Project Finance Lecture

History versus Contracts and Consultant Reports: Project

Finance versus Corporate Finance
Corporate Finance Project Finance
• Analysis is founded on history and • Since there is no history a series of
evaluation of how companies will consulting and engineering studies
evolve relative to the past. must be evaluated.
• Financing is important but not • The bank assesses whether the
necessarily the primary part of the project works (engineering report).
valuation. Without financing, no project.
• Successful companies expected to • Successful projects will pay of all
continue growing. debt from cash flow and cease to
• Focus on earnings, P/E ratios, operate.
EV/EBITDA ratios and • Focus on cash flow. Equity IRR and
Debt/EBITDA. DSCR.

2
 Project Finance and Non-Recourse Debt
• Solar case language:
• Notwithstanding any other provision of the Financing Documents,
there shall be no recourse against the stockholders … for any liability
to the Lenders in connection with any breach or default under this
Agreement
• Notwithstanding the foregoing, nothing contained in this Article
• (i) Borrower shall remain fully liable to the extent that be liable for
its own actions with respect to, any fraud, willful misconduct or
gross negligence,
• (ii) limit in any respect the enforceability against an Acceptable
O&M Reserve Letter of Credit, an Acceptable Major Maintenance
Reserve Letter of Credit, an Acceptable DSR Letter of Credit
• (iii) release any legal consultant in its capacity as such from
liability on account of any legal opinion rendered in connection
with the transactions contemplated hereby.

3
 City is Like a Corporation/Project is Business

Individual
Business or
Family is like
project Finance

4
Family is Like Corporation, Person is Like Project Finance

Person is the
project

Entire Family
is the
Corporation

5
 Time-Line is Crucial in Project Finance
RISK A crucial Feature of Project
finance is CHANGING --
DECLINING RISK
Time to Complete Task (months)
2 6 8 12 20 24 48 49

Financial Completion
Close Test

Sponsor
Risk

Construction

Project Technical Fuel Supply Permits

Letter Ground- Steady-State
Identi- and and Power Obtained
of breaking Operation
fication Economic Purchase Financial
Feasibility Intent Agreements Structure Commissioning
Negotiated
Financial
Agreements
Signed
Time
 Periods in Solar Case
• On the Term Conversion Date, Borrower may
convert a portion of the Construction Loans,
as set forth below, into Term Loans
• Availability. Each Lender agrees to advance
to Borrower from time to time during the
applicable Construction Loan Availability
Period, but no more frequently than once per
month, a “Construction Loan”
• Availability from Financial Close, to COD

7
 Project Finance Model Structure Changes at COD
Before COD, cash flow After COD, cash flow is
is presented in the presented in the cash
sources and uses flow waterfall and the
statement last line is dividends
Father of the Commitment
bride makes Fee
commitment
to pay for
wedding

Development is Dating Pay your Bills and re-structure

Pay for Wedding
period. Probability of with Other peoples your life. Stuck with PPA type
failure is high money contract. May default.

FC is just after COD is Decommissioning

engagement Wedding Date
date Date
Why Ratios are Different in Project Finance and
Corporate Finance
• Continuing Large Capital Expenditures in Corporate
Finance
• Large Bullet Repayments in Corporate Finance that Do
Not Correspond to Cash Flow
• No Customizing Repayments to Cash Flow
• In Corporate Finance, Source of Repayment in Re-
Financing
 Difference Between Ratios for Project Finance and
Corporate Finance

Corporate Finance Project Finance

• Interest Coverage Buffer • Debt Service Buffer
• EBITDA/Interest • DSCR
• EBIT/Interest • LLCR
• FFO/Interest • PLCR
• Time To Repay Debt • Skin in the Game
• Debt/EBITDA • Debt to Capital
• Debt/FFO or FFO/Debt • Debt to Equity
• Value of Company to Debt
• Debt to Equity
• Debt to Capital

10
 Valuation Metrics in Project Finance and
Corporate Finance

• Project Finance Investment • Corporate Finance Valuation

• Equity IRR •P/E Ratio
• Project IRR •EV/EBITDA
• Equity NPV •Projected Dividend and Earnings
• Project NPV •Free Cash Flow
• Project Finance Debt • Corporate Finance Debt
• DSCR •Times Interest Earned
• LLCR •Debt to EBITDA
• PLCR •Debt to Capital
• Liquidity • Corporate Finance Liquidity
• Debt Service Reserve •Current Ratio; Quick Ratio
 Simple Example of Credit Analysis in Corporate Finance and
Project Finance

• Illustration of re-financing risk in corporate

loans versus DSCR in project finance.

12
 Simple Example of Credit Analysis in Corporate Finance and
Project Finance

• Find the file named project and corporate

credit example.

13
 Three Different Cases
• Cases and Project Finance versus Corporate Finance
• Solar or Wind Farm
• Airport or Seaport
• Real Estate
• Hotel
• Mixed Development
• Multi-Family
• Construction Projects

• Others
• Hospital/School
• Toll Road
• Factory
• Oil Field

14
Airport Case and Project Finance Definition

15
Measurement of Credit Risk with Rating Systems – How Do you Come Up
with Good Rating

Map of Internal Ratings to Public Rating Agencies

Internal
Credit Corresponding
Ratings Code Meaning Moody's
1 A Exceptional Aaa Investment
2 B Excellent Aa1
Grade
3 C Strong Aa2/Aa3
4 D Good A1/A2/A3
5 E Satisfactory Baa1/Baa2/Baa3
6 F Adequate Ba1
7 G Watch List Ba2/Ba3
8 H Weak B1
9 I Substandard B2/B3
Junk
10 L Doubtful Caa - O
N In Elimination
S In Consolidation
Z Pending Classification
Project Finance ties to BBB- (Baa3)

Investment Grade Junk

Part 2: Bank Perspective in Project Finance: Risk
Analysis and Structuring with DSCR, LLCR and
PLCR
 DSCR Key Points
• The DSCR is computed from prospective cash
flow like other ratios in project finance including
the project IRR, equity IRR and other ratios.
• There could be many definitions of the DSCR,
but the general definition is CFADS/DS where:
• CFADS is cash flow available for debt service
• DS includes interest expense, debt repayment and
fees
• The DSCR can be explained with the graph of
CFADS and Debt Service
 DSCR as a Buffer to Break Even
• The key point about the DSCR is that it is a
measure of break-even from a forecasted cash
flow. For example if the cash flow is 150 and the
debt service is 100, the DSCR is 1.5. In this case
the cash flow can go down by 50 before a default
occurs. So in percentage terms this means that a
reduction of 50/150 or 33%.
• In terms of a formula, the percent reduction
before default can be expressed using the
formula:
• Percent reduction = (DSCR-1)/DSCR

20
 DSCR for Target Debt Size and Covenants
• The DSCR has at least two different uses in
project finance.
• One use is for determining the size of the debt. This
means that if the projected DSCR is below a certain
level, the loan should not be made. For example, if
the DSCR is below 1.35, then the amount of debt
must be reduced.
• A second is for dividend covenants (a lower level, say
1.1). This means if the DSCR falls below a certain
level, then dividends are not allowed to be paid. If
dividends are not allow (a dividend trap), then the
cash that could have been paid in dividends is put in a
reserve account.

21
 DSCR is Minimum over Debt Tenure
• DSCR is a measure of the chance of default.
When the DSCR is 1.0 or below, there is not
enough cash to pay the debt service.
• This means the probability of the DSCR falling
to 1.0 is similar to the probability of default.
• If the DSCR falls to 1.0 or below in any single
period, a default has occurred in the period.
This is why the minimum DSCR rather than the
average DSCR is used in discussing
transactions.

22
 Why DSCR is Used in Project Finance and Less in Corporate
Finance

• DSCR is used in project finance because the

debt service and in particular the repayments
are structured according to expected cash
flow.
• In corporate finance on the other hand, there
may be bonds with bullet repayments where
the ability to re-finance defines the credit
risk. With bullet repayments, the DSCR
would fluctuate.
• You can explain this with a diagram.

23
 DSCR Case Study and Exercise
• Wind Study with different probability levels (the
FPL Case)
• Solar case with probability levels
• No dividends allowed if the Average Annual Debt
Service Coverage Ratio calculated as of the
Repayment Date immediately preceding such
Distribution Date is less than 1.20 to 1.00
• Permit the Average Annual Debt Service
Coverage Ratio as of the last day of any Quarterly
Date commencing from the first Repayment Date
to be less than 1.10 to 1.00 or

24
 Three DSCR’s in Solar Case
Distributions
• Make any distribution unless such distribution is made from Distributable Cash and on a Distribution
Date; if the Average Annual DSCR calculated as of the Repayment Date immediately preceding such
Distribution Date is less than 1.20 to 1.00, or
• the Average Annual Projected DSCR (based upon the Term Conversion Date Base Case Projections but
updated for actual operating performance of the Project through the applicable Repayment Date)
calculated as of the Repayment Date immediately preceding such Distribution Date, is less than 1.20 to
1.00;
Financial Covenants (Default)
• Permit the Average Annual DSCR as of the last day of any Quarterly Date commencing
from the first Repayment Date to be less than 1.10 to 1.00 or
• Permit the Average Annual Projected DSCR (based upon the Term Conversion Date Base
Case Projections but updated for actual operating performance of the Project through the
applicable Repayment Date) calculated as of the Repayment Date immediately preceding
such Distribution Date, as of the last day of any Quarterly Date commencing from the first
Repayment Date to be less than 1.10 to 1.00;
Minimum Term Conversion Date Debt Service Coverage Ratio
• a minimum Average Annual Projected Debt Service Coverage Ratio for the twelve (12)
month period of 1.35 to 1 on a P50 Production Level during years 1 through 9, and,
• 1.00 to 1 under a P99 Production Level during years 1 through 9 of the amortization
schedule.

25
 Definition of CFADS in Solar Case
• Operating Cash Available for Debt Service for any period,
the sum of
• (a) Net Income, plus
• (i) amortization,
• (ii) income tax expense,
• (iii) the aggregate interest expense
• (iv) depreciation of assets and
• (v) any other expense that does not constitute an outlay of cash
• minus (c) any income that does not constitute cash received
• Operating Cash Available for Debt Service shall exclude any deposits of
the Major Maintenance Reserve Funding into the Major Maintenance
Reserve Account during such period.

• Should also include working capital changes and future

capital expenditures and be computed from EBITDA

26
 DSCR in Solar Case
• “Debt Service” - all obligations for principal and interest
payments due in respect of all Debt payable by Borrower
in such period. (Question: Do you think the DSCR should
also include fees for L/C’s and/or other fees paid to
Administrative Agent).
• “Average Annual Debt Service Coverage Ratio” means,
as of any Repayment Date, the ratio of
• (a) Operating Cash Available for Debt Service to
• (b) Debt Service, for the previous four (4) consecutive fiscal
quarters ending
• the Average Annual Debt Service Coverage Ratio for the 3
Repayment Dates after the Term Conversion Date shall be
calculated with actual figures which shall be pro rated on an
annualized basis.

27
DSCR for Solar PV

28
Example of DSCR and Why DSCR is Better Measure of Risk than Beta, VAR,
Implied Vol, Duration, EMRP

• You need to be at a meeting at 9:00 AM

• Elvis Presley is staying at a hotel next door and can walk a few
steps
• Michael Jackson is staying across town and must take a taxi.
Traffic can be good or bad. Google Maps said it takes 15 Minutes.
• Elvis will leave at 8:58 AM and have no problem in arriving
on time – this is a very low DSCR
• Michael will leave 30 minutes early at 8:30 AM to make
sure he will make be on time – this is a DSCR of 2.0 that is
higher because of higher operating risk. The google map is
like a financial model – it could be wrong and you must
estimate a downside case.
 Collections Coverage Ratio in Airport Case
• Is the collection coverage ratio relevant

• Consolidated Leverage Ratio means, for the last day of

any fiscal quarter, the ratio of: (a) total debt of the Borrower
as of such day to (b) Consolidated EBITDA for the most
recent four consecutive fiscal quarters ending on such date.

• The Borrower must ensure (and the Guarantor must use its
best efforts to ensure that) on each Interest Payment Date
that the Collection Account Coverage Ratio for the Interest
Period ending on such Interest Payment Date is 1.4:1 and,
commencing with the Determination Date ending 30 June,
2013, the Consolidated Leverage Ratio:

30
Revenue Collections Coverage

31
 Limited Use of Liquidity Ratios: General S&P Benchmarks

Note that liquidity

ratios are not
mentioned in the
table

For BBB companies the debt

to EBITDA ratio is 2.2 time
implying that if there was
no interest expense and no
taxes, it would take 2.2
years to repay debt. In
terms of the debt to FFO,
you can compute the ratio
through dividing 1 by
Benchmark Standards for Airport Debt to EBITDA

33
Cash Flow Terms for Ratios

34
Reconciliation of FFO and EBITDA

• Funds form Operations (FFO) =

Net Income + Depreciation and Amortization + Deferred Tax
+ Other Non-Cash Items
• EBITDA =
Net Income + Depreciation + Current Tax + Deferred Tax +
Interest + Other Adjustments
• Reconciliation of FFO and EBITDA
EBITDA is NI + depreciation + interest + taxes
FFO is NI + depreciation
Difference between FFO and EBITDA is interest and taxes
FFO = EBITDA – Interest – Current Taxes
FFO and Free Operating Cash Flow

• Funds form Operations (FFO) =

Net Income from Continuing Operations + Depreciation and
Amortization + Deferred Tax + Other Non-Cash Items
• Free Operating Cash Flow =
FFO + (-) Increase in Working Capital excluding changes in
cash – Capital Expenditures
• Reconciliation of FFO and Free Operating Cash Flow
Difference is Working Capital and Capital Expenditures
 Financial Ratios: Time to Repay and Debt/EBITDA

• If there is no interest, taxes or capital expenditures, then the

Debt/EBITDA measures the time to repay the loan.
• Eurotunnel 2003:
• Debt 6,365,028
• EBITDA 298,619
Debt to EBITDA 23.10

• Interest 340,386
• Capital Expenditures 41,118
• Working Capital Change 2,360
• Taxes 0
Free Operating Cash Flow to Debt (61,850)
Debt to Free Operating Cash Flow Infinity

Implication: Debt to EBITDA does not really measure how long it takes to
repay debt
 Why Do Not Debt to EBITDA in Project Finance

• Simple Example – note that the Debt to

EBITDA must decline over time while the
DSCR stays constant

38
CFADS in Project Finance vs EBITDA in Corporate Finance

• EBITDA
• Less Working Capital Changes
• Less Capital Expenditures
• Less Taxes
• Plus Interest Income
• Equals CFADS

• Demonstrates problems with EBITDA as measure of

cash flow
 Key Point about Credit Ratios like DSCR and Debt/EBITDA

• You should understand why the ratio is computed

• You cannot apply same ratio to companies with
different business risk
• This means what you really need to do is to understand
business risk
• Business risk cannot be boiled down to a simple
formula
• The place to start evaluating business risk is
fundamental economics
• Evaluating business risk is why you make financial
models
Problems with Debt to EBITDA – Compare FFO to Debt and Debt to EBITA

Compute the length of

time to repay debt with
Debt to FFO rather than
Debt to EBITDA

Assume that Maintenance

Cap Exp is 10% of EBITDA
and compute length of
time to repay debt.
Compute the CFADS to Debt and Debt to FFO in the Airport Case

• Start with EBITDA

• Difference between FFO and CFADS
• Subtract Interest Expense to Compute FFO
• Should you subtract maintenance capital
expenditures
• Compare FFO to Debt with EBITDA to Debt
• Compare Debt to FFO with BBB companies

42
Buffer for Coverage of Debt Service in Project Finance (DSCR)

• Alternative Debt Service Coverage Ratios for Different Types of Projects

• Electric Power with Fixed Contract: 1.3-1.4
• Resources with volatile prices: 1.5-2.0
• Telecoms with volume risk: 1.5-2.0
• Infrastructure availability payment or traffic: 1.2-1.6

• At a minimum, investment-grade merchant projects probably will have to

exceed a 2.0x annual DSCR through debt maturity, but also show steadily
increasing ratios. Even with 2.0x coverage levels, Standard & Poor's will
need to be satisfied that the scenarios behind such forecasts are defensible.
Hence, Standard & Poor's may rely on more conservative scenarios when
determining its rating levels.
• For more traditional contract revenue driven projects, minimum base case
coverage levels should exceed 1.3x to 1.5x levels for investment-grade.
 Use of Ratios Different Ratios in Different Industries: DSCR and Credit
Ratings in Project Finance

• Target rating of BBB-

• Target DSCR or LLCR
• Example of Toll-roads
Simple Example of DSCR, LLCR and PLCR
• Assume zero interest rate
• Assume 4-year case
• Evaluate alternative scenarios with different
DSCR, PLCR and LLCR relationships
• Understand break-even points in cash flow

45
Complexities in Corporate Finance - Alternate S&P Guidelines Depending on
Business Risk Profile
 Credit Ratings, Business Risk and Financial Risk

Business Risk/Financial Risk

—Financial risk profile—

Business risk profile Minimal Modest Intermediate Aggressive Highly leveraged

Excellent AAA AA A BBB BB
Strong AA A A- BBB- BB-
Satisfactory A BBB+ BBB BB+ B+
Weak BBB BBB- BB+ BB- B
Vulnerable BB B+ B+ B B-
Financial risk indicative ratios* Minimal Modest Intermediate Aggressive Highly leveraged
Cash flow (Funds from operations/Debt) (%) Over 60 45–60 30–45 15–30 Below 15
Debt leverage (Total debt/Capital) (%) Below 25 25–35 35–45 45–55 Over 55
Debt/EBITDA (x) <1.4 1.4–2.0 2.0–3.0 3.0–4.5 >4.5
S&P Risk Rating Example

• Assume:
• FFO to Debt is 40%
• Debt to Capital is 50%
• Debt to EBITDA is 1.5
• Business Risk is Modest
• Find the Rating
Use of Financial Ratios in Corporate Analysis - Credit Rating Standards and
Business Risk
Detail Benchmarks
Detailed Benchmarks Continued

Start with the business

risk and then find the row
with the index function

Use the Interpolate Function to

Find the Rating
Use of Different Ratios in Different Industries: Example of Using Ratios to
Gauge Credit Rating

• The credit ratios are shown next to the achieved ratios.

Concentrate on Funds from operations ratios.

