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Class notes project finance

47 important questions on Class notes project finance

Acceleration (of loan upon default)

acceleration (of loan upon default) = action of the lenders to make the whole of their debt due and payable following an event of default

Base case (financial model)

base case (financial model)= the projections of project cash flow at or shortly before financial close, agreed beween the project cie and the offtaker or contracting authority

Budget (construction v. operations)

budget (construction v. operations) =
construction : the cost of construction as agreed with the lenders - if deviations it will require lender consent even if there is still enough overall funding to complete the project but they should give some flexibility (it includes interest rate on loan drawings during construction)budget for operating costs (where these are under the project company’s control - outside any budgetary control because it is innapropriate for lenders to restrict the project company’s ability to fulfill its obligations under the project contracts - ie payment of input supplies to the supplier).

Completion / final acceptance date

completion / final acceptance date = Final completion or final acceptance date, by opposition to substantial completion (when project meets the basic requirements of the construction contract and project is handed over to project cie), it is when the project meets all the requirements set out in the construction contract such that project cie considers it complete; it reaches “project completion”. Usually, an engineer will certify the completion. (it is the final stage of project completion)

“LOI” (Letter of Intent)

“LOI” (Letter of Intent) = banks provide sponsors with letters of intent early in the development of the project to confirm their interest in getting involved in the project - this is non binding. (to differentiate with a commitment letter).

“MOU” (Memorandum of Understanding) = A memorandum of understanding (MoU)

“MOU” (Memorandum of Understanding) = A memorandum of understanding (MoU) is describing a bilateral or multilateral agreement between two or more parties. It expresses a convergence of will between the parties, indicating an intended common line of action. It is often used in cases where parties either do not imply a legal commitment or in situations where the parties cannot create a legally enforceable agreement. It is a more formal alternative to a gentlemen's agreement.

2. What is a Material Adverse Change ("MAC") clause? Why would you want a MAC clause as a lender?

MAC is requirement that there be no material adverse change to the project after financial documentation was signed. It can be a CP to financial close and drawings. It can also be found as an event of default because lenders cannot foresee everything that might go wrong with the project so it is a catch all provision to fill any gaps. The MAC provision enables the lender to refuse to complete the agreement and financing if the other party suffers such change.

3. What are the basic sections or key provisions of the Credit Agreement (also sometimes called Loan Agreement or Finance Agreement)? What purpose does each serve? What are likely to be the most hotly negotiated parts of each?

termpayment mechanismcontract monitoring rep and warrantiescovenantsCondition precedent performance bonding and guaranteesprepayment Permissions waivers and amendmentsrelief eventsevents of default terminationdispute resolution, governing law

Highly negotiated:
Negative covenants. Liquidated damagesPrice and terms on which payments are madeHow much retained until substantial completion (that is for construction contract

Think about how the Covenants, Representations and Events of Default work together.

A breach of covenants or rep can trigger events of default. In the former case there is a potential for cure, but not for representations and warranties which should have been accurate at time of the signature.

Covenants and reps are very similar, maybe even overlap but one is the statement of facts for the present (it is a picture of the current situation) whereas the other is a promise in the future. So covenants allow in a way to ask for maintaining the reps and warranties.

6. What provisions of the loan agreement are particular to project finance lending (as opposed to any other secured loan)? What specific representations, covenants and events of default might you see in a project loan agreement?

Term depends on the useful life of the project and equity return for investors and term of the debtPayment mechanism is very important because based on cash flow received and need a waterfall given the various parties involved

Condition precedent to Closing/Conversion:

Receipt of satisfactory Project pro forma projections confirming the Project’s economics demonstrate that the projected Debt Service Coverage Ratio averages at least 1.5 to 1.0 and is not less than 1.3 to 1.0 in any year occurring during the period extending to 20 years following the Scheduled Commercial Operation Date; and

Negative Pledge Clause

Clause in an agreement by a borrower with its lender not to give security over its assets to any third party.An agreement by a borrower or guarantor not to create or permit creation of liens, security interests, or other encumbrances on its assets.

Liquidated damages (L/Ds):

correspond to specific amounts, often with a cap, a contracting party is required to pay to another contracting party in the event an agreed-upon area of performance is not achieved, either as a consequence of delays and/or sub-standard performance, and/or in cases of breach of contract. The amount of the liquidated damages is stated in the contract in a good faith estimate, with the purpose of covering the costs not received by the grieving party as a consequence of the delay or breach.

Political risk insurance:

Political risks involving construction, operation, owning or financing of a cross-border transaction may be mitigated by means of political risk insurance coverage for the debt or the equity financing.

Bond (payment and performance)

Types of bonds intended to protect the owner in a construction project from contractor failure.

COD (Commercial Operation Date)

The date on which the independent engineer certifies that a facility has completed all performance tests or built to the specs in the EPC contract.

