PROJECT FINANCE IN INDIA

Rashi Anand Suri, PartnerSNG & PARTNERS, INDIA

PROJECT FINANCE

Project finance is the long term financing of infrastructure and industrial projects based upon the projected cash flows of the project rather than the balance sheets of the project sponsors. It involves non-recourse financing of the development and construction of a particular project in which lenders looks to the revenue expected to be generated by the project for repayment of its loans and to the assets of the project as collateral for its loan rather than to the general credit of the project sponsor .

Financing of long term infrastructure and/or industrial projects using debt and equity.Debt is typically repaid using cash flow generated from the operations of the Project.Limited recourse to project sponsors.Debt is typically secured by project’s assets, including revenue producing contracts

• First priority on project cash flows is given to the Lender• Consent of the Lender is required to disburse any surplus cash flows to project

sponsorsHigher risk projects may require the surety / guarantees of the project sponsors.

INFRASTRUCTURE IN INDIA

As per the RBI, a credit facility is treated as “infrastructure lending’’ to a borrower company which is engaged in developing, operating and maintaining any infrastructure facility that is a project in any of the following sectors ,or any infrastructure facility of a similar nature.

Infrastructure is a basic physical and organizational structure needed for the operation or the service and facilities necessary for an economy to function -set of interconnected structural elements that provide framework supporting an entire structure of development .

Roads including toll road, a bridge or a rail system;

Ports, airport, inland waterway;

Water supply project, irrigation project, water treatment system, sanitation and sewerage system or solid waste management system;

Telecommunication services whether basic or cellular including radio paging, domestic satellite service, broadband network and internet services;

An industrial park or special economic zone ; Generation and distribution of power; Transmission or distribution of power by laying a network of new

transmission or transmission lines; Construction relating to projects involving agro-processing and supply of

inputs to agriculture ; Construction of educational institutions and hospital ; Any other infrastructure facility of similar nature .

POWER IN INDIA :

1.The power sector ranked sixth among the leading sector of the Indian economy.

2.It has attracted US$ 4.6 billion in FDI since the year 2000.

ROADS IN INDIA :

1.India has about the third largest road network in the world.

2.Government will undertake the upgradation of around 3700 km of National Highways at a cost of about 4.26 billion.

3.It involves double laning of single lane highways in eight states.

PORTS IN INDIA:

1. India has one of the largest merchant shipping fleet and is ranked 16th among the maritime countries.

2. India has announced a combined US$ 110 billion package to develop its ports and shipbuilding industry by 2020.

3. The annual capacity of India's major and non-major ports is expected to increase upto 1.5 billion tonnes by 2012.

AIRPORTS IN INDIA:

AAI has planned a heavy investment of USD 3.07 billion over the next five years including focus on airports for metro cities and upgradation of other non-metro airports and in the modernization of the existing aeronautical facilities.

TYPICAL PROJECT STAGES

Set Up SPV

ESTABLISHING PARTNERSHIP WITH LENDER

CHARACTERISTICS OF PROJECT FINANCE

Limited or non-recourse based

Cash flow based

Performance is the nucleus

needs strong security structure

little more costly / complex

Project finance involves risk identification & allocation

Project finance is different from corporate finance

Usually accompanied by Special Purpose Vehicle

ADVANTAGES OF DEBT FINANCING:

• The primary advantage of debt financing is that it allows the founders to retain ownership and control of the company.

• The entrepreneurs are able to make key strategic decisions and also to keep and reinvest more company profits.

• Debt obligations are limited to the loan repayment period, after which the lender has no further claim on the business, whereas equity investors' claim does not end until their stock is sold.

• Furthermore, a debt that is paid on time can enhance a small business's credit rating and make it easier to obtain various types of financing in the future.

DISADVANTAGES OF DEBT FINANCING:

• The main disadvantage of debt financing is that it requires a small business to make regular monthly payments of principal and interest.

• Very young companies often experience shortages in cash flow that may make such regular payments difficult. Most lenders provide severe penalties for late or missed payments, which may include charging late fees, taking possession of collateral, or calling the loan due early. Failure to make payments on a loan, even temporarily, can adversely affect a small business's credit rating and its ability to obtain future financing.

• Another disadvantage associated with debt financing is that its availability is often limited to established businesses. Since lenders primarily seek security for their funds, it can be difficult for unproven businesses to obtain loans.

Risk and Project Phases

Engineering &Construction Phase

Start-up Phase

OperationPhase

Project Finance Life Cycle

Operations &Monitoring

Drafting of financing documents

Implementation &Monitoring

Resolution of due Diligence issues

Preliminary project assessment Due diligenceIssue of LOI

Issue of term sheet

Term sheet negotiations

Term sheet signing

Financial closure Project completion

Project identification

Debt servicing

RISK AND CHALLENGES IN PROJECT FINANCING IN INDIA:

1) COMPLETION RISK / CONSTRUCTION PHASE RISK :-

• It is the vital part of risk allocation of any project and carries the greatest risk for the financer .

• It carries a danger that the project will not be completed on time ,on budget or at all because of technical ,labour ,and other construction difficulties.

• Any delays or cost increase may delay loan repayments and cause interest and debt to accumulate .

• Commonly employed mechanism for minimizing completion risk includes:

Obtaining completion guarantee requiring the sponsor to pay all debts and liquidated damages if completion does not occur by the required date .

Ensuring that sponsors have a significant financial interest in the success of the project so that they remain committed to it by insisting that sponsor inject equity into the project .