Note that based on

business profile
scores published by
S&P
Credit Formula Definitions
Formulas for Ratios - Continued
Formulas for Ratios - Continued
 Airport Financial Ratios - Fitch
• Senior-/Subordinate-Lien DSCR: Total operating revenues minus
total operating expenses net of depreciation, divided by
senior-/subordinate-lien debt service. Available revenues may
include non-operating revenues such as passenger facility charges,
funds available to provide extra coverage and certain offsets to
debt service permitted under the bond/loan documents.
• Synthetic Annuity DSCR Approach: Typically calculated up to a
25-year period. CFADS for concession airports will also
incorporates major maintenance and renewal costs. Debt service is
calculated with the debt outstanding for the specific year and the
average cost of debt over the same tenor.
• LLCR: Ratio of the present value of net cash flows to outstanding
net debt.
• Interest Coverage Ratio (ICR): Cash flow available for debt
service divided by the cost of interest.

56
Risk of Operating Cash Flow in Project
Finance and Related Transactions
Why S&P Credit Criteria is Rubbish

Key Industry Characteristics And Drivers Of Credit Risk

   Credit risk impact: High (H); Medium (M); Low (L)
Regulatory/Gov Energy
Risk factor Cyclicality Competition Capital intensity Technology risk ernment sensitivity
Industry H H H L M/H H
Airlines (U.S.) H H H M M H
Autos* H H H M M M
Auto suppliers* H H M H L L/M
High technology* H H H M M/H H
Mining* H H H L M L
Chemicals (bulk)* H H H L M H
Hotels* H H H L L M
Shipping* H H H L L M
Competitive power* H H M L H H
Telecoms (Europe) M H H H H L

Note the lack of diversity in the

categories – when there is no
diversity the ratings are useless
Why S&P Credit Criteria – More Rubbish
EBITDA Volatility – Peak to Trough Percent (PTT) – Even More Rubbish
More Rubbish - 5 Cs of Credit

Character
Cash Flow/Condition
Capital
Capacity
Collateral
 Airport Risks, Fitch
• There are several reasons why most airports globally
remain financially solid and have ratings in the ‘A’ and
‘BBB’ categories, despite these risks.
• Competition is more limited as the capital-intensive nature of
airports, combined with the regulatory hurdles of a public
utility-like industry, creates strong barriers to entry.
• These barriers include the cost of land acquisition and air space
requirements, significant environmental hurdles and opposition
from the population affected by land acquisition and noise.
• Airports generally operate under a cost-recovery model that can
help keep cash flows relatively stable.
• While the airline industry continues to go through its profitable
and unprofitable cycles, airports do have a strong debt
repayment history and Fitch expects this to continue.

62
Airport Exercise – Make Classification

63
 Volume Risk for Airports
• Strong
• Large and robust metropolitan/regional air service area, in a region with a mature economy, with an O&D
enplanement base of 5 million or more
• Lower traffic volatility with historical and prospective peak-to-trough decline of around 5%
• Connecting traffic of up to 20% for domestic airports and higher for international gateways
• Single carrier concentration of 30% or less with extensive nonstop and international service offerings
• Relatively equal mix of business and leisure traffic
• Minimal competition from other airports/modes of transport
• Moderate
• Midsize air service area with solid economic underpinnings and an O&D enplanement base of 2 million−5
million, or an airport in a region with a developing-stage economy
• Moderate traffic volatility with historical and prospective peak-to-trough decline of around 10%–15%
• Connecting traffic of 20%−60% or supporting a primary connecting operation, or a major carrier base of
operations
• Single carrier concentration of 30%−60% with broad service offerings
• Leisure traffic exceeds business traffic
• Some competition from larger airports with more extensive service, or other modes of transport
• Weak
• Small air service area with an O&D enplanement base of 2 million or less
• Elevated traffic volatility with historical and prospective peak-to-trough decline of over 20%
• Connecting traffic of 60% or more.
• Single carrier concentration of more than 60% or limited service offerings
• Meaningful competition from other airports/modes of transport
64
 Limited Historic Data on Volatility
• How would you evaluate volatility

65
 Price Risk for Airports
• Strong
• High flexibility on charge-setting authority
• Ability to annually cover all necessary costs related to airport’s debt, capital investments
and operational costs from aeronautical revenues (primary basis) or other commercial
revenues independent of (or compensating) underlying traffic performance (e.g. take-or-
pay agreements)
• None or very minimal tariff or pricing caps
• Moderate
• Adequate charge-setting authority to cover all necessary costs related to airport debt,
capital investments and operational costs from aeronautical revenues (primary basis) or
other commercial revenues
• Limited use of balance sheet (e.g. airport funds) to subsidize rate setting
• Price caps offering some ability to index charges on the capex, but limiting flexibility
within the control period
• Weak
• Limited flexibility and charge-setting authority (e.g. non-indexed price caps)
• Elevated dependence on non-aeronautical revenues or airport funds to meet all required
costs
• Tariffs cannot be increased to compensate for traffic declines

66
 Price Risk Discussion in Loan Agreement
• Evidence of the enactment of legislation allowing the Borrower to charge
and collect each arriving passenger US$37.50 and each departing passenger
US$37.50, subject to exceptions for certain exempt passengers.
• (b) Evidence of the exemption of the Borrower from tax under the Income
Tax Act of Antigua and Barbuda for the transactions.
• (c) Evidence of the approval by the Cabinet of Antigua and Barbuda of the
waiver of the payment by the Borrower and any other Person of any
withholding tax and any stamp tax relating to the transactions.
• (d) Evidence of the authority of IATA to collect the Airport Administration
Charge and the Passenger Facility Charge on behalf of the Borrower and
directly deposit the funds into the Collection Account.
• (e) Evidence of the repeal of the Passenger Facility Charge Act.
• (f) Evidence of the repeal of the Embarkation Tax Act, 2002.
• (g) Evidence of the agreement of the Social Security Administration and the
Medical Benefits Scheme of Antigua and Barbuda of the deferral of
payment by the Borrower to it of outstanding statutory arrears

67
 Risk for Airports
• Strong
• Modern and very well-maintained airport
• Strong access to excess cash flow or external funding for critical or committed capex
• Short-term and long-term maintenance needs are well defined with solid funding plans
identified
• Concession framework provides for full recovery of expenditure via adjustment in rates (if
applicable)
• Moderate
• Well maintained airport
• Moderate access to excess cash flow or external funding for critical or committed capex
• Short-term and long-term maintenance needs are generally defined with some uncertainty
regarding timing and funding
• Concession framework provides for adequate recovery of expenditure via adjustment in rates
(if applicable)
• Weak
• Issues with the maintenance of the airport
• Limited access to excess cash flow or external funding for critical or committed capex
• Short-term and long-term maintenance needs are not well defined; timing and funding are
unclear
• Concession framework does not provide for significant recovery of expenditure via adjustment
in rates (if applicable)
68
 Operating Cost Risk for Airports
• Strong
• Senior debt
• No material exposure to refinance risk (i.e. fully amortizing debt)
• No material exposure to variable interest rates
• No imbalance from swaps/derivatives
• Strong structural features (e.g. 12-month DSRA, robust lock-up requirements)
• Progressive deleveraging, with sweep of significant portion of excess cash flow to repay debt

• Moderate
• Junior debt with limited subordination
• Limited exposure to refinance risk (i.e. moderate use of bullet maturities, some back-loading of debt)
• Limited exposure to floating-interest rates
• Some imbalance from swaps/derivatives
• Adequate structural features and reserves (e.g. six-month DSRA)
• Stable leverage or moderate deleveraging

• Weak
• Deeply subordinated debt exposed to, or negatively affected by protective features of the senior debt
• Material refinance risk exists (i.e. significant use of bullet or back-loaded maturity structure)
• Significant exposure to floating-interest rates
• Use of derivatives resulting in imbalanced exposure
• Loose structural features (limited ABT protection precluding excessive additional leverage) and reserves (e.g. less than
six-month DSRA)
• Increasing leverage

69
Using the Subjective Assessment and Debt to EBITDA

• Evaluate what you think the airport rating

should be
Real Measures of Industry Operating Risk – Demand and Price

• Demand Volatility with Mean Reversion

• Demand Volatility from Fashion Changes and/or
Technology Changes – No Mean Reversion
• Difference Between Short-run Marginal Cost and Long
Run Marginal Cost – Exposure to Price Change
• Demand Growth to Alleviate Surplus Capacity
• Surplus Capacity with Capital Intensity and without
Capital Intensity
• Shape of Supply Curve in the Industry
• Rate of Return in Industry
Real Measures of Industry Operating Risk – Operating Cost and Capital
Expenditures

• Fixed and Variable Cost – Percent of Revenues

• Fixed and Variable Cost – Per Unit
• Exposure to Volatile Prices
• Exposure to Increasing Competitiveness in Industry
Structure
• Potential for Obsolescence in Capital Expenditure
• Potential for Changes in Capital Expenditure Value
• Changes in Value for Inventory from Commodity Price
Spike
Real Measures of Company Position in Industry

• Cost position relative to competitors

• Cost per unit of fixed and variable
• Rate of return position and potential to fall to industry norm
• Price relative to competitors and relative to companies
in other countries
• Ability of company to maintain product differentiation
Contract Problems and Character

• You may say that anytime somebody breaks a contract

that they have bad character – they are not willing to pay.
• You may say that you cannot predict bad character
• You may even attribute bad character to an entire country
and call it political risk.

• Alternatively, you can look through the contracts and

understand if the contracts are economic in the first place.
• When contracts are not economic, it would be just plain
stupid to assume that they will remain in place.
 Risks and Hotel Case Study
• Apply statistics from Dubai downside
analysis to Hotel case.
• No excel work, just change assumptions and
create a downside case.
• Evaluate DSCR, LLCR, PLCR and Loan to
Value in the case
• Use read pdf file to extract data from Dubai
case

75
 Brazil Hotel Example (JLL)
• Brazilian hotels’ RevPAR fell by nearly 15 percent in
2015 after 10 years of consecutive growth. A number of
major hotel markets in the country experienced a decline
in RevPAR in 2015 which, coupled with a nearly 10
percent rise in inflation, negatively impacted hotels’ profit
margins. Average gross operating profits fell to 28.5
percent of total revenue in 2015 from 36 percent in 2014.

• Affected by the weak economy and an increase in supply,

which grew by 4.2 percent in 2015, occupancy rates also
experienced downward pressure. The biggest growth in
supply was recorded in hotels affiliated to domestic and
international chains at 9.2 percent.

76
 Dubai Case Study – What is the Required DSCR

• Compute decline in total revenues

• Use model of hotel and evaluate effect on
financial ratios

77
Examples of Variation in Occupancy Rate

78
How Much Can Do Rents Change from Year to Year (JLL)
Cap Rates for Evaluating the Exit Value

80
Evaluating Demand and Supply

81
Projected Hotel Rooms in Riyadh

82
Project Occupancy and Price

83
Output and Availability Projects
Definition of Output and Availability Projects
• Understanding the definition of output and
availability-based projects is a starting point in
project finance.
• Output-based Projects: The cash flows are
sensitive to volumes or demand.
• Availability-based projects: the cash flow is
sensitive to whether the projects are available to
deliver their service but not the actual services
produced.
• This means output-based projects are sensitive to
demand and availability-based projects are not.

85
Reason Why Some Projects are Availability Structured Projects

• Consider a hospital – one could imagine an output project

with a single price where the revenues depend on the
number of patients who are in the hospital.
• The hospital would hope for sick people and disease. This
has little to do with the way the hospital is being managed.
• If the government decides how many hospitals to build and
where to build them, an availability structure could be
developed where the hospital receives revenues on a fixed
basis, adjusted for items such as the availability and
efficiency of equipment that is under control of the
management.
• If an availability contract is established, the contract is
more complex.
Structure of Contracts for Availability Projects and Output Projects

• Output based projects and availability projects

have different structure of contracts.
• The availability projects generally are more
complex because incentives must be structured in
the contracts.
• A toll way example could be used. If a toll way is
structured as an output-based project, the revenues just
depend on traffic.
• If the toll way is output based, the revenues are not
dependent on traffic, but incentives must be structured
for making sure the road is in good condition and re-
surfacing is completed in an efficient and timely basis.

87
 Risks for Availability and Output Projects
• Risks of output-based projects primarily
involve making incorrect estimates of the
output such as traffic. This can be very
difficult because there is often no historical
basis for the forecasts.
• Risks of availability projects often involve
assessing whether the counterparty to the
contract will live up to the contract terms.
When the counterparty is a government
agency this becomes political risk.

88
Statistics for Availability and Output Projects
• Statistics to evaluate availability projects and
output projects are different.
• For availability-based projects the DSCR can
be relatively low and LLCR or PLCR not
emphasised.
• For output-based projects, the LLCR and the
PLCR are more important and the level of the
coverage must be higher.

89
 Project Finance and WACC
• In the last diagram it would be crazy to assume the
risks associated with a relationship are the same
over the course of the relationship.
• Similarly, assuming that the risk of a project is the
same over the life of a project makes no sense at all.
• Additionally, the equity to capital ratio on a book or
an economic basis is not the same over the life of a
project.
• This is unlike project finance, a corporation with
portfolios of projects may have a reasonably
constant WACC

90
Ras Laffan in Qatar

91
Qatar Background
 Project Finance Diagram – Ras Laffan
Off-taker: Korea and Japan
Utility Companies: Want
strong off-taker with
inactive to honor contract

EPC Contractor: Off-take

Price of Gas
Kellogg with Contract with
Strong Record Linked to Oil
Price minimum
and Finances supply

EPC: Fixed Price

Contract with LD

Special O&M
Supplier: Need Purpose
Supply O&M Contractor
to Understand Vehicle: Bond
Agreement Agreement
Economics and Rating of A-
Supply Curve

Loan
Shareholder Agreement –
Agreement Draws Green;
Sponsors: Debt Service
Want strong Lenders:
Red
sponsor: Issued bonds and
Mobil debt with long tenor
State and low rates
 Example: Ras Laffan Liquified Gas Company (Ras Gas)

• Summary of Original Transaction

• Project: 2 LNG Trains and cost of developing natural gas
reserves
• Cost $3.4 billion
• 5.2 millions of tons per annum
• Equity Sponsors
• 70% State of Qatar
• 30% Mobil Oil
• EPC Construction Contracts
• JCG/MW Kellogg for LNG Trains and on-shore facilities
• McDermott-EPTM/Chiyoda for off-shore platforms
• Saipan for off-shore pipeline connection
 Project Finance Representation with Contracts for Ring Fencing
Risks – This is the Idea of contracts

Debt is serviced entirely via

cash flow through the project
and the SPV This structure
exposes the lenders to
significant risks. If something
goes wrong, their recourse
against the sponsor, with its
typically larger balance sheet,
will be limited or none.
The loan is structured so
that bankers can step into
and take over the project if
things were to go wrong, a
so-called step-in right. This
process is also called ‘ring-
Ring-Fence fencing.’
Bad Diagram of Project Financing for Discussion
Explaining Project Finance with Diagrams: Bad Examples

97
 Explaining Project Finance with Diagrams
• SPV is a separate corporation in the middle
• SPV signs a lot of contracts that should be illustrate
with solid lines
• The contracts should be labeled (e.g. concession contract,
EPC contract, PPA contract, O&M contract, Loan
Agreement, Shareholders agreement)
• Contracts should be consistent with each other
• Diagram should show direction of money and start with
revenues (no revenues, no project)
• Quality of off-takers should be shown on the diagram in
the circles
• Insurances and guarantees should can be demonstrated

98
 Ras Laffan Liquified Gas Company

• Financing of $3.4 Billion

• $850 million in Equity
• $465 million supported by US EXIM
• $250 million supported by UK ECGD
• $185 million supported by Italy’s SACE
• $450 million uninsured loan from commercial banks
• $1,200 million from bond markets
• 10 and 17 year maturity
• Rated BBB+ by S&P
• Rated A3 by Moody’s
• Revenue Contracts
• 25 year contract with Korea Gas Corporation for output of one train
• Korean Gas Corporation built receiving facilities and purchased ships ($3.1
billion)
 Ras Laffan III

• Raised $4.6 billion in debt

• Bonds rated A+
• Elimination of sales volume risk through long-term contracts
• Few technological issues based on the construction of initial phase
• Sponsor support from ExxonMobil
• Virtually no supply risk from sourcing of natural gas
• Competitive cost position due to economies of scale and low
feedstock prices
• Elimination of construction risk through EPC contracts
• DSCR’s above 2x in stress scenarios; break even oil price of
$11/BBL and $2/MMBTU
 Ras Laffan III Weaknesses

• Linkages of prices to oil price and natural gas prices

in Europe
• High counterparty risk – 74% of sales volumes to
off-takers with BBB or below
• Counterparty risk from the necessity of third
parties to complete infrastructure projects such as
port facilities, terminal facilities, and ships
• Exposure to indemnity payments
• Absence of business interruption insurance
Ras Laffan III Off-takers
 Ras Laffan 3 Cash Flow Waterfall
• The diagram illustrates how the ordering of cash flow works in a cash flow waterfall
 Create Diagram for Solar Case
• PPA Contract Price
• Volumes from Solar Resource Analysis
• O&M Contract (see next slide)
• EPC Contractor
• Loan Agreement
• DSRA
• Equity Contribution

• “EPC Contractor” means Entropy Solar Integrators, LLC, a North

Carolina limited liability company.
• “Sponsors” means each of (i) York Credit Opportunities Fund, L.P.
and (ii) York Credit Opportunities Investments Master Fund, L.P.,
acting by its general partner York Credit Opportunities Domestic
Holdings, LLC.

104
 O&M Contract Language from Loan Agreement
• “O&M Contractor” means ReNew Solar Delaware Limited shall be
approved by the Required Lenders to manage the Project in accordance
with the Credit Agreement.
• “O&M Costs” means
• all actual cash maintenance and operation costs incurred and paid
• state and local Taxes, insurance, consumables, payments under any lease,
payments pursuant to the agreements for the management, operation and
maintenance, reasonable legal fees, costs and
• expenses paid by Borrower in connection with the management, maintenance or
operation of the Project, costs and
• expenses paid by Borrower in connection with obtaining, transferring,
maintaining or amending any Applicable Permits and
• reasonable general and administrative expenses.
• If the O&M Contractor is not providing services to the Project in
accordance in with the provisions of the O&M Agreement, the contractor
may be replaced.
• Note: where are the L/C fees paid to the bank

105
Petrozuata – Deal of the Decade

106
Broke Just About Every Record for Financing in Latin America
Structure of Petrozuata Ownership – Value of
Construction Guarantee from Parent
 Contract Issues in Petrozuata
• Was the type of purchase good for the project
or would the project have been better with a
production sharing agreement.
• Royalty rate was 0.5%
• Conoco owned 51%
• Negotiations were like Columbus and Indians
Structure was very Different From Production Sharing Contract

• Example of rate of return limit in some

production sharing contracts
Summary of Project from Sources and Uses
• Picture of project pre-COD from Uses and
sources: Operating Cash Flow as equity
Post COD Picture – DSCR. PLCR and LLCR
• Enormous buffer – even using a 15 USD Oil
Price
Outcome of Petrozuata
Time Line and Nationalisation
Example of Arbitration Language
• Disputed
findings
 Dispute Resolution in Airport Case
• The English courts and the Cayman Islands
courts have exclusive jurisdiction to settle
any dispute arising out of or in connection
with any Finance Document, including any
dispute relating to any non-contractual
obligation arising out of or in connection
with any Finance Document (a Dispute).