Commitment of supply (fixed/variable; dedicated; interruptible)

FIXED/VAR: supplier agrees to provide a fixed quant of supplies on an agreed schedule or a variable suppply between an agreed max and min.

DEDICATED: supplier dedicates the entire output from a source, its own plant.

Cost plus contract

Cost-plus contract: the contractor will be paid for all of its allowed expenses to a set limit, PLUS additional payment to allow for profit. Contrast with: fixed-price contract (contractor only paid a negotiated amount regardless of incurred expenses).

Liquidated Damages (Delay LDs/ Performance LDs)

Provision that allows for the payment of a specified sum if one of the parties is in breach (mainly concerning situations where actual damages are difficult to ascertain).

DELAY: failure to complete the project on the agreed date.

PERFORMANCE: failure to meet minimum required performance standard.

O&M Agreement

A project contract to operate and maintain a process-plant project on behalf of the project company.

heat rate curve:

The amount of fuel required to produce a set amount of electrical power.

Interest rate cap

A hedging contract that sets a maximum interest rate for the Project Company’s debt.

Interest rate collar

A hedging contract that sets a floor (minimum) on the interest rate payable by the Project Company.

Liquidated damages (L/Ds)

The Pre-agreed level of loss when a party does not perform under a contract (LDs); cf. delay LDs, performance LDs. Penalties.

Most Favored Nation Clause (“MFN”):

A level of status given to one country by another and enforced by the World Trade Organization. A country grants this clause to another nation if it is interested in increasing trade with that country. Countries achieving most favored nation status are given specific trade advantages such as reduced tariffs on imported goods. Special consideration is given to countries that are classified as "developing" by the World Trade Organization.

Merchant power plant ("MMP") or merchant plant "on the grid”:

An IPP that does not have a PPA, but relies on selling its power into a competitive market.

RFQ (Request for Qualifications)

Request for prospective bidders’ financial and technical qualifications, at the initial (pre- qualification) PQQ stage of a public- procurement process (RFQ).

Tolling contract (push / pull):

An input supply contract in which the fuel or raw material is supplied free, and the Project Company is paid for processing it.

Guaranteed Investment Contract:

a fixed rate of interest paid by a depository bank on the proceed of a bond issue until theses are required to pay construction costs for a project.

S&P (Moodys, etc.):

Standard & Poor's Financial Services LLC (S&P) is an American financial services company. It is a division of McGraw Hill Financial that publishes financial research and analysis on stocks and bonds. S&P is known for its stock market indices such as the U.S.-based S&P 500, the Canadian S&P/TSX, the Australian S&P/ASX 200, and India's S&P CNX Nifty. S&P is considered one of the Big Three credit-rating agencies, which also include Moody's Investor Service and Fitch Ratings.

O&M agreement: operation and maintenance agreement

Contract with an experienced operator providing comfort to the lender in case the project fails to operate as projected due to poor management (loss of revenue or higher operating cost).
The O&M contractor does not guarantee the revenues or costs of the project, and the penalties are usually capped around 2-3 years’ fee.

sponsor limited-recourse guarantees

A type of financing in which the Lender has no ability to make claims against the Sponsor in excess of the value of the Collateral if such Collateral is insufficient to repay the debt. Sometimes called “Non-Recourse” even though the Lender does have recourse to the Collateral.

Cost overrun guarantee

Guarantee of a cost increase or budget overrun, involves unexpected costs incurred in excess of budgeted amounts due to an underestimation of the actual cost during budgeting. (Cost overrun should be distinguished from cost escalation, which is used to express an anticipated growth in a budgeted cost due to factors such as inflation).

Financial completion guarantee: or completion bonds

An agreement by a bonding company (a type of insurance company) that if its customer, a contractor, does not complete work under a specified contract, the bonding company will pay to have it completed. These are designed to protect against contractors going belly- up during construction. Completion Bonds are not viewed as particularly comforting, since they are issued by insurance companies, and insurance companies tend to like to collect premiums and resist paying claims.

"A" loans / "B" loans:

When the primary lender decides to syndicate the loan, it maintains a portion of the loan for its own account (A Loan), while selling participations to the remainder (B Loan). The primary lender remains the sole contractual lender, and acts on its own account and on behalf of the B Loan participants.

debt service coverage ratio (DSCR):

Measure the amount of cash flow available to meet annual interest and principal payments on debt. A DSCR of less than 1 would mean a negative cash flow. A DSCR of less than 1, say .95, would mean that there is only enough net operating income to cover 95% of annual debt payments. (DSCR= Net Operating Income/ Total Debt Service)

multilateral/bilateral development agencies (MDFI/BDFI):

International Financial Institutions (IFIs), created by a group of countries, that provides financing and professional advising for the purpose of development.

