing by sponsors
Capital Subscription - Equity AgreementIntercreditor Agreement - Between the creditorsShareholder Agreement - Agreement between
shareholders on rights/ obligations of each (Board/ Management)
Completion Agreement - Guarantees for the loan by sponsors till completion of
the project (guarantee to ensure project completion)
Agreements
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Finance ProvidersEquity - Private equity, Public, Banks, International Finance
Corporation, Customers, Contractors, Equipment suppliers, Operators, offtakers, Input (Fuel)
suppliers, Infrastructure funds (GE Capital, Asian infrastructure fund), Warrants
Underwriters - Investment Banks, Brokers, Banks, various mutual funds
Quasi equity - Subordinated loans from promotors- Interest free advance from customers (Oil)- Royalty based loans (Technology Development Board)- Convertibles (loans, preference shares)- Interact free loans from sponsors- Preference shares of long maturity
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ParticipantsDebt - Suppliers’ credit from equipment supplier
- Bonds subscribed by institutional investors Pension funds, Insurance companies etc., based on credit rating
- Loans, guarantees, insurance from export credit agencies (Exim Bank / OPIC)- Multilateral, bilateral credits, mixed credits (IBRD, KFW, ADB)- Senior debt / syndicated debt- Debentures- Bank loans- Securetised debt
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ParticipantsDebt - Secured / unsecured
- Fixed / floating interest rates- Foreign currency / local currency- Ballooning repayment schedules- Differential interest rates after
construction- Take o ut financing
Insurance - MIGA (Political insurance for equity / debt) (AIG, GIC etc)
Guarantees - Banks, IBRD- Letter of Credit (Banks)
Credit Enhancers - Offtake / supply agreementsRating Agencies - CRISIL, ICRA, FITCH etc.
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Interest of various participants in the project
Sponsorsa) Segregation of project risk from the existing
operationsb) Maximum leverage – Maximum debtc) Flexible loan covenantsd) Well negotiated risk sharinge) Exclusion of all assets other than that of the
project from securityf) Lenders willing to restructure loans rather than
recall in case of difficultiesg) Management controlh) Low interest / low transaction costi) High cash flow potential
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Lendersa) Good construction contract for timely
completion within the budgetb) Turnkey contracts with firm price, time
of completion, compatible with the regulatory network and performance of the project with respect of output
c) Completion guarantee / performance bonds
Interest of various participants in the project
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d) Good inter-creditor agreementse) Financial closure – no more loans
required for completionf) Adequate contracts of economic valueg) Legally satisfactory contracts / structuresh) The entire risk is properly allocated to
suppliers, contractors and offtakersi) Proper assignment of contractsj) Good debt service coverage ratio (1.5 –
2.0)k) Project complying with all the regulations
Interest of various participants in the project
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l) Good pricingm) Favourable covenantsn) Proper warranties / representationso) Collaterals viability funding / shadow toll
agreement / credit enhancement / completion guarantee
p) Right to appoint consultants to oversee projectq) Pari passu security for allr) No overrun / delays) Credit worthiness of all project participantst) Guarantees if project is abandoned
Interest of various participants in the project
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Contractora) Minimum penalties for escalation/ late
deliveryb) Maximum price, bonusc) Credit worthiness of the sponsord) Satisfactory financial tie upOperatora) Limiting the price risk penalties
Interest of various participants in the project