117
 Price Risk in Projects

• Loans were granted on the presumption that housing AES Drax and UK Merchants
prices would follow historic trends and continue to
increase. The most fundamental of economic Declines in prices were not predicted in merchant
principles dictate that prices eventually move to electricity markets after increases in supply.
long-run marginal cost, or the cost of building a new Losses were estimated to be $100 billion. In the
home. As a corollary, economics suggests that prices U.K. changes in the market structure and
can move to short-run marginal when surplus increased supply pushed prices to marginal cost.
capacity exists. The graph of median housing prices
in the U.S. shown below illustrates how the basic
economic principles were ignored.

UK Annual Electricity Prices

30
• . 28
29.0
27.0
26 26.0
25.0
24 24.0 24.0
23.0
GBP/MWH 22 22.0
21.0
20 20.0
19.0
18
17.0
16 15.5
• . 14
12
10
1990 1991 1992 1993 1994 1995 1996 1997 1999 2000 2001 2002 2003
Eurotunnel – Contract Structure, Ownership and Timing
 Eurotunnel Part 1 – Development Stage
Off-taker: Railways signed
contracts using estimate
price. Signed before FC

EPC Contractor: Development

Combination of Accepted Traffic Cost for RFP Paid
French and English. Risk from Study for by TML –
Not Conventional with no History Seven Months
Technology
EPC: Fixed Price
Contract with LD

Special Purpose
Eurotunnel.
Manager Assigned
by Government
Shareholder
Sponsors: 60% Loan
Agreement with
owned by TML; Agreement with
investment and
other Owners draws and
dividends Lenders: Made
were Banks repayments
Commitment and
and Institutions
required equity
capital
 Eurotunnel Part 2 – Construction Stage
SIMPLISTINC TRAFFIC STUDY
Off-taker: Railways signed
contracts using estimate price.
Signed before FC

BAD EPC
CONTRACT: Accepted Traffic Risk from
Combination of Study with no History. Big
French and English. over-supply risk
Not Conventional
Technology EPC: Change
Orders all favour
EOC

Special Purpose
Eurotunnel.
Manager Assigned
by Government Loan
TML owns Agreement
Increased LENDERS RELY
small amount IPO ON DEBT TO
CAPITAL NOT
REAL: Lenders:
Stuck with
NO STRONG project and
SPONSOR: increased
Individual investment
Shareholders who
could not stand up
to EPC
Excerpt from Prospectus for IPO Describing Construction Contract
EPC Contract part 1 – Note the Not a Fixed Price Contract for
Tunnels and Underground Structures
EPC Contract Part 2 – Procurement of Locomotives and Other
Items
EPC Contract Part 3 – Liquidated Damages for Delay

• Test
Performance Bonds and Guarantee
 Sources and Uses for Estimated and
Actual
.
 Cost Over-Run Summary
• Scope Changes from Government – Safety
standards of navettes and other risks
• Definition of who bears responsibility and risk The rolling stock for the shuttle
allocation trains was let on a procurement
• A form of political risk; politically sensitive basis. TML would manage their
deadlines; managers with political experience acquisition on behalf of
rather than technical experience Eurotunnel, and be paid a
percentage fee for this service.
Percent Difference
250%

Percent
Difference
200%
Original Final
Tunnels 1,329.0 2,110.0 59%
150%
Terminals 448.0 553.0 23%
Fixed Equipment 688.0 1,200.0 74%
100% Rolling Stock 245.0 705.0 188%
Subtotal 2,710.0 4,568.0 69%
50% Corporate and Inflation 1,111.0 3,358.0 202%
Subtotal 3,821.0 7,926.0 107%
0%
Financing Costs 500.0 1,500.0 200%
Tunnels Terminals Fixed
Equipment
Rolling Stock Subtotal Corporate and
Inflation
Subtotal Financing Costs Total
Total 4,321.0 9,426.0 118%
Eurotunnel Debt/EBITDA

The debt to
capital ratio for
Eurotunnel at
financial close
of 76% was in
line with other
projects, but it
was irrelevant
Projected Traffic Revenues
 Actual and Projected Revenues

Actual and Proejcted Eurotunnel Revenues

2000

Revenues - Annual Reports

1800
Projected
1600

1400
Revenues in GBP (000's)

1200
Wrong by a
1000 factor of 2 at
start of project
800

600

400

200

0
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

131
 Traffic Studies
• Many infrastructure projects depend on highly complex models
that measure the number of trips on every single road in an area
and then attempt to project the number of people who will use a
toll road. These forecasts have turned out to widely off in many
cases where the road is supposed to create economic activity.

132
 Structuring and Strong Sponsors -- Iridium

• International Coverage
• 66-LEO Satellites
• Launched 72; got 67; 5-year life each
• 12 Ground Stations
• Handset Cost = US$3,000
• Call Cost = US$3.00-US$7.50 per min.
• US$800 million PF
• LIBOR + 4%; 2-year Bullet
 Sources and Uses of Funds

Uses of Funds
Payments Under Space System Contract 3,380,000,000 71%
Payments Under Terrestial Contract 238,000,000 5%
Other Construction Expenditures 409,002,000 9%
Pre-Operating Expenses 749,162,000 16%
Interest Paid 362,552,300
Total Uses of Funds 5,138,716,300 100%

Sources of Funds
Equity Financing 2,140,000,000 40%
Guaranteed Bank Facility 745,000,000 14%
Senior Bank Facility (Spread of 2.5%) 800,000,000 15%
Senior Notes - A (Yield of 13%) 278,000,000 5%
Senior Notes - B (Yield of 14%) 480,000,000 9%
Senior Notes - C (Yield of 11.25%) 300,000,000 6%
Senior Notes - D (Yield of 10.88%) 342,000,000 6%
Subordinated Notes (Yield of 14.5%) 238,453,000 4%
Interest on Cash Balance 1,307,606,655
Total 5,343,769,601 100%
 Iridium Sources and Uses

Total 1991 1992 1993 1994 1995 1996 1997 1998 1999

Uses of Funds
Payments Under Space System Contract 3,380,000,000 98,500,000 98,500,000 197,000,000 197,000,000 802,000,000 836,000,000 577,000,000 574,000,000 -
Payments Under Terrestial Contract 238,000,000 - - - - - - 64,000,000 174,000,000 -
Other Construction Expenditures 409,002,000 18,312,750 18,312,750 18,312,750 18,312,750 26,178,000 164,415,000 145,158,000 - -
Pre-Operating Expenses 749,162,000 5,483,000 5,483,000 10,966,000 16,729,000 26,436,000 70,730,000 177,474,000 435,861,000 -
Interest Paid 362,552,300 - - - - - 18,937,500 113,170,000 230,444,800 -
Total Uses of Funds 5,138,716,300 122,295,750 122,295,750 226,278,750 232,041,750 854,614,000 1,090,082,500 1,076,802,000 1,414,305,800 -

Sources of Funds
Equity Financing 2,140,000,000 200,000,000 200,000,000 200,000,000 200,000,000 800,000,000 315,000,000 - 225,000,000 -
Guaranteed Bank Facility 745,000,000 - - - - - 505,000,000 (230,000,000) 350,000,000 120,000,000
Senior Bank Facility (Spread of 2.5%) 800,000,000 - - - - - - 300,000,000 200,000,000 300,000,000
Senior Notes - A (Yield of 13%) 278,000,000 278,000,000
Senior Notes - B (Yield of 14%) 480,000,000 480,000,000
Senior Notes - C (Yield of 11.25%) 300,000,000 300,000,000
Senior Notes - D (Yield of 10.88%) 342,000,000 342,000,000
Subordinated Notes (Yield of 14.5%) 238,453,000 - - - - - 238,453,000 - - -
Interest on Cash Balance 1,027,260,859 - 2,331,128 4,732,189 4,085,792 3,247,113 1,706,107 808,405 3,405,868 -
Total 5,343,769,601 200,000,000 202,331,128 204,732,189 204,085,792 803,247,113 1,060,159,107 1,128,808,405 1,120,405,868 420,000,000

Percent Equity 40%

Percent Guaranteed Debt 14%
Percent Senior Debt 41%
Percent Subordinated Debt 4%
 Violation of Rule that Trusts Strong Sponsors (Motorola) - Iridium

Projected and Actual Revenues for Iridium

According to one story an 9,000,000
Actual
investor called the rating Salomon Smith
agency Standard & Poor’s and 8,000,000
Barney
Credit Suisse/First
asked what would happen to 7,000,000 Boston
Lehman Brothers
default rates if real estate
prices fell. 6,000,000 Merrill Lynch

CIBC Oppenheimer
5,000,000

“The man at S&P couldn’t say;

its model for home prices had 4,000,000

no ability to accept a negative 3,000,000

number. ‘They were just

assuming home prices would 2,000,000

keep going up…’” 1,000,000

0
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Fundamental Differences in Risks from Sources of Revenues

• Price Risk: Oil, LNG, Mining,

Petrochemical, Refining, Merchant
Electricity
• Volume Risk (Traffic Risk): Toll Roads,
Airports, Sea Ports, Bridges,
Telecommunication, Metro, Tunnels
• Availability Risk: PPA electricity plants, PPP
projects for schools, airports etc.

137
 Operating Budget – In Airport Case
• Operating Budget will be prepared and will specify, for each
month during the calendar year
• (i) the Revenues of the Borrower anticipated to be received and
• (ii) the anticipated Operating Costs, together with a comparative
presentation of Revenues of the Borrower and Operating Costs in
the prior calendar year, and will describe in reasonable detail
• (A) the anticipated maintenance and overhaul schedule (including any
major maintenance or overhauls which are projected for the next
succeeding calendar year),
• anticipated staffing plans, mobilization schedules, capital expenditure
requirements, equipment acquisitions and spare parts and consumable
inventories (including a breakdown of capital items and expense items),
and administrative activities,
• (B) a high-level summary of reasonably anticipated major maintenance or
overhaul activities and capital expenditure projects for the next
succeeding two (2) calendar years and (C) any other material underlying
assumptions in connection with such Operating Budget.

138
 Operating Budget Control
• Operating Budget; provided that the Facility Agent’s approval will be
automatically given if
• (i) the proposed Operating Budget provides for (x) an increase in
aggregate Operating Costs budgeted of not more than 110% of the
aggregate Operating Costs budgeted then in effect,
• (y) Operating Costs constituting no more than forty-five per cent. (45%)
of actual Revenues of the Borrower for the calendar year then-ending and
• (z) capital expenditures of no more than US$750,000 for such calendar
year or
• (ii) (x) the Revenues of the Borrower for the calendar year then-ending
are more than 110% of the Revenues of the Borrower for the prior
calendar year and
• (y) the proposed Operating Budget provides for an increase in aggregate
Operating Costs of not more than 45% of actual Revenues of the
Borrower for the calendar year then-ending.
PLCR and LLCR Versus DSCR
 DSCR, LLCR and PLCR Basic Definition
• What the Abbreviations Stand for:
• DSCR: Debt Service Coverage Ratio
• LLCR: Loan Life Coverage Ratio
• PLCR: Project Life Coverage Ratio
• Coverage Ratios are All Measures of Break
Even Until Default or Loss
• Basic Formulas:
• DSCR: Cash Flow/Payments to Bank
• LLCR: Value of Cash Flow over Loan Life to Debt
• PLCR: Value of Cash Flow over Project Life to
Debt

141
 First the LLCR and PLCR Definition
• When defining the LLCR and PLCR a key project finance
formula should be understood.
• This formula is the equivalence between the PV of debt
service and Debt at COD:

• NPV(Debt Service) = Debt at COD

• So,
• LLCR = NPV CFADS Loan Life/PV DS
• LLCR = NPV CFADS Loan Life/Debt at COD

• PLCR = NPV CFADS Project Life/PV DS

• PLCR = NPV CFADS Project Life/Debt at COD
 Fundamental Formulas for Credit in Project Finance for DSCR,
LLCR and PLCR

• DSCR = Cash Flow Available for Debt Service/[Debt Service]

• PLCR = PV(Cash Flow Available for Debt Service)/PV(Debt Service)
• LLCR = PV(Cash Flow Available for Debt Service over loan life)/PV(Debt
Service)
• Debt at COD = PV(Debt Service using Debt Interest Rate)
• Therefore,
• PLCR = PV(Cash Flow Available for Debt Service)/Debt - DSRA
• LLCR = PV(Cash Flow Available for Debt Service over loan life)/Debt – DSRA

• Theory
• Minimum DSCR measures probability of default in one year
• LLCR measures coverage over the entire loan life even if project must be re-
structured
• PLCR measures coverage over the entire project life and the value of the tail
 How to Use the Ratios in Measuring Cash Flow Sensitivity

• The key behind these ratios is understanding what they

measure. Each ratio can be used to measure how
much cash flow can fall before something bad occurs:
• DSCR: Cash flow reduction before one time default
with formula % reduction = (DSCR-1)/DSCR
• PLCR: Cash flow reduction before loan will not be
repaid by end of project life after restructuring the loan
with the formula % reduction = (PLCR -1)/PLCR
• LLCR: Cash flow reduction before loan will not be
repaid before the end of the loan life even if it must be
restructured. You can measure the cash flow reduction
with % reduction = (LLCR-1)/LLCR.

144
 When Would You Use PLCR and LLCR Rather than Only DSCR

• If you have a project with a contract like a

PPA contract or an availability contract, the
cash flows should be stable from year to year.
In this case you would generally focus on the
DSCR.
• In output based projects or commodity based
projects, the cash flow may vary more on a
year to year basis. For these projects you
would more often see the LLCR and PLCR
used.
145
Why Discounting is at the Interest Rate (or the Debt
IRR in the Case of Changing Interest Rate)

• The reason that CFADS is discounted at the

interest rate is that if there is a default, it is
assumed that the defaulted amount must be
re-structured and re-paid later on.
• The amount of default is assumed to re-paid
with interest at the same interest of the loan.
• This means that you can compare CFADS
over different time periods

146
 DSCR, PLCR and Value of Tail
• The tail is the difference between the loan life
and the project life.
• To see what the PLCR measures you can
consider two loans with the same cash flow.
One loan has the same DSCR and PLCR
because the loan has no tail.
• The second loan has a shorter tenor and a tail.
In this case the DSCR will be lower than the
PLCR.

147
DSCR versus LLCR versus PLCR and Sculpting

Level Payment and Tail

Min DSCR < LLCR < PLCR

Sculpting and Tail

DSCR = LLCR < PLCR

Sculpting and No Tail

DSCR = LLCR = PLCR

Idea of Risk Allocation Matrix and Use of DSCR, PLCR and LLCR
to Measure Break-Even

• Risk allocation matrices will be used to demonstrate how the

DSCR and LLCR can be used to determine acceptable unmitigated
risks:
• The formula:
• break-even cash flow reduction = (DSCR-1)/DSCR.
• Also break-even cash flow over life of loan
• BE reduction = (LLCR-1)/LLCR
• BE reduction for Project Life = (PLCR-1)/PLCR
• Different project finance structures that involve:
• availability payments versus output-based revenues;
• commodity price (merchant) risk;
• traffic or volume risk (pipelines), and
• resource risk (wind, solar and run of river hydro) will be derived.
• For each of the project finance types, an illustrative risk allocation
matrix and project diagram will be developed.
149
Risks of Commodity Prices versus Traffic

Crude oil, average ($/bbl) Volatility 29.64%

Natural gas, US ($/mmbtu) Volatility 40.50%
Correlation 52.72% Last Value of Crude oil, average 54.35 Last Value of
Natural gas, US 3.26
16.00 140.00

14.00 Determine the break-even 120.00

price relative to historic
12.00
Natural gas, US ($/mmbtu)

Crude oil, average ($/bbl)

prices: Do with DSCR, LLCR 100.00
10.00 or PLCR 80.00
8.00
60.00
6.00
40.00
4.00

2.00 20.00

0.00 0.00
01-janv-79

01-janv-92

01-janv-05
01-avr-82

01-avr-95
01-mai-83

01-août-86

01-oct-88
01-nov-89
01-déc-90

01-mai-96

01-nov-02

01-avr-08
01-mai-09

01-août-12

01-oct-14
01-nov-15
01-juin-84
01-juil-85

01-juin-97
01-juil-98
01-août-99

01-oct-01

01-déc-03

01-juin-10
01-juil-11

01-déc-16
01-mars-81

01-mars-94

01-févr-06
01-mars-07
01-févr-80

01-sept-87

01-févr-93

01-sept-00

01-sept-13
Natural gas, US ($/mmbtu) Crude oil, average ($/bbl) N/A

150
 You Can Go the Other Way to Find the DSCR

• Formulas for Break-Even: Say that you want to know

how big the DSCR should be to cover for an availability
payment that could be reduced by 20%.
• The formulas below are for DSCR; you could also use
LLCR and PLCR
• Break-even cash flow = (DSCR-1)/DSCR
• BE = (DSCR-1)/DSCR
• BE x DSCR = DSCR – 1
• DSCR – BE x DSCR = 1
• DSCR * (1-BE) = 1
• DSCR = 1/(1-BE) or 1/.8 or 1.25
• Note: Be careful with fixed costs. If an oil project has
fixed costs you have to make a more complex formula

151
IRR in Project Finance
 Project IRR or DSCR
• Importance of Project IRR. Objective in a sense
is to maximize the equity IRR given a level of
project IRR.
• Danger of high project IRR from banking
perspective. In commodity price analysis means
that others will come into the market and the
margin will be reduced. Must have demonstrated
cost advantage.
• Danger of high project IRR and political risk.
Eventually the government will understand if
the project price is uneconomic

153
 IRR versus Return on Investment
• Project finance uses IRR instead of return on equity
or return on invested capital
• In project finance, the investment on the balance
sheet (net plant) declines investment over the life of
the project.
• If you compute the ROE or the ROIC, the number
starts very small and becomes very large.
• Unless you develop a weighted average that accounts
for the cost of capital and the level of investment on
the balance sheet, it is very difficult to find a good
ROE or ROIC statistic to summarise the project.