Domestic capital markets:

National markets for buying and selling equity and debt instruments. Capital markets channel savings and investment between suppliers of capital such as retail investors and institutional investors, and users of capital like businesses, government and individuals.

Export-import financing agencies:

A financial institution or agency that provides trade financing to domestic companies for their international acitivites. Export credit agencies (ECAs) provide financing services such as guarantees, loans and insurance to these companies in order to promote exports in the domestic country. The primary objective of ECAs is to remove the risk and uncertainty of payments to exporters when exporting outside their country.

"hell or high water" commitment:

Non-cancelable clause whereby the debtor must make the specified payments to the lender, regardless of any difficulties they may encounter.

Lead manager (Lead Arranger):

Bank arranging and underwriting project-finance debt, or the investment bank placing a project-finance bond.

Original issue stock:

Stock issued when the company is first incorporated.

S&P (Moodys, etc.):

Standard & Poor’s, Credit Rating Agency (CRA). An agency may rate the creditworthiness of issuers of debt obligations, the debt instruments, and/or in some cases, the servicers of the underlying debt, but not individual consumers.

World Bank/IBRD (International Bank for Reconstruction and Development):

International organizations created after World War II dedicated to providing financing, advice and research to developing nations to aid their economic advancement.

What are the advantages/disadvantages of public debt vs private debt?

Private Debt potential benefits:
Contractual return: Repayment schedule and interest rate terms are fixed by contract. Repayment priority over equity shareholders on cash flow.Less expensive form of capital for the private debt issuer than equity.Low correlation with public bonds investments fluctuation. If one declines, the other one is less likely to decline as well.Private Debt potential risks:
Credit risk, mitigated by higher interest ratesLack of independent credit ratingsLack of liquidity: Loan repayment usually scheduled over long period of time.Private debt is more expensive than Public debt.

Compensation - prompt; adequate/full; effective:

Standard of payment to justify the expropriation of the investment by the host government to the owner; It normally means the fair market value of the expropriated investment immediately before the expropriatory action was taken or become known.

If you were representing a developing country in the negotiation of a BIT or regional free trade agreement, what rights might you push for, and why?
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Answer: The treaties are generally designed to take away uncertainties of investing in countries with certain uncertainies. Without the treaty and its necessary assurances, foreign capital will not be attracted to the developing country.
Certain levels of predictability of return of investments and return on an investment will mean cheaper financing costs for the project which benefits the developing country. There may be some things around the edges of the agreement to extend times for performance etc. that may make the bilateral agreement seem less onerous

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Project finance Class notes

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Class notes project finance

47 important questions on Class notes project finance

Acceleration (of loan upon default)

Base case (financial model)

Budget (construction v. operations)

Completion / final acceptance date

“LOI” (Letter of Intent)

“MOU” (Memorandum of Understanding) = A memorandum of understanding (MoU)

2. What is a Material Adverse Change ("MAC") clause? Why would you want a MAC clause as a lender?

3. What are the basic sections or key provisions of the Credit Agreement (also sometimes called Loan Agreement or Finance Agreement)? What purpose does each serve? What are likely to be the most hotly negotiated parts of each?

Think about how the Covenants, Representations and Events of Default work together.

6. What provisions of the loan agreement are particular to project finance lending (as opposed to any other secured loan)? What specific representations, covenants and events of default might you see in a project loan agreement?

Condition precedent to Closing/Conversion:

Negative Pledge Clause

Liquidated damages (L/Ds):

Political risk insurance:

Bond (payment and performance)

COD (Commercial Operation Date)

Commitment of supply (fixed/variable; dedicated; interruptible)

Cost plus contract

Liquidated Damages (Delay LDs/ Performance LDs)

O&M Agreement

heat rate curve:

Interest rate cap

Interest rate collar

Liquidated damages (L/Ds)

Most Favored Nation Clause (“MFN”):

Merchant power plant ("MMP") or merchant plant "on the grid”:

RFQ (Request for Qualifications)

Tolling contract (push / pull):

Guaranteed Investment Contract:

S&P (Moodys, etc.):

O&M agreement: operation and maintenance agreement

sponsor limited-recourse guarantees

Cost overrun guarantee

Financial completion guarantee: or completion bonds

"A" loans / "B" loans:

debt service coverage ratio (DSCR):

multilateral/bilateral development agencies (MDFI/BDFI):

Domestic capital markets:

Export-import financing agencies:

"hell or high water" commitment:

Lead manager (Lead Arranger):

Original issue stock:

S&P (Moodys, etc.):

World Bank/IBRD (International Bank for Reconstruction and Development):

What are the advantages/disadvantages of public debt vs private debt?

Compensation - prompt; adequate/full; effective:

If you were representing a developing country in the negotiation of a BIT or regional free trade agreement, what rights might you push for, and why? .

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If you were representing a developing country in the negotiation of a BIT or regional free trade agreement, what rights might you push for, and why?
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