Requiring the project to be developed under fixed price, fixed time turnkey contracts by reputable and financially sound contractors whose performance is secured by performance bonds or guaranteed by third party.

2) OPERATION RISK:

• Operation risks are more common in mining project, rail project, power station or toll road. This risk may affect the cash – flow of the project by increasing the operating costs or affecting the project’s capacity to continue to generate the quantity and quality of the planned output over the life of the project .

• Such resource risk are usually minimised by :

experts’ report as to the existence of the inputs or estimates of public users of the project based on surveys and other empirical evidence

Requiring long term supply contracts for inputs to be entered into as protection against shortages or price fluctuation.

Obtaining guarantees that there will be a minimum level of inputs.

3) MARKET /OFF-TAKE RISK:

• Market risk is the risk to find the buyer for the product at a price sufficient to provide adequate cash flow to service the debt .

• The best mechanism for minimizing market risk before lending takes place is an acceptable forward sales contact entered into with a financial sound purchaser.

• “take or pay’’ off –take contracts which require the purchaser to make minimum payments even if the product cannot be delivered

RISK COMMON TO BOTH CONSTRUCTION AND OPERATIONAL PHASES

1) PARTICIPANT /CREDIT RISK:

• These are the risks associated with the sponsors or the borrowers themselves.

• Credit risk is also important for the sponsors' completion guarantees. To minimise these risks, the financiers need to satisfy themselves that the participants in the project have the necessary human resources, experience in past projects of this nature and are financially strong.

2) TECHNICAL RISK:

• This is the risk of technical difficulties in the construction and operation of the project's plant and equipment, including latent defects.

• Financiers usually minimise this risk by preferring tried and tested technologies to new unproven technologies.

• Technical risk is also minimised before lending takes place by obtaining experts reports as to the proposed technology.

• Technical risks are managed during the loan period by requiring a maintenance retention account to be maintained to receive a proportion of cash-flows to cover future maintenance expenditure.

3) CURRENCY RISK :

Currency risks include the risks that:

• a depreciation in loan currencies may increase the costs of construction where significant construction items are sourced offshore;

• a depreciation in the revenue currencies may cause a cash-flow problem in the operating phase;

• Mechanisms for minimising resource include:

matching the currencies of the sales contracts with the currencies of supply contracts as far as possible

Denominating the loan in the most relevant foreign currency

4) REGULATORY / APPROVALS RISK :

• These are risks that government licenses and approvals required to construct or operate the project will not be issued or that the project will be subject to excessive taxation, royalty payments, or rigid requirements as to local supply or distribution.

• Such risks may be reduced by obtaining legal opinions confirming compliance with applicable laws and ensuring that any necessary approvals are a condition precedent to the drawdown of funds.

5)FORCE MAJEURE RISK:

• The risk of events which render the construction or operation of the project impossible, either temporarily or permanently.

• Mechanisms for minimising such risks include:

conducting due diligence as to the possibility of the relevant risks

allocating such risks to other parties as far as possible

requiring adequate insurances which note the financiers' interests to be put in place.

• Common mechanisms for minimising political risk include:

requiring host country agreements and assurances that project will not be interfered with ;

obtaining legal opinions as to the applicable laws and the enforceability of contracts with government entities.

RAISING CAPITALOption A:

Debt : Equity – 60% : 40%

BORROWER

EQUITY

40%

PROJECT 1:

SPV 1

DEBT

60%

PROJECT SPONSORS

LENDERS

DEBT

60%

DEBT

60%

RAISING CAPITALOption B:

Debt : Equity – 80% : 20%

BORROWER

EQUITY

20%

PROJECT 1:SPV 1 DEBT

20%

PROJECT SPONSORS

CONSORTIUM MEMBER

DEBT60%

CONSORTIUMMEMBER

LOAN AMOUNT / TYPE

60% of the market value of the Project / Property is the maximum debt which may be granted

Short / medium / Long Terms Loans

Loans granted are typically used to finance:

Land acquisition

Preliminary expenses

Construction

REPAYMENT

Flexible Repayments Terms

Grace Period Offered During Construction

Repayment Schedule Matched to the Project Cash Flow Streams

Early Repayment Option

SECURITY / COLLATERAL

Typical Security / Collateral Includes:

Mortgage Charge on Land and Construction Works

Pledge of Shares of the Borrowing Company

Corporate Guarantees of Parent / Holding Company

Personal Guarantees of Ultimate Beneficial Owners

Assignment of all Project Proceeds

Security Agent:

Internal / External Legal Advisors acceptable to both parties

PRICING

Typical Upfront Fees:

Arrangement Fee – Once off calculated on Loan Amount Documentation Fees Legal Fees

Other Possible Fees:

Commitment Fees – X % p.a. calculated on the daily/monthly/quarterly aggregate un-drawn amount of the Loan

Administration Fees Prepayment Fees

ABOVE FEES ARE ONLY INDICATIVE FEES. FEES DEPEND ON PROJECT STRUCTURE AND RISKS INVOLVED

CONDITIONS PRECEDENT

Typically include but are not limited to :

Property valuation report prepared by professional valuer acceptable to the Bank

Satisfactory due diligence on the Borrower, Corporate Guarantors, Properties offered as Security, etc.

Independent Official Confirmation, verifying : Existence of construction permits from local authorities

Existence of permits for the commencement of construction works

Approval of Loan Facility and Security by the Borrower’s Board of Directors