154
 IRR and Growth Rate in Cash Flow
• The equity IRR or Project IRR can be thought of as a
growth rate in cash flow. If there is no intermediate
cash flow, the CAGR and the IRR are the same.
• The problem with the IRR is that cash flow that occurs
before the end of the project (i.e. intermediate cash) is
assumed to be re-invested at the IRR itself. If the IRR
is really high, you may not be able to find another
investment with the same IRR. Further, the MIRR
provides no help to this.
• The IRR can be compared to stock market total
returns.

155
 Negative Cash Flow and Different IRR’s
• For the IRR, there should be negative cash
flows at the beginning reflecting the investment
followed by positive cash flows.
• In project finance you can compute the project
IRR without tax, the project IRR after tax, the
equity IRR and the debt IRR.
• The project IRR reflects the overall return on
the project and is relatively simple to calculate.
• The after-tax project IRR is the same as the
equity IRR if there would be no debt financing.

156
 Project IRR, Debt IRR and Equity IRR Interpretation

• The debt IRR can be computed from the perspective of debt

holders. The debt drawdowns are the negative cash flow while the
debt service including interest and principal are positive cash
flows. The fees should be included as cash flow. The debt IRR
can be called the effective interest rate or the all-in rate.
• The project IRR is an effective statistic for evaluating the overall
competitiveness of a project. If the project IRR is very high, you
should ask questions about why others cannot create similar
projects and charge a lower price. If the project IRR is below the
cost of debt, you should ask why the project is occurring.
• The equity IRR is the focus of investors because it reflects money
taken out of their pocket relative to dividends received. In
structuring debt terms such as a cash sweep or the debt to capital,
the equity IRR can be used to understand the perspective of the
sponsor.

157
 IRR in Solar Case
• IRR Statistics from original model

158
Part 3: Availability and Capacity
Based Projects
 Private Public Partnerships and Capacity Based Projects

• Economic Theory and Risk Allocation

• Allocation of Risks
• Tricky Allocation of Risks
• Spot Pricing Cons and Pros

160
 Off-taker
EPC
Contractor
PPA Contract
Four Part Tariff
Fixed Price Fixed Capacity Charge at Fin
Contract with LD Close
LD Penalty for Delay Risk
Contract O&M Charge
Contract Heat Rate
Fuel
Fuel Supply
Supply Availability Penalty
Fuel Index
Fuel Index

Fuel Supply Contract

with Index
Special Contract with
Guaranteed Heat Rate
Corresponding to Purpose and Availability O&M
PPA Vehicle Penalty Contractor
and Fixed Fee

Shareholder
Agreement Loan
Agreement

Sponsors Lenders

Letter of
Credit for
Equity Cash
 Basic Equations for Revenue Build Up
• Electricity plants have capacity which is the ability to produce at an
instant
• kW, mW, W
• For producing revenue, there must be some kind of time dimension
attached to the capacity
• Hours, months, years
• kW x h, kW x month, kW x year
• kWh, kW-month, kW-year
• There is a basic distinction in project finance for availability and output
based projects. Output base projects earn revenues on production,
availability based projects earn revenue as long as the plant is available
to produce even if it does not produce.
• Output based projects (renewable): revenue = price x kWh
• Availability based projects (dispatchable): revenue = price x kW-
month
 Drivers and Cost of Electricity – Slide 1
• Plant Cost and Construction Delay (€/kW or € million/MW or €/W)
• Carrying Charge Rate (% of total cost recovered in a year)
• Annual Capital Cost Recovery: Plant Cost x Carrying Charge or
• Annual Charge per year
• €/kW-year = €/kW x Carrying Charge Rate
• Capacity Factor (% of Time (hours per year plant is running)
• Annual Charge per hour
• Generation = kW x hours operated
• Generation = KW x 8766 hours per year x capacity factor
• Annual Charge per Hour = Annual Charge per year/hours
operated
• €/MW-year = €/kW x Carrying Charge Rate x
1000/Generation
 Drivers and Cost of Electricity – Slide 2
• Efficiency (Heat Rate)
• Kj/kWh, BTU/MWH, kBTU/MWH, MMBTU/MWH, kWh/kWh
• Fuel Use or Resource Use = HR x Generation
• MMBTU = HR x Generation
• MMBTU = (MMBTU/kWh) x MWh
• Fuel Price
• Measured in €/MMBTU, €/kJ, €/kWh
• Fuel Cost = Fuel Price x Fuel Price
• Fuel Cost/MWH = Fuel Cost/Generation
• Fuel Cost/MWH = HR x Generation x Fuel Price/Generation = HR x Fuel Cost
• Fuel Cost/MWH = HR x Fuel Price = kJ/MWH x €/kJ (kJ cancels)
• Variable O&M Expense
• Cost that depends on running the plant - €/MWH
• Fixed O&M Expense
• Cost independent of running the plant €/kW -year
 Risk Allocation and Drivers in PPA
Agreement

Risk in Electricity Production Allocation of Risk Off-taker and IPP

1. Plant Cost and 1. IPP Controls and Takes Risk
Construction Delay
2. IPP Control and Risk
2. Efficiency (Heat Rate)
3. Off-taker Risk
3. Fuel Price
4. Off-taker Controls Dispatch,
4. Capacity Factor and
Availability Factor from IPP controls Availability
Forced and Unforced 5. IPP Control and Takes Risk
5. Variable O&M Expense 6. IPP Control and Risk
6. Fixed O&M Expense
7. Off-taker
7. Carrying Charge Rate
 Begin with Fundamental Question of Risk
Allocation Between Off-taker and PPA

Risk to IPP Price Mechanism Contract Protection

• Construction Over-run • Fixed Capacity Charge • EPC Fixed Price
• Construction Delay • LD in for Delay
• LD in EPC Contract
• Availability • Availability Penalty
• O&M Contract LD
• Efficiency • Heat Rate Target
• O&M Fixed Price • Efficiency
• O&M Cost Over-runs
• Capacity Amount • Capacity Payment • O&M Cost Over-runs
• EPC and O&M
General Purchased Power Agreement Pricing
• Components
• A – Capacity Payment
• Covers debt service, taxes and equity return from project budget
• Deductions for unavailability of plant
• Currency adjustments and currency split
• B – Fixed O&M Charge
• Escalates with general inflation
• Could have currency adjustment
• C – Fuel Energy Charge
• Use the target heat rate
• HR x Fuel Price = Energy Charge
• D – Variable O&M Charge
• Definition of fixed and variable costs
• Start-up costs
 Four Part Tariff in Availability-based Dispatchable Plants

• If the revenues and profits depend on the availability and not

output but some costs depend on the output of the project then the
pricing structure must be designed to compensate to cover
variable as well as fixed costs. Some costs of producing
electricity are fixed and some are variable, including fuel costs.
Therefore, a variable price must be implemented to cover variable
costs and a fixed charge must be included to cover fixed charges:
1.Availability Charge: €/kW-month x Available MW
2.Fuel Charge: €/MWh x Energy Production in MWH
• (MWh = MW x hours of production or MW x capacity factor x hours in
period)
3.Variable O&M Charge: €/MWh x Energy Production in MWH
4.Fixed O&M Charge: €/kW-month x Available MW
Four Part Tariff Example
 Tricky Allocation Issues
• Who should take
• Temperature risk when the plant (thermal or
solar) operates less efficiently at higher
temperatures
• Fuel transport risk such as insufficient gas
supply
• Transmission risk if the power cannot be
delivered to the distribution system. Consider
both renewable and thermal.
• Distribution risk if the distribution system cannot
accept the load
 Drivers and Contracts - Dispatchable

IPP Risks Contract Mitigation

• Cost of Project, Time • EPC Contract with
Delay and Technology Fixed Price and LD
Parameters (LSTK)
• Availability Penalty • O&M Contract
• Heat Rate Risk • O&M Contract with LD
(Adjusted) Provision
• O&M Risk • O&M Contract
• Interest Rate • Interest Rate Contract
Fluctuation (Fix Rates)
 Drivers and Profit and Loss Statement -
Dispatchable
• Cost Driver • Profit and Loss Account
• Cost x Carrying Charge + Fuel Cost + • Total Revenue from Four Part Tariff
Variable O&M + Fixed O&M
• Fuel Expense
• Fuel Cost – HR x Gen x Fuel Pr

• Fixed and Variable O&M Expense

• Variable and Fixed O&M

• Capacity Charge Revenue (€/kW-year x

kW) • EBITDA (Operating Margin)

• Portion of Capacity Charge • Depreciation

• Portion of Capacity Charge • Taxes
• Portion of Capacity Charge • Interest

• Portion of Capacity Charge • Net Income

Exercise on Allocation of Risks Outside of IPP Control

• Single price with production risk versus fixed

capacity charge with no production risk
• Effect on DSCR
• Effect on Credit Spread
• Effect on Debt Tenure
• Effect on Equity IRR
 Problem of Allocating Uncontrollable Risks
• The general idea that risks which can be accepted at a reasonable
cost should be allocated to IPP versus the off-taker. The allocation
process is demonstrated with databases that show the volatility of
commodities and interest rates. For example, fuel price is allocated
to the off-taker because of variation on natural gas, coal and oil
prices.
• But variation in iron prices that cause construction costs to change
are allocated to the IPP. The class discussion involves nuances of
whether risks should be allocated.
• Non-dispatchable plants have a one part tariff while dispatchable
plants have a multi-part tariff. Discussion of resources that discuss
risk allocation are shown below. The left hand figure demonstrates
where to find the resource and the right hand figure shows an
example of the analysis. The first figure illustrates summary slides
and the second slide demonstrates a database of commodity prices.
Alternative Way to Look at PF Structure – Key is are Paying too
Much for Risk

175
Significant Emerging Country Defaults (S&P 2007)
Other Problem Loans (S&P 2007)
 Allocation of Risks that Are Out of IPP Control

• Start with capacity factor risk

• What would the IPP want to take the output risk
• If there is surplus capacity, consumers still pay
fixed cost of the plant
• What do you conclude about taking capacity
factor or output risk
• Fuel price risk
• Are the issues with fuel price risk the same as
output risk
• What about negotiating fuel prices
Contract Risks
Case Study of Risk and Return and Danger of Un-economic
Projects
Dabhol Case Study

181
Making Money in Different Places by Receiving Money from PPA
Contracts

Off-taker
pays money PPA – Four Part Tariff
EPC Contractor: LD for Delay Risk
for PPA
ENRON Fixed Capacity Charge at FC
EPC Profit Contract O&M Charge
Fixed
Contract Heat Rate
Price
Capacity Charge with Index
Contract
Availability Penalty
with LD
Special
Purpose
Corporation Fuel ENRON –
(IRR) Supply Fuel Mgmt.
Contract Fee
Contract
with
Guaranteed
Heat Rate Loan
and Shareholde Agreement
Availability r Agreement
ENRON O&M
Profit Penalty
and Fixed Lenders
Fee ENRON IRR
on SPV
Very High Cost of USD Off-taker Needs Rate Increase
1,400 per kW of 27%-39% to Pay PPA State of
Maharashtra
Bechtel
Construction
Off-taker –
Maharashtra State Guarantee
EPC Electricity Company
Management
by Enron Federal
Letter Government
of India
PPA
GE Equipment Contract
EPC
Contract

Dabhol Fuel
Supply ENRON –
SPV Fuel Mgmt.

O&M
Contract Shareholders Loan
Agreement LNG from
Agreement
Qatar
O&M Contractor
- Enron Lenders

Sponsors – Enron,
GE and Bechtel
PRI/PRG
IRR on SPV
PRI/PRG
OPIC
Dabhol Award for Structuring

184
 Issues in Dabhol Case
• Economics of the plant
• Careful Benchmarking of Costs
• Ability of off-taker to pay
• Trust in contracts that are not economic
• Compute Project IRR
 Simple Model for Case Study of Availability Project

• Read the PDF file with PDF to Excel

• Input the Capital Expenditures and the
Capacity
• Compute the Revenues from the PPA contract
• Assume EBITDA = Capacity Revenues +
Fuel Management Fee Revenues
• Compute Pre-tax IRR Assuming 1 year
construction
Output Risk in Renewable Energy

187
 Renewable Energy Introduction
• Wind versus Solar
• Development
• Resource Risk
• Operation and Maintenance
• Transmission Risk

188
 P50 and P90 in Solar Case
• “P50 Production Level” means the aggregate
annual energy production level of the Project that
has a probability of exceedance of 50% over a one-
year period of time, according to the Independent
Engineer’s solar production forecasts included in
the report delivered to Administrative Agent.
• “P99 Production Level” means the aggregate
annual energy production level of the Project that
has a probability of exceedance of 99% over a one-
year period of time, according to the Independent
Engineer’s solar production forecasts included in
the report delivered to Administrative Agentt.

189
 Term Coverage Ratio in Solar Case
• “Minimum Term Conversion Date Debt
Service Coverage Ratio” means,
• a minimum Average Annual Projected Debt
Service Coverage Ratio for the twelve (12)
month period of
• 1.35 to 1 on a P50 Production Level during years
1 through 9, and

• 1.00 to 1 under a P99 Production Level during

years 1 through 9 of the amortization schedule.

190
Renewable Energy Ratings – Solar PV

191
 Risk Allocation and Drivers in PPA
Agreement
1. IPP Controls and
1. Plant Cost and Takes Risk
Construction Delay 2. IPP Control and Risk
2. Efficiency (Heat Rate) 3. Off-taker Risk
3. Fuel Price 4. Off-taker Controls
4. Capacity Factor and Dispatch, IPP
Availability Factor from controls Availability
Forced and Unforced 5. IPP Control and
5. Variable O&M Expense Takes Risk
6. Fixed O&M Expense 6. IPP Control and Risk
7. Carrying Charge Rate 7. Off-taker
 Drivers and Contracts - Renewable
• IPP Risks • Risk Mitigation
• Cost of Project, Time • EPC Contract with
Delay and Technology Fixed Price and LD
Parameters (LSTK)
• Capacity Factor Risk • NONE !!!
• O&M Risk • O&M Contract
• Interest Rate • Interest Rate Contract
Fluctuation (Fix Rates)
 P90 and P50 DSCR with Actual Case
• Actual case where P50 and P90 were
estimated.
 Loss Diagram
Illustration

• Convert loss diagram into

capacity factor and compare
different cases.
• Difficult to compute
performance ratio from
these diagrams.
• Generally, the loss due to
temperature is the largest
loss factor.
Understanding Computation of P90 and P99
• Everything from standard deviation
• What goes into standard deviation

196
• If produced at full capacity factor (kWp) during the day and
nothing at night, the capacity factor would be 50% and the yield
would be 8760/2 = 4380. Just need solar patterns over the day.
Don’t need anything else.

Illustration of STC
 P50 and P99 in Solar Case
• Evaluate the P50 and P99 using the DSCR
criteria.

198
 Benchmarking Capital Cost – Solar Case
• Compare with Mexico case

199
 O&M Cost Benchmarking
• Compare O&M Cost

200
Part 4: Effect of Loan Structuring
Provisions on Bidding for Projects
 Structuring versus Risk Analysis and Bidding for PPA or PPP
Projects

• Importance of project finance loan elements

for different technologies.
• Elements of a term sheet in the context of
both the equity IRR and the bid price.
• Evaluate elements of loan contract for
bidding
• PPP and PPA may be more about structuring
than risk analysis.

202
 Effects of Debt Structure on the Bid Price
• The effects of:
• Debt sizing,
• Debt funding
• Debt tenor,
• Debt repayment type, and
• Debt pricing (interest rates and fees)
• Debt Protections

Context of alternative technologies.

Items of a term sheet such as the minimum DSCR, maximum
debt to capital, step-up credit spreads, debt sculpting, debt
funding, DSRA’s, MRA’s and cash sweeps used to evaluate
financial impacts of various financing and timing issues on the
required bid price for a project.

203
 Definition of Capital Intensity
• Capital intensity is not just the amount of
capital spent on a project
• It is the capital relative to operating costs
• It includes the lifetime of the project
• Formula:
• Capital Intensity = Capital/Revenues

204
Illustration of Effects of Debt Structuring on Capital Intensive and
Non-Capital Intensive Projects

205
Alternative Debt Provisions, Bidding and Carrying Charge Rate

206
Effects of Financing on Bid Price – Capital Intensive

Waterfall Chart for Low Cost Solar with Tracker

90

80
74.64

70
(5.78)

60

50 (15.77)

(8.55)
40 (2.18)

30.56
30 (8.75) (0.57)
(1.43)
(1.05)

20

10

0
High Longer Tenor Higher Debt Lower Sculpting and Reduced IRR - No Taxes - Ballon - 25 Low IRR - Best
Financing - 5 versus 15 Percent - Interest Rate - Inflation 7,50% versus 0,00% versus versus 20 5,50% versus Financing
Cost 68.86 85,00% versus 3,50% versus 42.36 17,00% 25,00% 31.61 7,50% Case
74.64 50,00% 7,00% 33.61 33.04 30.56 30.56
53.09 44.54

207
Effects of Debt Provisions on Fuel Intensive Diesel Technology

Waterfall Chart for Diesel

180

157.91
160
(2.71)

140
(14.46)
(7.84)
(2.21) 120.00
120 (8.41) (0.39) (0.85) (1.04)

100

80

60

40

20

0
High Longer Higher Debt Lower Sculpting Reduced IRR No Taxes - Ballon - 25 Low IRR - Best
Financing Tenor - 5 Percent - Interest Rate and Inflation - 7,50% 0,00% versus 20 5,50% Financing
Cost versus 15 85,00% - 3,50% 130.69 versus versus 121.04 versus Case
157.91 155.20 versus versus 17,00% 25,00% 7,50% 120.00
50,00% 7,00% 122.28 121.89 120.00
140.74 132.90

208
With Good Financing Structure can Achieve Low Costs
Part 5: Nuances of Debt to Capital Constraint and
DSCR Constraint in Different Circumstances
 Debt Sizing - Introduction
• Detailed analysis of the term sheet and loan
agreements begins with debt sizing.
• Difference in sizing debt on the basis of:
• maximum debt-to-capital ratio: from cost and
sources and uses
• minimum DSCR: from financial model
• Notion of negotiated base case and downside
for evaluating DSCR.
• Limit the debt to assure equity is in project
and the value of the project is above the debt
 Debt Size in Solar Case
• Solar Case Debt Size
• Term Loans. The aggregate principal amount of all Term Loans made by
the Lenders outstanding at any time shall not exceed Ten Million Five
Hundred Thousand Dollars ($10,500,000) (the “Total Term Loan
Commitment”).

• $6,471,614, the “Minimum Equity Contribution” or the funding of any

remaining unfunded portion, including by delivery of a letter of credit, and
verification by the Independent Engineer.

• What is the debt to capital ratio

•.

212
 Airport Capital Expenditures Compared to Debt

• Compute the Debt to Capital

213
 Debt Sizing – Key Philosophical Question

• Debt to Capital Ratio – Trust sponsor to be smart

enough to not invest in a bad project. Make sure
the sponsor is taking downside risk. With no cash
invested in the project, there is only upside
potential and the sponsor will not care about
downside evaluation. The test is historic
investment and do not have to look forward.
• The notion of DSCR implies that you are smart
enough to make a forecast. If you really believe
your forecast and even variation around your
forecast, you can back into the debt from the
DSCR. This is the notion of negotiated base case
and downside for evaluating DSCR.
• Limit the debt to assure equity is in project and the
value of the project is above the debt
 -
-

100,000.00
120,000.00
140,000.00
160,000.00
180,000.00
200,000.00
100,000.00
120,000.00
140,000.00
160,000.00
180,000.00
200,000.00

20,000.00
40,000.00
60,000.00
80,000.00
20,000.00
40,000.00
60,000.00
80,000.00
01-janv-20 01-janv-20
01-août-20 01-août-20
01-mars-21 01-mars-21
01-oct-21 01-oct-21
01-mai-22 01-mai-22
01-déc-22 01-déc-22
01-juil-23 01-juil-23
01-févr-24 01-févr-24

CFADS
CFADS
01-sept-24 01-sept-24
01-avr-25 01-avr-25
01-nov-25 01-nov-25

Cash Sweep
Cash Sweep

Debt Service
Debt Service

01-juin-26 01-juin-26
01-janv-27 01-janv-27
01-août-27 01-août-27
01-mars-28 01-mars-28
01-oct-28 01-oct-28
01-mai-29 01-mai-29
01-déc-29 01-déc-29
01-juil-30 01-juil-30
01-févr-31 01-févr-31
01-sept-31 01-sept-31
01-avr-32 01-avr-32
01-nov-32 01-nov-32
01-juin-33 01-juin-33
01-janv-34 01-janv-34
01-août-34 01-août-34

Base Traffic 15,000

Base Traffic 15,000

01-mars-35 01-mars-35
01-oct-35 01-oct-35
01-mai-36 01-mai-36
01-déc-36 01-déc-36
01-juil-37 01-juil-37
01-févr-38 01-févr-38
01-sept-38 01-sept-38

NPV of Debt Service 3,028,608 Debt to Capital Result 89.80%

NPV of Debt Service 2,536,916 Debt to Capital Result 76.00%

01-avr-39 01-avr-39
01-nov-39 01-nov-39
01-juin-40 01-juin-40
01-janv-41 01-janv-41
Target DSCR 1.2 Debt/Cap 95% Equity IRR 15.58%
Target DSCR 1.2 Debt/Cap 76% Equity IRR 11.76%

01-août-41 01-août-41
01-mars-42 01-mars-42
01-oct-42 01-oct-42
01-mai-43 01-mai-43
01-déc-43 01-déc-43
01-juil-44 01-juil-44
01-févr-45 01-févr-45
01-sept-45 01-sept-45
01-avr-46 01-avr-46
Debt.
too high debt to
Illustration of DSCR and Debt to Capital Constraint

is the Value of the

constrain the debt.

Discounted Red Area

believe your forecast.

capital ratio. Need to
Lower DSCR results in

DSCR sizing means you

(using the interest rate)

215
 Which Constraint is in Place
• Items have an effect on whether the debt to capital constraint
or the debt to capital constraint applies:
• Need to Understand that NPV of Debt Service is Loan Value
• High Project IRR  More Likely Debt to Constraint;
• Long Tenor  More Likely Debt to Capital Constraint;
• Sculpting  More Likely Debt to Capital Constraint;
• Low Interest Rate  Morel Likely Debt to Capital Constraint.
• Low Project IRR  More Likely DSCR Constraint;
• Short Tenor  More Likely DSCR Constraint;
• Level Payment  More Likely DSCR Constraint;
• High Interest Rate  More Likely DSCR Constraint

216
Evaluation with Geometry and NPV Formula

217
 Model with Debt Sculpting
• Input Minimum DSCR
• Compute Target Debt Service
• Compute PV of Debt Service
• Use PV of Debt Service as Debt in Sources
and Uses
• Compute PV of CFADS
• LLCR for Max Debt to Cap is PV of CFADS
divided by Cost * Debt/Cap

218
 Sculpting Equations - Basic
• One of the main ideas about the repayment process in project finance is
that the modelling is much more effective when you combine formulas
with other excel techniques. If you try and solve these things with a brute
force method that uses a copy and paste method or goal seek things will
get very messy. Formulas used for repayment and debt sizing are listed
below: The fundamental two sculpting formulas are:
• (1) Target Debt Service Per Period = CFADS/DSCR
• (2) Debt Amount at COD = PV(Interest Rate, Target Debt Service)
• Non-Constant Interest Rates
• However this is by no means the only formula you should use when
working on repayment. In cases when the interest rate changes, a simple
present value formula cannot be used. Instead, an interest rate index can
be created that accounts for prior interest rate changes as follows:
• (3) Int Rate Index(t) = Int Rate Indext-1 x (1+Interest Rate(t))
• (4) Debt Amount at COD = ∑ Debt Service(t)/Interest Rate Index(t)

219
 Sculpting Equations with Debt to Capital Constraint

• Use of LLCR when there is a Target Debt to Capital constraint

that drives the amount of the debt. If the debt is being sized by
the debt to capital ratio, a higher DSCR must be used.
• This raises the issue of how to compute sculpted debt
repayments when debt is sized with the debt to capital ratio
and the DSCR is not from the DSCR constraint.
• When the Debt is Sized by Debt to Capital the LLCR can be
used to size the debt, because with sculpting, the DSCR =
LLCR. Formulas in this case include:
• (5) Target Debt Service(t) = CF(t)/LLCR
• (6) LLCR = NPV(Interest Rate, CFADS)/Max Debt from Debt to
Capital
• (7) DSCR Applied = MAX(Target DSCR,LLCR with Max Debt)

220
 Sculpting Equations with LC Fees
• Adjusting Sculpting Equations for Debt Fees: Debt fees such as the fee on a letter
of credit is part of debt service. To include the fees in the sculpting equations, you
should subtract the fees when you compute the net present value of debt, as the
fees reduce the amount of debt service that can be supported by cash flow. To make
the sculpting work you should also make the repayment lower by the fees as shown
below:
• (14) Repayment = CFADS/DSCR - Interest - Fees
• (15) Debt = NPV(Interest Rate, Debt Service-fees)
• Debt = NPV(rate, Debt Service) - NPV(rate, Fees)
• Note Debt Service in the above equation means debt service without fees and debt
is reduced by PV of fees
• Adjusting LLCR for Debt Fees: The sculpting analyses include calculation of the
LLCR to evaluate whether the debt to capital constraint is driving the constraint. In
this case the PV of CFADS is not the correct numerator for the analysis. Instead,
the PV of the LC fees should be added to the denominator of the LLCR as follows:
• (16) LLCR = PV(CFADS)/(Debt + PV of LC Fees), where
• (17) Debt = Project Cost x Debt to Capital

221
 Sculpting with DSRA as Final Payment
• Sculpting and Changes in the DSRA balance including Final
Repayment
• After working through letters of credit for the DSRA, taxes, interest
income and other factors that cause difficult circular references, the
final subject addressed is using the DSRA to repay debt.
• A similar result occurs when changes in the DSRA are included in
CFADS. Incorporating these changes in a financial model without
massive circularity disruptions can be tricky, but it can be solved by
separately computing the present value of changes in the DSRA.
• Changes in the DSRA can be modelled using the following equations:
• (18) Debt Adjustment = PV(Interest Rate, Change in DSRA/DSCR)
• (19) Repayment = Repayment from Normal Sculpting + Change in
DSRA/DSCR

222
Part 6: Debt Sizing: Including Items in Project Cost
(such as development fees and owners cost) that do
not Involve Cash Outflow to Increase Returns
Reconciling Debt to Capital with DSCR

Cash Flow results in Increase the project

too high DSCR cost WITHOUT
meaning that you Yes
spending money on
have debt to cap things like land value
constraint

After you are finished with the

No term sheet it looks like the DSCR
constraint and the debt to
capital constraint give you the
Try to increase tenor same answer. This could be
to reduce increase because of the process.
the DSCR

224
 Effects of Non-Cash Increases in Project Cost

• When does asset increase matter and when does it not

• Importance of paying cash or not paying cash
• Examples of non-cash increases in project cost
• Development fees
• Owner costs
• Some development costs
• Contingencies
• Value of Land allocated to project
• EPC profit if EPC is sponsor
• Games with EPC profit

• Items that can increase the cost of a project affect returns

primarily when the debt to capital constraint applies and have
less or no importance when the DSCR drives debt capacity.

225
 Debt Sizing: Including Items in Project Cost that do not Involve
Cash Outflow
• Accounting allocations to the project can have large effects on the
equity IRR through debt sizing derived from the debt to capital
ratio.
• If the DSCR drives debt sizing, the accounting allocations, fee
allocations and other adjustments have no effect on the equity IRR.
• Accounting allocations and non-cash contributions can change the
structure of returns when multiple investors are involved in the
project. If one party is allowed to include non-cash allocations as
the basis for his investment, his return is much higher.
• Depending on the manner in which project costs are accounted for,
multiple investors pay debt service and receive dividends, but the
investor who did not invest as much cash effectively borrows less
relative to the cash investment.

226
 Debt Sizing: Profits from EPC Contractors or O&M Contractor
when Investor is also Contractor

• If the EPC profits do not affect the debt size and there is
only one investor, placing profits at the EPC contractor level
or the investor level does not influence overall returns (i.e. if
DSCR drives debt size).
• Depending on whether the debt to capital constraint applies
or there are multiple investors, EPC profits can increase
equity IRR (by increasing the debt size).
• Cash Flow Waterfall and issues associated with including
profits in O&M contract rather than in SPV cash flow.
Profits on the O&M contract versus including O&M costs at
the SPV level can affect the distribution of dividends as the
O&M fee is paid before debt service.

227
 O&M Contractor is Sponsor
Off-taker: Korea and Japan
Utility Companies: Want
strong off-taker with
inactive to honor contract
Profits to O&M
Reduce the SPV
Off-take Contract Cash Flow. O&M
with minimum
supply but no fixed paid before debt
price service

Special O&M
Purpose O&M Contractor
Vehicle: Bond Agreement
Rating of A-
Sponsors:
Want strong
sponsor:
Mobil
State Loan
Agreement

Lenders:
Issued bonds and
debt with long tenor
and low rates
Illustration of Non-Cash Accounting

229
 Development Fee Theory

• Development fees can be a percent of project cost or a multiple of

the amount spent on development.
• This yields big profits to developers when the notice to proceed
occurs and can be a cash outflow for the sponsor. The big profit
accounts for the low probability of success during development.
• If the developer and the sponsor are the same, this profit is not a cash
outflow from the perspective of the project.
• Better to put development fees into cost with debt to capital
constraint

230
Case Study - Funding
Enron - Subic Bay, Philippines

Philippines Equip’t Cos. Warranties Enron Power Completion

Operating Co. Guarantee
Government Fluor Daniel EPC

15-year Turnkey
Enron Power Enron
Phils. Op’g Co.
Performance BOT Construction Corp.
Undertaking Concession Contract
O&M Enron Subic
Supply Agreement Power Corp
Napocor Fuel Free
113MW
Ground
Subic 65% Enron Power
Lease Philippines Corp
Buyout Power
Rights
Corp. 35%
•Capacity Charge Philippine
•O&M Charge Insurances Investors
•Energy Charge
PPA US$105 million, 15-year Notes
 113 MW Diesel Generator Power Station
Subic Bay, Philippines
Sources of Funds:
Notes $ 105 M
Subordinated Note 7
Equity of Sponsor 28
Working Capital 2
TOTAL $ 142
Uses of Funds:
Turnkey Contractor $ 112 M
Bonus to Turnkey Contractor 7
Development and other related costs and Fees 14
Pre operating, Start-up and Commissioning Costs 3
IDC 4
Working Capital Loan 2
TOTAL $ 142
 Development Cost Documentation
• Equity Contribution.
• (i) evidence (including copies of invoices and
other documentation, as reviewed and
confirmed by the Independent Engineer) of
the payment of Project Costs in connection
with the development and construction of the
Project on or prior to the Closing Date

233
BOT/PPA Contract

• 15 year BOT and toll process

• NAPOCOR (government owned generation company) to
supply fuel & take electricity - no fuel availability risk
• Capacity fee $21.6/kW/month on available capacity
• Capacity fee is dollar denominated – no direct foreign
exchange risk, overseas a/c
• O&M fixed fee and energy fee is in Peso - $4.56/kW/Month
• heat rate penalty & bonuses
• buy out rights @ NPV capacity fees- late payment, change
of BOT law, war, etc.
 Adjustments for Development Fee
• Add Development Fee to Sources and Uses
• Adjust the Equity IRR for Development Fees
Received
• Adjust Model to have Debt to Capital
Constraint
• Use Goal Seek to Compute Development
Fees

235
Part 7: Debt Funding: Nuanced Issues with Pre-
Commercial Cash Flow and Equity Bridge Loans
Up-Font Equity in Solar Case

237
 Issues with Funding

• In general, debt funding is difficult without some kind of

support from outside of the project.
• If the project return is above the interest rate, equity return
increases when the equity is contributed later and debt
earlier.
• From bank perspective, the equity should be put in first
and the loan in last.
• Specific Issues:
• Funding of equity first or pro-rata
• Capitalisation of interest
• Pre-operating cash flow
• Interest on sub-debt or shareholder loan
• Equity bridge loan

238
 Draw Request and Funding - Introduction
• When a borrower uses cash during
construction, the funding request includes:
• Notice of Borrowing
• Payment and draw details
• Construction certificate
• Schedule of construction costs and cumulative
amounts
• Insurance certificates
• Financial reports and other documents
 Project Finance Loans – Drawdown during Construction
(Reference)

• Prior to satisfying the options conditions, it is the

usual practice for the financiers to:
• be able to rely on other contractual or financial resources
(recourse or some kind of support from sponsors) to repay
that funding [if the project fails to be completed];
• If equity is not up-front may require letter of credit,
sponsor guarantee or really strong EPC contract; and,
• to roll up the capitalized interest-during-construction
(“IDC”) into the financing (i.e. capitalizing interest).
• During the construction phase, equity and debt funds
are used to finance the project construction with
funds generated from the project cash flow covering
the operation period.
 Capitalised Interest and Interest Capitalised During Construction
for Accounting (IDC)

• Interest (and fees) can be paid during

construction or capitalized to the debt balance
(not paid now, but paid later).
• If interest is capitalized and the debt is the same
percent of the project cost, the capitalizing of
interest does not make any difference.
• Whether the interest is paid or capitalized, it is
recorded as part of the project cost as interest
during construction (IDC).
• Note there is no capitalization of the equity cost
of capital in a manner similar to debt.
 Nuanced Issues with Pre-Commercial Cash Flow

• The effects of accounting for pre-commercial cash

flows as either equity or reduction in project cost.
• In terms of accounting, pre-commercial cash flow is
income and should be part of equity.
• Alternatively, one could call the pre-commercial cash
flow a reduction in the cost of the asset.
• Related issues include the issue of government grants
and early production.
• With an extreme case the labelling the pre-commercial
cash flow as equity results in improved returns but
from banker’s perspective is not “skin in the game.”
 Illustration of Accounting for Pre-commercial Cash Flow

Note the
operating cash
flow is included
as equity. More
than the Paid in
equity.

243
 Review Basic Project Finance Diagram
Off-taker: Korea and Japan
Utility Companies: Want
strong off-taker with
inactive to honor contract

EPC Contractor:
Kellogg with Off-take Contract
Strong Record with minimum
and Finances supply but no fixed
price
EPC: Fixed Price
Contract with LD

Special O&M
Supplier: Need Purpose
Supply O&M Contractor
to Understand Vehicle: Bond
Agreement Agreement
Economics and Rating of A-
Supply Curve

Loan
Shareholder Agreement –
Agreement Draws Green;
Sponsors: Debt Service
Want strong Lenders:
Red Issued bonds and
sponsor:
Mobil debt with long tenor
State and low rates
Multiple Projects with Separate SPV’s
 Project Finance Diagram – Multiple Projects with Single SPV

Special Purpose Vehicle: - Combine

Green is debt
Green is equity Projects contribution, red
contribution, red is debt service
is dividends Project 1 Project 2 Project 3 and fees

Project 4

Loan
Agreement –
Shareholder
Draws Green;
Agreement
Debt Service
Red

Sponsors:
Want strong Lenders:
sponsor: Issued bonds and
Mobil debt with long tenor
State and low rates
 Equity Bridge Loans and Recourse Debt

• In some projects, equity holders provide loans to the project from

their balance sheet instead of equity.
• Example
• A project finance transaction is structured with equity first
financing (i.e. equity put in to finance construction before debt).
• The sponsor secures a separate loan to finance its equity
requirements, meaning it does not put any equity when you
count the corporate side.
• The loan will be re-paid in a bullet (with interest capitalised) at
the end of the construction period or maybe even later.
• When the loan is re-paid, the sponsor provides equity to finance
the loan.
• The equity bridge loan must have a parent guarantee.
 Nuanced Issues with Equity Bridge Loans
• In pure project finance, equity should be contributed before debt during
the construction period to assure that equity does not walk away from
the project during construction.
• Pro-rata debt and equity contributions or equity bridge loans require
some kind of sponsor support and can in theory distort the equity cash
flow.
• An equity bridge loan requires parent support, the cost of which is not
included in the equity IRR. The effects of IDC on equity bridge loan on
project taxes and the effects of equity bridge loans in different interest
rate environments and on different types of projects will be discussed.
• Issue
• Should the equity bridge loan be included in computing Equity
IRR.
• The loan uses resources of the parent and must be guaranteed by
the parent
 Issues with EBL

• If there are multiple sponsors, one of which

provides a guarantee, how should the benefits
of the EBL be allocated
• The IDC increases the cost of the project and
increases other debt capacity if there is a debt
capacity constraint

249
 Nuanced Issues with IDC on Shareholder Loans

• Shareholder loans seem to have no effect on

senior debt. All of the covenants and waterfall
issues occur after the senior debt is paid.
• If senior debt limits the dividends to shareholders,
it will also limit the shareholder loan payments
• Equity IRR should consider the shareholder loan
and any other equity as combined cash flows
• The shareholder loan may affect taxes which will
increase the cash flow (and cause a circular
reference problem).
 Standby Loans for Construction Cost Over-run and the Issue of
Cost Under-run

• With a cost over-run facility, the commitment

fee can increase the cost of the project.
• If the debt is subordinated to senior debt the
over-run facility is similar to shareholder
loans.
• If there is a cost under-run and the debt has
been committed with and EBL or pro-rata, a
question arises as to whether the debt should
be reduced or whether the proceeds should
accrue to shareholders.
 Evaluation of Delays in Construction

• In evaluating delays in construction, it is

generally better not to change the S-curve but
rather to assume there is dead time.
• After accounting for the reductions in PPA
revenues, the liquidated damage can accrue to
reduction of debt to maintain the DSCR.
 Complex IDC Calculations with Portfolios
• The IDC calculations can be complex if some
parts of the project are completed while others
are continuing to be constructed.
• This is a typical problem in real estate and solar
roof-top
• To resolve the problem:
• Keep track of plant in service and construction
work in progress in separate accounts
• Allocate interest from the ratio of CWIP to (CWIP
+ Plant in Service)
• IDC itself will also be in CWIP and Plant in Service

253
 Draw-downs and Management of Disbursement of Funds

• The strict control of fund disbursements can provide

a mechanism to maintain leverage over contractors
and thus help to minimize construction risk in the
better rated projects.
• Loan documents typically give lenders the right to
closely monitor construction progress and release
funds only for work that the lender's engineering and
construction expert has approved as being complete.
• Third-party trustees, acting in a fiduciary capacity,
will generally manage disbursement of funds to
protect debtholders' interest in the project. (Multiple
Investors)
 Draw-downs and Retention of Funds
• Retention of all debt-financed funds in a segregated account
by a trustee experienced in management of power project
construction, preferably an experienced bank or other lender
for these projects;
• Payment structures that retain a small portion of each amount
payable, about 5%, until the project reaches commercial completion;
• Disbursements made only for work certified as complete by an
independent project engineer retained by the construction trustee
solely for approving disbursements;
• Right to suspend or halt disbursements when the trustee concludes
that construction progress is materially at risk (reversals or
revocations of necessary regulatory approvals or changes in law or
cost outside the levels anticipated by the budget and schedule)
• Authority to approve all change orders or authority to limit
change orders to a pre-determined amount (example MCV)
 Credit Enhancements - Introduction
• Various added provisions that are included in loan
agreements to provide additional protection to lenders.
• These provisions that can include:
• DSRA’s
• MRA’s
• Cash sweeps
• Dividend lock-up covenants
• While the credit enhancements can be the subject of
intense negotiation, they cannot change a failed project
into a good project from a lender perspective.
• Instead, they can only either limit dividends or reduce the
amount of effective net debt associated with a project.

256
Part 9: Debt Repayment Structure: Sculpted Repayment and Nuanced
Issues associated with Debt to Capital or DSCR Constraints
Combined with Repayment Patterns
 Debt Repayment - General
• The structure of debt (the draw down and term to
maturity) can seem to have more important impacts
on the value of a project than the size of the debt and
certainly more than the interest rate on the debt.
• Average life is the general way in project finance to
measure the length of the debt although duration is a
is better way in theory to measure the effective term
of the debt.
• The debt structure should depend on the economic
characteristics of a project such as the revenue and
expense contracts. But it may be able to re-finance
debt.
 Maturity in Cases
• Airport Case
• Tranche A Final Maturity Date means 15 June
2020.
• Tranche B Final Maturity Date means 15 June
2023.

• Maturity in Solar Case:

• Mini-Perm 9 Year
• Amortisation 17.25

• Maturity and the economic life of the project

259
Multiple Capacity Charges and Optimisation of Debt Repayment

• For some countries and financial institutions, DSCR

constraints and debt repayment patterns are given.
• In these cases, synthetic sculpting can be developed
with alternative tariff structures that have a step down
element (Malaysia, Pakistan).
• In other cases a flexible maintenance contract can be
used to create synthetic sculpting (Brazil).
• Incentive issues associated with step-down tariffs
where sponsors can have an incentive to walk away
from the project and techniques to measure the cost
and benefits of alternative maintenance structures will
be addressed as part of the session.
260
 Example of Repayment (Bullet Not Shown)

• Loan tenor is
explained by the
repayment period is
still within the PPA
terms (i.e. 20 years
from PCOD), giving
a one year tail, and
the project is a Build,
Own and Operate
(BOO) and a BOOT.
Sculpting versus Equal Installment with DSCR Constraint

Note the big increase in IRR with the DSCR constraint – because of
the larger debt size. Recall that can effectively make the DSCR
constraint be in place
Sculpting versus Equal Installment with Debt to Capital Constraint
 Alternative Repayment Patterns
• Given a DSCR constraint and the formula that the
present value of debt service equals the amount of debt
at COD, use geometry to maximize debt.
• The general idea of maintaining a constant DSCR over
the life of a project in sculpting when the risks can
increase over time.
• Contrasts to the requirement that banks must increase
capital with longer terms and that an implicit assumption
of constant credit spreads is increasing risk over time.
• Sculpting versus alternative methods in the context of
different revenue patterns (indexation, flat fee-in tariffs,
tax depreciation, etc.)

264
 Complex Sculpting Issues
• Complex sculpting issues can involve:
• Letter of credit fees
• Balloon payments as a percent of the loan
amount
• Interest income on sweeps for balloon payment
• Taxes and net operating losses
• DSRA as final debt payment
• To resolve these issues use equations and
some fancy excel. Do not try to use brute
force.

265
Example of Synthetic Sculpting with O&M Payments

266
 Borrowing Base and Resource Transactions
• Computation of borrowing base
• Debt repayment and borrowing base – must pay-
off debt that is below the maximum borrowing
base
• Rational for borrowing base
• Rate of production extraction
• Problems with borrowing base
• Declining prices and acceleration of loan re-payments
• Increasing prices and reduction of loan re-payments
• Modelling of borrowing base
 Equity IRR without Balloon

Data table with structuring – need to use

macro instead of basic data table

Weighted
Debt to Average
DSCR Capital Tenor SIBOR Dev Fee Equity IRR Avg Debt Life Constraint Margin
Base Case 1.25 85.00% 20 Increasing Marrgin2.50% 20 1 5.41% 11.90 Debt from DSCR 2.30%
Aggressive Case 1.20 85.00% 22 Fixed Margin 1.50% 50 2 12.35% 12.78 Debt to Capital constraint 1.75%
Conservative Case 1.30 70.00% 18 Conservative Margin
3.00% 0 3 4.16% 10.94 Debt from DSCR 3.00%
DSCR Aggressive Case 1.20 85.00% 20 Increasing Marrgin2.50% 20 4 5.46% 11.90 Debt from DSCR 2.30%
Debt to Capital Aggressive Case 1.25 85.00% 20 Increasing Marrgin2.50% 20 5 5.41% 11.90 Debt from DSCR 2.30%
Tenor Aggressive Case 1.25 85.00% 22 Increasing Marrgin2.50% 20 6 5.55% 13.19 Debt from DSCR 2.34%
Credit Spread Aggressive Case 1.25 85.00% 20 Fixed Margin 2.50% 20 7 6.29% 11.87 Debt from DSCR 1.75%
Aggressive Case 1.25 85.00% 20 Increasing Marrgin1.50% 20 8 7.56% 11.60 Debt from DSCR 2.30%
SIBOR Aggressive Case 1.25 85.00% 20 Increasing Marrgin2.50% 50 9 5.41% 11.90 Debt from DSCR 2.30%
DSCR Conservative Case 1.30 85.00% 20 Increasing Marrgin2.50% 20 10 5.37% 11.90 Debt from DSCR 2.30%
Debt to Capital Conservative Case 1.25 70.00% 20 Increasing Marrgin2.50% 20 11 5.39% 11.90 Debt to Capital constraint 2.30%
Tenor Conservative Case 1.25 85.00% 18 Increasing Marrgin2.50% 20 12 5.31% 10.64 Debt from DSCR 2.25%
Credit Spread Conservative Case 1.25 85.00% 20 Conservative Margin
2.50% 20 13 4.34% 12.13 Debt from DSCR 3.05%
Conservative Case 1.25 85.00% 20 Increasing Marrgin3.00% 20 14 4.66% 12.05 Debt from DSCR 2.30%
SIBOR Conservative Case 1.25 85.00% 20 Increasing Marrgin2.50% 0 15 5.41% 11.90 Debt from DSCR 2.30%

268
 Equity IRR with Balloon
This case assumes large balloon payment at
the end of the life – 20%. Note how the equity
IRR increases.

Weighted
Debt to Average
DSCR Capital Tenor SIBOR Dev Fee Equity IRR Avg Debt Life Constraint Margin
Base Case 1.25 85.00% 20 Increasing Marrgin2.50% 20 1 5.99% 11.85 Debt from DSCR 2.30%
Aggressive Case 1.20 85.00% 22 Fixed Margin 1.50% 50 2 65.75% 12.78 Debt to Capital constraint 1.75%
Conservative Case 1.30 70.00% 18 Conservative Margin
3.00% 0 3 3.09% 11.14 Debt from DSCR 3.00%
DSCR Aggressive Case 1.20 85.00% 20 Increasing Marrgin2.50% 20 4 6.16% 11.85 Debt from DSCR 2.30%
Debt to Capital Aggressive Case 1.25 85.00% 20 Increasing Marrgin2.50% 20 5 5.99% 11.85 Debt from DSCR 2.30%
Tenor Aggressive Case 1.25 85.00% 22 Increasing Marrgin2.50% 20 6 6.50% 13.12 Debt from DSCR 2.34%
Credit Spread Aggressive Case 1.25 85.00% 20 Fixed Margin 2.50% 20 7 7.99% 11.87 Debt from DSCR 1.75%
Aggressive Case 1.25 85.00% 20 Increasing Marrgin1.50% 20 8 11.54% 11.54 Debt from DSCR 2.30%
SIBOR Aggressive Case 1.25 85.00% 20 Increasing Marrgin2.50% 50 9 5.99% 11.85 Debt from DSCR 2.30%
DSCR Conservative Case 1.30 85.00% 20 Increasing Marrgin2.50% 20 10 5.86% 11.85 Debt from DSCR 2.30%
Debt to Capital Conservative Case 1.25 70.00% 20 Increasing Marrgin2.50% 20 11 5.90% 11.85 Debt to Capital constraint 2.30%
Tenor Conservative Case 1.25 85.00% 18 Increasing Marrgin2.50% 20 12 5.71% 10.60 Debt from DSCR 2.25%
Credit Spread Conservative Case 1.25 85.00% 20 Conservative Margin
2.50% 20 13 4.14% 12.07 Debt from DSCR 3.05%
Conservative Case 1.25 85.00% 20 Increasing Marrgin3.00% 20 14 2.97% 12.29 Debt from DSCR 2.30%
SIBOR Conservative Case 1.25 85.00% 20 Increasing Marrgin2.50% 0 15 5.99% 11.85 Debt from DSCR 2.30%

269
 Part 7: Repayment Tenure: Length of Debt
Repayment, Mini-perms, Bullet Repayments and
Re-financing
 Re-financing, Corporate Finance and Project Finance

• Now move to the length of the debt or the debt

tenure
• In corporate finance, debt is re-financed continually
and the debt to capital is developed on a market
value basis.
• In project finance, the initial assumption is that debt
to capital reduces and for a portion of the project
life the total financing can come from equity.
• In reality, if a project is performing well, it will be
sold and/or re-financed. Continual re-financing can
result in a similar outcome a very long-term debt.
 Debt Repayment Structure and Risk
• A project's debt amortization schedule often
influences the rating, more so than the degree of
leverage.
• Front-loaded principal amortization schedules
that capitalize on the more predictable project
cash flows in the near term may be less risky that
those with whose delayed amortizations seek to
take advantage of long-term inflation effects.
• Flexible re-payment structures can be developed
where the project has irregular cash flows.
 Debt Tenure and Return
• It seems that the debt tenure is more
important than the interest rate (depending on
the relationship between the project return
and the interest rate).
• You can try some different debt amounts and
interest rates and see how the length of the
debt is an crucial element (two way data
tables).
• The problem with this is that it does not
account for re-financing.

273
 Statistics on Project Finance Debt Tenor
• Commercial Bank Market
• Up to 15 years
• Private Placement Market
• Up to 20 years
• Rule 144A
• Up to 30 Years
• Requires investment grade rating
• Project Finance average maturity 8.6 years
Fundamental Effect of Debt Tenure with Debt to Capital Constraint

275
 Re-financing Changes Everything
• There is a fundamental philosophical and
strategic issue about re-financing in project
finance.
• The above charts are distorted because of the
assumption that there is no re-financing.
• With re-financing, the effect of the debt tenure
is much less if not reduced to almost nothing.
• Assuming no re-financing is a very negative
assumption (like and oil price of zero because
we cannot predict everything).

276
 Debt Length and the Interest Rate Assuming Size Driven by
Debt/Capital Ratio

• The table below illustrates the relationship

between the length of the debt and the
interest rate in terms of equity IRR.
• Note that the length makes more difference
than the interest rate (with no re-financing)

277
 Debt Length and the Debt to Capital Ratio
• The table below illustrates the relationship between the length
of the debt and the debt to capital ratio in terms of equity IRR.
• Note that the inter-relationship between the length of the debt
and the leverage.
• But the length of the debt still has a big effect (again without
re-financing).

278
 Mini-perms
• Matching the tenor of repayment to the life of the project and
even considering terminal value in the repayment in the
context of both achieving a higher DSCR and an improved
equity IRR.
• Problems with multi-lateral agencies that allow long-term
maturity can be contrasted with commercial banks and bond
financing that may be more flexible and sometimes could have
lower costs.
• Specifically, the effects of hard and soft mini-perms on the
profitability of a project along with the difficult problem of
required re-financing assumptions.
• How the DSRA could be used to re-finance debt at end of loan
life and how potential terminal value can be used to justify
partial bullet repayment at end of loan.

279
 Capital Requirements and Mini-Perms
• Capital Requirements.
• If any Lender determines
• (i) any Change of Law affects the amount of capital
required or expected to be maintained
• and (ii) the amount of capital maintained by such Lender
must be increased as a result of such Capital Adequacy
Requirement (taking into account such Lender’s policies
with respect to capital adequacy)
• Borrower shall pay such amounts as such Lender shall
reasonably determine are necessary to compensate
such Lender for such reasonably increased costs to
such Lender of such increased capital.
 Mini-Perm
• Start with Amortisation Profile – this is what
drives the debt size.
• Compute debt size form Amortisation period

281
 Mini-Perm in Solar Case
• Term Loan Principal Scheduled
Payments. Borrower shall repay to
Administrative Agent, for the
account of each Lender, the
aggregate unpaid principal amount
of the Term Loans made by such Amortization Schedule
Lender in installments payable on Quarterly Payments
1-4
Amount
$102,600
each Repayment Date in 5-8 $111,400
9-12 $118,500
accordance with the Amortization 13-16 $128,000
Schedule set forth below, together 17-20
21-24
$136,000
$146,250
with any remaining unpaid 25-28 $157,000
29-32 $168,250
principal, interest, fees and costs 33-36 $180,000
due and payable on the Term Loan Term Loan Maturity Date $5,508,000

Maturity Date. The Parties hereto

acknowledge and agree that the
Amortization Schedule set forth
below shows the amount of each
installment payment of the Term
Loans to be made on each
Repayment Date:

282
 Mini-Perm Assumptions in Solar Case
• Some kind of re-financing assumption must
be made.

283
Mini-Perm and Re-financing Assumption

284
 Credit Analysis of Mini-Perm
• To evaluate the effects of being unable to re-
finance a cash sweep assumption can be
used.
• You can then see how low a variable can go
before the loan will not be re-paid.

285
 Mini-Perm Extension
• Term Loan Maturity Date Extension.
• The Borrower may:
• not sooner than twelve (12) months and,
• not later than six (6) months prior to the then-
current Term Loan Maturity Date
• Request that the Term Loan Maturity Date be
extended for an additional period selected by
Borrower of up to an additional five (5) years
(an “Extension Request”).

286
 Mini-Perm Extension - Continued
• Borrower and the Lenders mutually agree to alternate
terms and conditions not later than four (4) months prior
to the then-current Term Loan Maturity Date
• No Lender shall have any obligation to agree to have any
of its Term Loans extended pursuant to any Extension
Request.
• To the extent that not all Lenders approve an Extension
Request, the Borrower shall have the right to replace each
Lender that voted not to approve such Extension Request,
and add as “Lenders”
• On the then-current Term Loan Maturity Date, the
Borrower shall repay each non-consenting Lender its
Proportionate Share of the Term Loans.

287
Part 12: Interest and Fees: Step-up Credit Spreads,
Swap Rates and Hedging
 Interest Rates in Case Studies
• Airport Case
• Tranche A Interest Rate means ten per cent. (10%) per annum. 
• Tranche B Interest Rate means thirteen per cent. (13%) per annum.

• Solar Case

•.

289
 Payment in Kind Interest – Airport Case
• PIK Interest
• If the Tranche B Payment Conditions have not occurred,
interest on the outstanding principal amount of the Tranche B
Loans accrued during each Quarterly Period will be payable in
kind by increasing on such date the outstanding principal
amount of the Tranche B Loan by the amount of such interest
accrued during such Quarterly Period (the PIK Interest).
• The PIK Interest will itself bear interest, from and after such
day when it became due, at the rate of interest from time to
time in effect with respect to the Tranche B Loans. The
outstanding principal amount of the Tranche B Loans will
include any interest that has theretofore been paid in kind and
added to the outstanding principal amount of the Tranche B
Loans.

290
 Default Interest Rate
• In the event that an Event of Default shall have
occurred and be continuing, the Default Rate shall
apply to all then outstanding Term Loans from
and after the date of the occurrence of such Event
of Default.
• Interest on an overdue amount is payable at a rate
calculated by the Facility Agent to be 2 per cent.
per annum if such overdue amount is principal of
or interest on the Tranche B Loans, the Tranche B
Interest Rate or (ii) if such overdue amount is any
other amount, the Tranche A Interest Rate.

291
 Interest Rate Swaps and Hedging
• Interest Rate Agreements. On or prior to the Term Conversion Date,
Borrower shall have entered into and shall thereafter maintain through the
Term Loan Maturity Date, one or more Hedge Transactions, with the Swap
Counterparty, which include
• (i) an interest rate swap, to obtain a net fixed rate,
• (ii) an interest rate cap, to obtain a cap on three month LIBOR or
• (iii) a customized, structured solution for agreed tenors on terms and conditions,
• Hedge Transactions shall
• (i) be based upon the Amortization Schedule in effect as of the Closing Date,
• (ii) have a termination date no earlier than the Scheduled Term Loan Maturity
Date,
• (iii) have an aggregate notional amount subject to the Hedge Transactions equal to
at least seventy-five percent (75%) and no more than one hundred percent (100%)
of the projected outstanding Term Loan Facility balance and
• (iv) be for a minimum term of three (3) years except, in the case of any such
Hedge Transactions entered into less than three (3) years prior to the Scheduled
Term Loan Maturity Date, such lesser term equal to the then remaining period
until the Term Loan Maturity Date.

292
 Use of Floating Rate Debt
• Project Financings are generally funded on a floating-rate basis
due to the necessity for:
• Flexibility in the timing of draw downs
• Flexibility in early repayment.
• Floating rates computed as the LIBOR average for the prior six
months.
• 86% of Project Finance Loans are floating rate.
• But the floating rate loans can be fixed with interest rate swaps.
• Because of flexibility in take downs and repayments, there
would be significant interest rate risk with fixed rate
transactions.
• Extension risk
• Contraction risk
 Swap Settlements
• Bank financing in project finance generally uses floating interest
rates rather than fixed rates (e.g. LIBOR plus 150-200 basis
points).
• Because floating rate financing can create risks particularly in
projects with tight debt service cover such as PFI, projects often
use interest rate swaps to convert floating rates to fixed rates.
• Swaps that convert floating rate to fixed rate debt involve:
• Establishing a notional amount that corresponds to the face amount of
the loan;
• Paying interest on the floating rate loans;
• Receiving settlements on the swap if the floating interest rate rises so that
the effective interest rate is fixed;
• Paying settlements on the swap if the floating interest rate declines so
that the effective interest rate is fixed.
• The net value of the swap is generally zero when the swap is established.
 • Premium for fixing rates is very expensive

01-janv-17
01-août-16
01-mars-16
Floating versus Fixed Rate Debt

01-oct-15
01-mai-15
30 YR Swap Rate
Overnight LIBOR

01-déc-14
01-juil-14
01-févr-14
01-sept-13
01-avr-13
01-nov-12
30 YR Swap Rate [Final Value 2.07 ] vs
Overnight LIBOR [Final Value 0.43 ]

01-juin-12
because of expected inflation.

01-janv-12
01-août-11
01-mars-11
01-oct-10
01-mai-10
01-déc-09
01-juil-09
01-févr-09
01-sept-08
01-avr-08
01-nov-07
01-juin-07
01-janv-07
01-août-06
01-mars-06
01-oct-05
01-mai-05
01-déc-04
01-juil-04
01-févr-04
01-sept-03
01-avr-03
01-nov-02
01-juin-02
01-janv-02
01-août-01

7.00

6.00

5.00

4.00

3.00

2.00

1.00

0.00
30 YR Swap Rate
 Discussion of Interest and Fees
• Consistent with the discussion of debt as having five
components, interest and fees between the time debt
draws occur and debt is fully repaid is the next topic.
• Interest rates consist of credit spread and base rate.
• Debt IRR is the money the lenders receive including
fees, relative to the amount funded by lenders
• Credit spreads can include step-ups – why they are
present in many transactions and what they mean in
terms of re-financing.
• Loan agreements often require hedging and interest
rate swaps.

296
 Commitment Fee, Up-Front Fee and Debt IRR

• Commitment Fee
• (a) The Borrower will: (i) commencing on the date of the first
Utilisation Date until (and including) the last day of the Availability
Period for the borrowing under the Tranche A Facility, pay for a
commitment fee computed at a rate of four per cent. (4%) per
annum on the undrawn and uncancelled portion of the Tranche A
Commitments allocated to the Second Tranche A Loans;
• Commencing on the date of the first Utilisation Date until (and
including) the last day of the Availability Period for the borrowing
of the Second Tranche B Loan under the Tranche B Facility, pay the
Facility Agent for each Lender a commitment fee computed at a rate
of five per cent. (5%) per annum on the undrawn and uncancelled
portion of the
• Tranche B Commitments allocated to the Second Tranche B Loan;
and

297
 Importance of Credit Spreads
• In the cases without re-financing it seemed that
the credit spread did not make that big a
difference to the equity IRR.
• But when re-financing was included the credit
spread made a big difference as should be
expected – the credit spread is a big driver from
the difference between project IRR and equity
IRR.
• The credit spread is driven by the probability of
default and loss, given default in theory. The
problem is that these statistics are not observable.
 Example of Interest Rates
• NRG Yield presented a table with the margin
earned on interest rates. Most of the project
finance transactions had margins between 2%
and 2.5%. The longest tenor in the table is the
year 2038 implying a remaining term of 23
years.

299
 Expected Loss Can Be Broken Down Into Three Components

Credit Spread must cover the expected loss and

is driven by probability of default x loss given
default
Borrower Risk Facility Risk Related

EXPECTED Probability of Loss Severity Loan Equivalent

LOSS Default Given Default Exposure
= x x
(PD) (Severity) (Exposure)
$$ % % $$

What is the probability If default occurs, how If default occurs, how

of the counterparty much of this do we much exposure do we
defaulting? expect to lose? expect to have?

The focus of grading tools is on modeling PD

 Comparison of PD x LGD with Precise Formula
-- LGD and Multiple Years
Assumptions
Years 5 BB 5
Risk Free Rate 1 5% 7
Prob Default 1 20.8% PD 20.80%
Loss Given Default 1 80%

Alternative Computations of Credit Spread

Formula demonstrating
Credit Spread 1 3.88% that Credit spread is
PD x LGD 1 16.64% function of PD and LGD
Proof and the risk free rate.
Opening Closing Value
Risk Free 100 127.63 127.63
If you are lazy, just use
a goal seek
Prob Closing Value
Risky - No Default 100 0.95 153.01 145.36

Risky - Default 100 0.05 30.60 1.53

Total Value 146.89 FALSE

Credit Spread Formula

With LGD
cs = ((1+rf)/((1-pd)+pd*(1-lgd))-rf)^(1/years)-1
 Implied PD from Credit Spread
• Use example of 6% and understand compounding of the credit
spread

• For one year if LGD is 50%, then implied PD is about 11.32%

as shown below for a zero coupon bond example.

302
 Implied PD Explodes with Longer Term Debt
• Like any other interest rate, the credit spread is an IRR
and it compounds dramatically over time. Scenarios with
6% credit spread and 5, 10 and 15 years are shown below.
S&P Study of PD and LGD for Project Finance

There is not much data, but

the data shows that the
LGD is very high for project
finance. This is logical given
the long-term nature of the
assets.
 Project Finance Defaults

A lot of
merchant
plants in US.
Note the
initial rating of
BBB-
 LGD for
S&P Recovery Rates Defaults –
Not much
data
Project Finance is Unfair to Africa

Credit spreads are

much higher in
Africa, but compute
the ratio of defaults
to loans.

For U.S. the ratio is

32/21 or 1.53.

For Africa the ratio is

3/8 = .375.
Useless but Interesting Chart on PD
 10
12
14
16
18
20

0
2
4
6
8
1-Sep-97
1-Jan-98
1-May-98
1-Sep-98
1-Jan-99
1-May-99
1-Sep-99
1-Jan-00
1-May-00

#N/A
#N/A
1-Sep-00
1-Jan-01
1-May-01
1-Sep-01
1-Jan-02
1-May-02

Merrill Lynch B Adj Spread

1-Sep-02
2008 Crisis

1-Jan-03
1-May-03
1-Sep-03
1-Jan-04

#N/A
#N/A
1-May-04
1-Sep-04
1-Jan-05
were very low prior to
BBB and other spreads

1-May-05
1-Sep-05
1-Jan-06
1-May-06

Merrill Lynch BB Adj Spread

1-Sep-06
1-Jan-07
1-May-07
1-Sep-07
1-Jan-08

#N/A
1-May-08
1-Sep-08
Project Finance

1-Jan-09
1-May-09
1-Sep-09
1-Jan-10
1-May-10
1-Sep-10
Merrill Lynch BBB Adj Spread

1-Jan-11
1-May-11
1-Sep-11
1-Jan-12
#N/A

1-May-12
1-Sep-12
1-Jan-13
1-May-13
1-Sep-13
BBB- should be

Project Finance

1-Jan-14
1-May-14
representative of
Target Rating and Credit Spreads – Why the target is BBB- in

1-Sep-14
Merrill Lynch AAA Adj Spread
Note the spread for

1-Jan-15
1-May-15
1-Sep-15
1-Jan-16
1-May-16
309

1-Sep-16
Probability of Default for BBB and Other Ratings

S&P PD by Credit Rating and Tenure

60.00

AAA AA+ AA AA- A+ A

A- BBB+ BBB BBB- BB+ BB
BB- B+ B B- CCC/C
50.00

40.00
Default Rate (Count)

30.00
BBB-

20.00

10.00

.00
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
 Credit Spreads, PD, LGD and RORAC
• You can use the credit spreads along with the PD tables from
S&P to evaluate the IRR earned on different ratings. There are
two scenarios: one where there is no default and another where
the default history by tenure are attributed a loss given default.
The first scenario assumes equal debt service.
After adjusting for risk, IRR
is much higher for B Spread

311
 Credit Spreads with AA Rated Bonds
• In this case, the AA rated spreads from the database are
combined with the default probabilities to evaluate the
risk adjusted IRR from the lower credit spreads. The
risk adjusted IRR now is much smaller than the higher
credit spreads.

312
 Credit Spreads with BBB Rated Bonds which are Proxy for Project
Finance
• In this case, the BBB rated spreads from the interest
rate database are combined with the S&P default
probabilities to evaluate the lender risk adjusted IRR
from the lower credit spreads. The risk adjusted IRR
now is much smaller than the higher credit spreads.

313
 Pre-payments Maturity Extensions from Fixed Rate Debt

• Pre-payments
• If fixed interest rates are in the transaction and rates
are high, the borrower wants pre-payment option
and the lender does not. There can be a set of
defined pre-payment penalties.
• Pre-payments can come from a “divorce” clause
were the borrower pays back the loan instead of
taking some action.
• Maturity Extensions
• If cannot meet the required maturity payments from
cash flow, the loan agreement allow the maturity
payments to be extended
 Contraction Risk from Fixed Interest Rates (Declining Interest
Rates)

• Borrower Perspective
• When interest rates decrease, if the loan is at a fixed rate,
the borrower will want to re-finance but the lender will not
want this. Prepayments accelerate (people re-finance).
• Lender Perspective
• From the lenders perspective, the high interest rates are
lost and the lender must issue loans at lower rates. Form
the borrowers perspective, the proceeds will be re-invested
at a lower rate and that bonds will be more expensive.
• The results are like selling a call option for debt
holders -- the upside is limited but the downside is
not limited.
 316

1-Feb-17
1-Nov-16
1-Aug-16
Total Rate assuming BBB Spread with 10 year Swap Rate

1-May-16
1-Feb-16
1-Nov-15
1-Aug-15
1-May-15
Merrill Lynch BBB Adj Spread

1-Feb-15
1-Nov-14
1-Aug-14
1-May-14
1-Feb-14
10 YR Swap Rate

1-Nov-13
1-Aug-13
1-May-13
1-Feb-13
1-Nov-12
1-Aug-12
1-May-12
1-Feb-12
1-Nov-11
1-Aug-11
1-May-11
1-Feb-11
1-Nov-10
1-Aug-10
1-May-10
10 YR Swap Rate

1-Feb-10
1-Nov-09
1-Aug-09
1-May-09
1-Feb-09
1-Nov-08
1-Aug-08
1-May-08
1-Feb-08
1-Nov-07
1-Aug-07
1-May-07
1-Feb-07
1-Nov-06
1-Aug-06
1-May-06
1-Feb-06
Note the low credit

1-Nov-05
1-Aug-05
spread before the
1-May-05
1-Feb-05
1-Nov-04

financial crisis
1-Aug-04
1-May-04
1-Feb-04
1-Nov-03
1-Aug-03
1-May-03
1-Feb-03
1-Nov-02
1-Aug-02
1-May-02
1-Feb-02
1-Nov-01
1-Aug-01

12.00

11.00

10.00

9.00

8.00

7.00

6.00

5.00

4.00

3.00

2.00

1.00

0.00
10 YR Swap Rate
Example of Pricing and Changing Credit Spreads
Step-up credit spreads encourage re-
financing. To not assume re-financing in
a base case or upside case in
inconsistent with the whole idea of
increasing rates.
Part 12: Credit Enhancement: DSRA, MRA, Cash
Flow Sweeps and Covenants
 Default Events and Project Finance Philosophy

• What can you really do if:

• A company does not pay debt service
• A company has a big cost over-run
• There is a big delay in construction
• Answer
• Waiver
• Events of Default
• Failure to Make Payments
• Judgments
• Misstatements
• Cross Default
• Breach of Project Documents
• Breach of Terms of Agreement
• Default in Construction; Schedule (Covenants)
• Loss of Applicable Permits

319
 Remedies for Default: Step-in Rights
• Possession of Project. Enter into possession of the Project
and perform any and all work and labor necessary:
• to complete the Project substantially according to the EPC
Agreement and
• the Plans and Specifications or to operate and maintain the
Project,
• and all sums expended by Administrative Agent in so
doing, together with interest on such total amount at the
Default Rate, shall be repaid upon demand and
• shall be secured by the Financing Documents,
notwithstanding that such expenditures may, together with
amounts advanced under this Agreement, exceed the
amount of the Total Construction Loan Commitment.
 Financial Enhancements – Alternative Definition

• Cash flow capture (dividend lock-up, cash trap) covenants

• Cause debt to be re-paid early or debt service reserves to be built-up
if debt service coverage ratios are low. Bad time covenant.
• Cash flow sweep covenants
• Cause debt to be re-paid early or debt service reserves to be built-up
if cash flow is high (or low). Good-time covenant.
• Debt service reserves
• Assure debt service can be paid if market prices or other risks cause
cash flow to be low for an extended period of time.
• Subordinated debt and mezzanine finance
• Protects the cash flow coverage of senior debt instruments.
• Contingent equity or sponsor guarantees
• Provide for additional equity funding in downside cases.
 Example of Covenants
• DSCR Target
• Minimum Senior DSCR of 1.20x in Base Case
• Lock-up Covenant
• Minimum Senior DSCR for the previous 12
months to be greater than 1.10x for distribution
• Event of Default
• Minimum Senior DSCR of 1.05x
• Standard Covenant
• Senior Debt not to exceed 80% of the total
project costs
 Dividend Distributions in Solar Case
• “Distribution Date” means 30 days after
each Repayment Date; provided, however,
that no Distribution Date shall occur prior to
the fourth (4th) Repayment Date.
• Implications and grace period

323
 What Covenants Cannot and Can Do
• Covenants cannot increase the operating cash
flow of a project
• Covenants cannot make a project that does not
have enough cash flow to avoid default
• Covenants cannot make a bad project into a
good project
• Covenants can change the timing of dividends
• Covenants and DSCR can force liquidity into
a project
Investors Need Some Dividends Before All Debt is Paid Off

• The timing of debt service (i.e. loan interest payments and

principal repayments) is one of the biggest factors that
drives the rate of return for equity holders in a project. If
the debt service is structured to allow no dividends until all
debt is paid, return will be lower. This will generally be
unacceptable to sponsors.
• The faster investors in a project are paid dividends, the better
their rate of return.
• Investors therefore do not wish cash flow from operations of the
project to be devoted to lenders at the expense of these dividends.
• Lenders, on the other hand, generally wish to be repaid as rapidly
as possible. Striking a reasonable balance between these
conflicting demands is an important part of loan negotiations.
 Covenants and Structural Enhancements Cannot Make a Bad
Project into a Good Project

• The most important aspect of the underwriting process is

determining whether the plant is economically sound. This means
that the cost structure and the technology of the plant must be viable.
• However, once a plant is determined to be economically viable, the
credit quality of a transaction can be enhanced by various structural
features – covenants, debt service reserves, liquidation damages,
subordinated debt, contingent equity etc. The potential for structural
enhancements to improve the credit quality of a transaction is
described in the statement by Standard and Poor’s below:
• Project structure does not mitigate risk that a marginally economic project
presents to lenders; structure in and of itself cannot elevate the debt rating
of a fundamentally weak project to investment-grade levels. On the other
hand, more creditworthy projects will feature covenants designed to identify
changing market conditions and trigger cash trapping features to project
lenders during occasional stress periods.
 Covenants and Cash Flow Waterfall

• A cash flow waterfall defines the priority

of uses of cash flow that is received for a
project.
• The important part of a cash flow
waterfall is what happens if there is not
enough cash flow to pay all expenses,
debt service and debt service reserve
requirements. It is the area after senior
debt payments and before dividends
• If sufficient cash is available to pay
dividends, the cash flow priority defines
how and when a distribution can be made.
 Modelling of Cash Flow Waterfall
• Set-up Cash Flow Working from EBITDA to CFADS
• Take away senior debt service assuming that debt
service is paid
• Use a lot of sub-totals for cash flow after debt service,
cash flow before default, cash flow before use of
DSRA etc.
• Use MAX(number,0) or Max(-number,0) to test for
what to do when sub-total is positive or negative
• Use MIN(subtotal, opening balance) to limit the
amount of sweep, DSRA use, repayment of default
etc.

328
 Example of Cash Flow Priority
• All revenues accrued on and after the Commercial Operation
Date will be deposited with the Trustee into the Operating
Revenue Account. The Trustee will withdraw amounts on a
monthly basis and make deposits in the following priority, but
only to the extent funds are then available in the Operating
Revenue Account:
• (1) the operations and maintenance expenses for the Project for such month, subject
to certain limitations;
• (2) the Tax Equalization Account
• (3) (A) an amount that will not be less than the amount of interest on the Bonds to
become due on such Interest Payment Date, and (B) an amount that will not be less
than the amount of principal or sinking fund payment to become due on such
principal or sinking fund payment date;
• (4) an amount, if any, sufficient to cause the amount on deposit in the Debt Service
Reserve Account to equal the Debt Service Reserve Account Requirement;
• (5) an amount, if any, sufficient to pay amounts due pursuant to the Working Capital
Facility;
• (6) an amount equal to the balance of the Operating Revenue Account shall be
deposited into the Surplus Account and will be transferred monthly to the Operating
Revenue Account.
 Example of Lock-up and Cash Flow
• Amounts in the Surplus Account will be annually
transferred on the first business day of January to the
Distribution Account and distributed to the Partnership
within 90 days thereafter if:
• the Debt Service Coverage Ratio for the Project is equal to
or exceeds 1.20 to 1.00 for the calendar year preceding the
distribution date and is projected to be equal to or exceed
1.20 to 1.00 for the current calendar year;
• the Partnership does not have knowledge, or could not
reasonably be expected to have knowledge, of the
occurrence and continuance of an event of default …;
• Working Capital Facility and the Waste Supply Support
Facility have been fully restored.
• If not so distributed, amounts in the Distribution
Account shall revert to the Surplus Account.
 Theory of Lock-up and Cash Flow Sweep
• Cash Lock-up (dividend lock-up, cash trap) is a “bad time” covenant.
It stops dividends when there is not much cash left anyway.
• Cash lock-up – if things are getting bad, do not allow dividends and try
to get a little more protection for things getting even worse.
• Program lock-ups from historic DSCR with a switch variable.
Prospective lock-ups cause a circular reference that is probably not
worth solving.
• Cash sweeps can be though of as a “good time” covenant. They can
limit dividends when there is a lot of cash available and protect the
lender for later periods when there is less cash.
• Cash sweeps are programmed with MAX/MIN functions and sub-totals
• MAX so the sweep occurs only when cash flow is positive
• MIN to make sure you do not sweep too much cash flow
• It would not make sense to have some formula for a cash sweep that
prepays debt when some low level of DSCR occurs – this is redundant
with the lock-up. Ratios like Debt/EBITDA make work better.
Volatility and Risk Reduction from Cash Flow Sweeps

• A cash sweep covenant only makes sense in situations

where the cash flow is volatile and/or there are
potential downward trends in prices.
• Think about a sudden 2008 type decline in cash flow.
Lenders do not like to have paid dividends only to later
have a default
• If cash flow is always low there is no cash flow to sweep
anyway. Here the sweep will not help.
• If cash flow is always high, there is no need for the cash
sweep.
• To assess the effectiveness of the covenant, cases that
incorporate realistic price volatility and potential
price trends must be run in the model.
 Example of Risk and Return Analysis for Cash Flow Sweep

Sweeps really help when there is a sudden decline in

cash flow – when you would have paid dividends
otherwise. A sweep would have reduced the default in
the example below.

Dividends Default
Default

Repayment of
default
 Economic and Financial Analysis of Cash Sweeps, Reserve
Accounts and Covenants

• Cash sweeps, reserve accounts and covenants can have

negative effects on the equity IRR of a project.
• Methods to consider the risk benefits to the bank versus the
costs to sponsors are addressed.
• Mechanics of cash sweep with different triggers and theory of
what kinds of transactions would be relevant for cash sweep
(e.g. hydro but not solar because of volatility) are addressed.
• The theory of what kind of triggers make sense
(Debt/EBITDA but not DSCR and operational triggers).
• Contrast between cash sweeps and cash trap covenants. As
with other issues, the effects of cash sweeps on equity returns
should be addressed with and without re-financing
assumptions.
334
Importance of Re-financing Analysis with Cash Sweep

• Cash Sweeps seem to dramatically reduce the

cash flow
• But after the prepayments from the sweep (or
even before), the project can be re-financed
• You can even lock-in interest rates if you are
worried about interest rate risk.
• Again, re-financing changes everything – you
can get you super dividends when you re-
finance.

335
 Prepayment in Airport Case
• The Borrower may, prepay any Tranche B Loan at
any time in whole or in part, which
• (i) after the Tranche A Loans and all Obligations in
relation thereto have been unconditionally and
irrevocably repaid and paid in full,
• and (ii) prior thereto will be applied
• (A) first, to pay any accrued but unpaid interest that
has not yet been paid in kind and
• (B) second, to repay such portion of the principal
amount outstanding of the Tranche B Loans, if any,
that is equal to the remaining portion of the
prepayment amount on the date of prepayment.

336
Debt Service Reserve Accounts
 Theory of DSRA
• Cost of Debt Service Reserve Account compared
to benefits
• Who funds the debt service reserve account, debt
or equity or debt and equity
• Mechanics and theory of using and L/C for the
debt service reserve account and support of parent
• Measuring the benefits of using an L/C account
compared to a funded DSRA with different
scenarios
• Effect of L/C fees in O&M expense versus L/C
fees as part of debt service

338
 DSRA and Liquidity
• DSRA is built to get liquidity into the project because holding
cash is very expensive – often 6 months of debt service which
is arbitrary
• Return on cash is about zero and opportunity cost of funds is equity
or debt IRR
• You can sometimes use a letter of credit instead of cash.
• Letter of credit should have a parent guarantee
• Paying an LC fee costs much less than the opportunity cost of funds
• If debt size is driven by the DSCR and not the debt to capital,
then the DSRA is funded by equity and not debt. This is
because the level of debt is given.
• If the debt to capital is high and the equity contribution is low,
the DSRA can be very costly to the equity IRR because of
high debt service and low equity.
 Using the DSRA as the Final Repayment in Sculpting

• Bankers should not care if the DSRA is

funded by debt or equity – the idea is just to
have liquidity when temporary bad things
happen or to have time to restructure.
• You can make the last repayment the DSRA.
In this case, with sculpting, the amount of the
cash flow increases and the debt also
increases. This has a small positive effect on
the equity IRR as shown in the next slide.

340
 Example Using the DSRA as the Final Repayment in Sculpting

• The example below shows the effect of using the DSRA in

sculpting debt. The left hand side includes DSRA and the right
hand side does not. Without DSRA the IRR is 12.65%.

341
 Use of LC Instead of the DSRA
• The example below shows that with a high debt to
capital ratio driven by sculpting and a high IRR,
the DSRA in LC can make a big difference to the
equity IRR – 11.96% to 14.92% as shown below.

342
 DSRA as LC in Solar Case
• “Acceptable DSR Letter of Credit”
• issued by a financial institution whose long-term senior unsecured debt is
rated at least “A-” by S&P and “A3” by Moody’s,
• naming Administrative Agent on behalf of the Lenders as the beneficiary, and
• including provisions that
• (i) such letter of credit shall automatically renew upon the expiration
• (ii) if no agreement for a renewal or replacement of the letter of credit has been made
after the long-term senior unsecured debt rating of the financial institution that
provides the letter of credit is downgraded below “A-” by S&P or “A3” by Moody’s,
the stated amount of the letter of credit shall be automatically drawn and the
proceeds automatically deposited in the Debt Service Reserve Account.
• Letter of credit
• (A) shall have an initial expiration date of at least one year after issuance,
• (B) shall not impose on Borrower any obligation to reimburse drawing payments,
and
• (C) shall be issued in a face amount equal to amounts required to be retained in the
Debt Service Reserve Account.

343
 Debt Service Reserve Account in Airport Case
• The Borrower must ensure that, on the first Utilisation Date, the balance of the
Debt Service Reserve Account is US$5,000,000. On each Monthly Transfer Date
thereafter, the Borrower must ensure that the balance in the Debt Service Reserve
Account is an amount equal to US$5,000,000
• or, if a Funds Insufficiency has occurred and the Borrower or the Facility Agent has
applied monies from the Debt Service Reserve Account to cover such Funds
Insufficiency, an amount equal to: (i) if the balance in the Debt Service Reserve Account
is less than US$3,000,000, the amount equal to the difference between US$3,000,000 and
the amount then on deposit in the Debt Service Reserve Account the sum of (x) three
million US Dollars (US$3,000,000), plus (y) the aggregate amount of transfers made
from the Collection Account to the Debt Service Reserve Account, which transfers the
Borrower must ensure, in accordance with agree to or propose any major adjustment or
increment request on design standard and/or structure or otherwise or any material change
on bills of quantities, contract value or construction period, or otherwise vary, modify,
supplement or amend or agree to the variation, modification, supplementation or
amendment in any way of any material provision of either China Civil Engineering
Construction Contract of the performance of any material obligation by any other Person
under such China Civil Engineering Construction Contract, in each case by entry into a
supplementary agreement or otherwise; provided that the Facility Agent will not
unreasonably withhold its consent to any of the foregoing if such consent is requested by
the Borrower;

344
 Debt Service Reserve Language
• On the Closing Date, an amount equal to 10% of the original principal amount of
the Bonds will be deposited in the Debt Service Reserve Account of the Debt
Service Reserve Fund from the proceeds of the Bonds.
• The amounts in the Debt Service Reserve Account will be used only for the
purpose of making payments into the related Interest Subaccounts, the Principal
Subaccounts and Sinking Fund Installment Subaccounts for the Bonds
• If a disbursement is made under a Debt Service Reserve Account Facility, the
Trustee shall apply amounts transferred from the Operating Revenue Account to
the applicable Debt Service Reserve Account to either cause the reinstatement of
the maximum limits of such Debt Service Reserve Account Facility. The Trustee
will apply moneys on deposit in a Debt Service Reserve Account prior to any
drawing on any Debt Service Reserve Account Facility.
• In the event that any amount shall be withdrawn from a Debt Service Reserve
Account for payments into an Interest Subaccount, Principal Subaccount or
Sinking Fund Installment Subaccount or there exists a deficiency in a Debt
Service Reserve Account which is to be reinstated, such withdrawals shall be
subsequently restored from Revenues available on a pro rata basis after all
required payments have been made into such Interest Subaccount.
 Case Flow Waterfall
• Accounts
• Airport Case
• Revenue Account means the bank account
no. 4603 held in the name of the Borrower
into which all Revenues of the Borrower,
other than those deposited into the Collection
Account are deposited.

346
 Solar Case Accounts
• Accounts. On or prior to the Closing Date, Borrower and Administrative Agent
shall establish at the Depositary accounts entitled
• “Solar Construction Account” (the “Construction Account”),
• “Solar Operating Account” (the “Operating Account”),
• “Solar Distribution Account” (the “Distribution Account”),
• “Solar O&M Reserve Account” (the “O&M Reserve Account”),
• “Solar Debt Service Reserve Account” (the “Debt Service Reserve Account”),
• “Solar Distribution Reserve Account (the “Distribution Reserve Account”),
• “Solar Completion Reserve Account” (the “Completion Reserve Account”),
• “Solar Interest Reserve Account” (the “Interest Reserve Account”)
• “Solar Loss Proceeds Account” (the “Loss Proceeds Account”),
• “Solar Delay Proceeds Account” (the “Delay Proceeds Account”)
• “Solar Major Maintenance Reserve Account” (the “Major Maintenance Reserve
Account”).
• Any deposits, transfer or application of funds in the Accounts shall be in
accordance with the Depositary Agreement.

347
Section 8: Re-financing and effects of Debt
Tenure (as well as other debt terms)
 Re-financing and the Importance of Debt Tenure

• Assume that the debt is sized from debt to capital

ratio for the next set of slides (this assumption
will be changed later on)
• Assume that the debt can be re-financed on the
basis of DSCR (this assumption will also be
changed in later slides).
• Various assumptions will be made about re-
financing
• The slides will demonstrate that with these
assumptions, re-financing makes the length of the
debt much less important.
 Re-financing Introduction
• Every project has the possibility to increase equity
returns through re-financing
• Re-financing is a real option without a cost if there is
no pre-payment penalty (except for fees on new debt)
• As with any option, the value of the option is driven
by uncertainty – there is uncertainty with respect to
when the re-financing occurs, the parameters of the
re-financing, the credit spreads and the amount of the
re-financing
• The re-financing option has much much more value
when the initial tenor is short.

350
Assumptions and Mechanics of Re-financing
• The excerpts below show the assumptions
and the mechanics behind re-financing
 Re-financing Scenarios
• The table below illustrates alternative re-financing
scenarios using the assumption of DSCR driving
the debt size in re-financing. Results of these
sensitivities are presented in subsequent slides.
This kind of table should be in every model
 Re-financing Case 1 – Multiple Re-financings

• If there are multiple re-financings, the effect

of the tenure on the IRR is dramatically
reduced as shown in the two tables below.
 Philosophy and Re-financing
• An argument against the dramatic effects of re-
financing is that the length of the debt is a very strong
signal – like a stamp of approval – that the project has
reasonable risk.
• If one project obtains an advantageous financing at the
financial close, why would the project not also receive
better terms in re-financing.
• If the short tenure is just a reflection of market
conditions in a country or the necessity to establish
historic results.
• There are many possibilities about how re-financing
could occur and sensitivity analysis can be performed.
 Re-financing Case 2 – Later Refinancing

• This scenario shows that if the re-financing occurs later

there is a smaller effect because higher dividends occur
in early years. The table shows Equity IRR
 Re-financing Case 3 – Shorter Tail in Re-financing

• This scenario demonstrates that if the re-

financing occurs later but there is a longer tenure
for the re-financing then the effect is increased.
 Re-financing Case 4 – Reduced DSCR and Interest Rate on Re-
financing

• The scenario with reduced interest and

reduced DSCR demonstrates higher returns
in all scenarios.
 Re-financing Case 5 – Effect of Interest Rates when Re-financing
Included

• When re-financing is included interest rate changes make a big

difference and loan tenor is much less important. If you believe that
you can re-finance, it is more important to negotiate a low interest rate.
 Re-financing Case 6 – Effect of Changing Interest Rates
and DSCR for Sizing Re-financing
• When re-financing is included and the interest rate is reduced on future
financing and the DSCR is reduced, the re-financing effects are more
dramatic. The gearing makes more difference and the initial tenor has
a smaller effect.
 Re-financing Conclusions
• Not being “allowed” to consider re-financing
is silly.
• Consider a variety of re-financing
possibilities with scenario analysis
• Re-financing can dramatically change the
implications of interest rates and tenures.
• Re-financing a particularly important issue
for cases where the loan tenure is a lot shorter
than the project life.
 Part 14: Other Project Finance Subjects: IRR
problems, Risk and Value Changes over Life of
Project, Resource Analysis and Debt Sizing
 A Little Theory about Valuation and Risk of Projects
• Valuation theory with respect to projects generally involves risk reduction as a
project progresses through phases.
• In Europe, there are many stories (but not much data) about how insurance
companies purchase existing projects with operating history and are willing to
accept equity IRR’s as low as 5-6%.
• The idea behind a low cost of capital for mature projects is the following:
• During the development stage, expenditures occur with large risks associated with permitting,
problematic wind studies, construction cost over-runs, ability to secure tariffs etc. The required
equity IRR during the development stage can be 15% to account for the project not being
successfully methods.
• Once the development is finished or in late stages, the risk is reduced by a large margin.
However there are still risks associated with successfully completing construction at budget
and on time. The reduced risk during the construction phase may reduce the required equity
IRR to something like 12%
• After construction, the remaining risk for a project with a fixed price contract is that the
estimated wind production will not be met. Given this risk, the discount risk is still above the
cost of capital for bonds and may be in the range of 8-10%.
• Once operating history is available, the risk is not much higher than the debt cost or the
interest rate on long-term bonds. With bonds yielding below 3%, a return of 6% provides a
good premium for risk.

362
 Re-financing and Early Project Sale
• Timing strategies and sales value. How
different types of projects have differences in
risk reduction over time, and why wind
projects probably have more of a risk
reduction than other electricity projects. Show
how the effects of changing risk and selling to
a Yieldco can be demonstrated with
measuring IRR over time with changing buyer
IRRs. Demonstrate how optimal holding
periods can be computed with various IRR
hurdle rate assumptions.

363
 Verification of Cost of Capital from Published Data in Yieldco
Reports

• As part of this task we have reviewed detailed financial data of

Yieldco’s including prospectuses and annual financial reports. One of
the last companies that we investigated was Brookfield Renewable
Energy Partners (BEP). In its notes to financial statements, discount
rates that are applied to both contractual cash flows and non-
contracted cash flows in asset valuation are presented. It is assumed
that the cost of capital represents after tax cost of capital although this
is not specified in the report.

364
 Equity Returns and Re-Financing

Equity IRR with and without Re-financing

50.0%

44.6%
45.0% Re-Finance
No Re-Finance
40.0%
37.3%
E
q 35.0%
u
29.2%
i 30.0%
t
25.0%
y 21.7%
20.0% 18.9%
I 16.0%
R 15.0%
R
10.0% 7.8% 7.7%

5.0%

0.0%
Low Base High Very High
Traffic Scenario
 Transaction Multiples from Yieldco IPO’s

• For valuation of assets the most relevant multiple is the EV/EBITDA

ratio. This is because the EBITDA is not affected by financing and
because the EV/EBITDA ratio can be computed from IPO’s of
Yieldco’s. For Yieldco projects that have minimal capital expenditures
and small or no growth in cash flow, the EV/EBITDA can be used to
derive an implied pre-tax IRR and an overall cost of capital (this is
further explained in the appendix). The IRR’s from this analysis are
lower than the low case pre-tax cost of capital assumption.

366
 Equity Returns for Tollroads

• The following slide shows equity returns over time

and how they have come down
 Part 3: Creating or Destroying Value through
Contract Provisions Including Liquidated Damages,
Penalty Provisions and Efficiency Incentives
 General Notion of Back to Back Contacts
• Begins with Project Contract (Concession
Contract, PPA Contract, Availability Contract).
• Back to back contracts follow the Project
Contract
• Fixed Price EPC Contract from Fixed
Availability Payment
• Transfer Delay Risk with Liquidated Damage
• Transfer O&M Risks with Incentives and
Penalties

369
 Economic Efficiency of Contracts in Project Finance

• Notion of allocating risks to IPP that can be controlled

• Incorporation of different risks in multipart tariffs
• The general idea that risks which can be accepted at a
reasonable cost should be allocated to IPP versus the
off-taker.
• Nuances of whether risks should be allocated.
• Notion that penalties and bonuses should reflect off-
taker costs combined with SPV costs
• Use of marginal cost analysis in measuring availability
benefits and costs in different periods
• Calculation levelized prices in PPA contracts

370
Example of Delay Damage in PPA Contract

371
Example of Delay LD in EPC Contract

372
Theory of Risk and Return in Project Finance
• Different parties in project finance including EPC contractors,
O&M contractors, insurance companies, financial institutions
and sponsors are paid for taking risk.
• The general idea that if parties are paid too much or too little
for accepting risk, the off-taker will pay too much for the
service and/or sponsors will not receive an adequate return will
be demonstrated.
• Off-taker economics as well as the technical aspects of the
facility must be fully understood to effectively negotiate
project finance terms.
• The theory and practice of computing delay liquidated
damages, availability penalties, target heat rates and other
items through the central idea of minimizing the sum of off-
taker costs and IPP costs.

373
 Contracts
Off-taker
EPC
Contractor
PPA Contract
Four Part Tariff
Fixed Price Fixed Capacity Charge at Fin Close
Contract with LD LD Penalty for Delay Risk
Contract O&M Charge
Contract Heat Rate
Availability Penalty

Fuel Supply
Fuel Index

Fuel Supply Contract Contract with

with Index Special
Guaranteed Heat
Corresponding to Purpose O&M
Rate and Availability
PPA Vehicle Contractor
Penalty
and Fixed Fee

Shareholder
Agreement Loan
Agreement

Sponsors Lenders

Letter of
Credit for
Equity Cash
Example of O&M Contract
Tradeoff Between Cost and Availability
Optimisation and Minimum Cost
In Theory, Minimum is
where replacement cost
change = maintenance
cost change