Financial Management

Financing Infrastructure Projects

51st All India Course on

“Project Planning, Monitoring and Control Systems”
14th October 2006
 Public Finance
 A government borrows funds to finance an infrastructure
project and gives a sovereign guarantee to lenders to repay
all funds. Government may contribute its own equity in
addition to the borrowed funds.
 Lenders analyse Government’s total ability to raise funds
through taxation and PSU revenues, including new tariff
revenue from the project.
 The sovereign guarantee shows up as a liability on
Government’s list of financial obligations.

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 Corporate Finance
 A private company borrows funds to construct a new
treatment facility and guarantees to repay lenders from its
available operating income and its base of assets. The
company may choose to contribute its own equity as well.
 In performing credit analysis, lenders look at the
company’s total income from operations, its stock of
assets, and its existing liabilities.
 The loan shows up as a liability on the company’s balance
sheet (“Mining the Corporate Balance Sheet”)

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 Project Finance
 A consortium of private firms establish a new project company (SPV)
to build, own and operate a specific infrastructure project.
 The SPV is capitalised with equity contributions from each of the
sponsors.
 The project company borrows funds from lenders. The lenders look to
the projected future revenue stream generated by the project and the
SPV’s assets to repay all loans: Non-recourse lending
 The host country government does not provide a financial guarantee to
lenders; sponsoring firms provide limited guarantees. “Off-Balance-
Sheet” financing.

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 Project funding alternatives
 Common equity represents ownership of the project.
Sponsors usually hold a significant portion of the equity.
 Preferred equity also represents ownership of the project.
However, this has a priority over the common equity in
receiving dividends and funds in the event of liquidation.
 Convertible debt is convertible to equity under certain
conditions, usually at the option of the holder. This debt is
generally considered subordinate and senior lenders regard
it as pseudo-equity.
 Unsecured debt can be either short- or long-term and,
although not secured by specific assets, is senior to equity
and pseudo-equity in receiving dividends and repayment of
principal.
 Secured debt may also be short- or long-term and is secured
by specific assets or sources of revenues.
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 Short term funding options
 Construction financing

Used for construction purposes; Very flexible drawdowns

On completion of construction, it is replaced by one or more of
the longer-term securities described above.

Construction financing lenders require a designated long-term
investor to commit to paying out the construction finance at a
predetermined time.
 Bridging finance

Similar to construction financing but can be used for other
purposes, usually during inception.
 Line of credit funding

is obtained and repaid on a regular basis throughout the project

Used as a cash management tool and are usually set up with
various banks.

The fee structure: Commitment fee (1 to 3 % of the total line of
credit committed) + A standard short-term interest rate on any
amount drawn on the line of credit.
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 Investor profiles
 Promoter

usually the government department responsible for providing
services to the public (private company in case of unsolicited bid)

Primarily concerned with ensuring the provision of services of
sufficient quantity and quality, and on a non-discriminatory basis.
 Sponsors

usually include construction, supply, management and finance
companies.

They may derive other opportunities (e.g. construction, supply or
management contracts).

Other investors may require the sponsors to hold their investment
for a minimum period

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 Investor profiles..
 Equity funds

May include locally registered unit trusts or foreign equity funds

Most funds have an investment mandate that allows them to invest
in certain industries (e.g. infrastructure) or geographical locations

Primarily interested in the prospect of earning dividends or
appreciation on their investment.
 Non-bank financial institutions

Pension and insurance funds, with a primary function of investing
their assets in medium or long-term securities.

Usually invest in the more senior securities to ensure that they
obtain the cash flow required for meeting their payout obligations

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 Suppliers

may provide short to medium-term debt or extended terms on
accounts payable

A supplier may also be a sponsor and may invest in equity

The suppliers’ primary interest in the project is usually the supply
contract with the project company.

Project companies may also enter into other risk-reducing
agreements with suppliers, such as a long-term fixed price and
quantity agreement.

Investors will closely scrutinise the supplier’s credit rating when
an agreement involves the future delivery of services.

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 Indirect forms of financing
 End-user financing

Prepayment for the future delivery of services, OR a take-or-pay
contract in which the end-user commits to purchasing a minimum
amount of services over a period .
 Government

May not necessarily directly finance a project

Provides indirect financing through guarantees, take-or-pay
contracts, sole provider licences and other commitments.
 Public participation

Usually comes at the operating stage

The process of listing a company’s equity and/or debt is often
included in an understanding between the sponsors, the government
and the lenders, to allow the original equity investors to plan their
exit strategy.

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 Investor profiles: Banks
 Financial adviser (Investment Bank) hired to formulate a
financing strategy. Should be independent of the lenders
and underwriters to avoid conflicts of interest
 Banks act as short-term / long-term lenders and financial
arrangers (underwriters): both debt and equity
 Large projects: consortium/ syndicate to raise funds

Lead bank manages the syndication. Selection is based on the
banks’ experience in raising funds in a certain industry and
country
 Banks raise fund on “firm commitment” or “best efforts”
basis. The underwriting fees paid to the bank for providing
a firm commitment is higher.
 Underwriting fees

1.5 to 5% of the amount raised

Depends on project size, the type of security, the risk associated
with the project and the level of commitment

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 Investor criteria
 Strength and experience of the project sponsors and the
government department or PSU
 Project fundamentals and economics
 Credit of the project participants
 Contractual arrangements between the parties
 Assurance on competing facility
 Financial covenants

minimum equity to debt level; minimum debt coverage ratio.

restriction on the payment of dividends till certain ratios are met
 Other covenants

restrictions on the transfer of ownership of the project

restrictions on the nature of the services a sponsor may provide.

standard procurement policies to be followed by the project
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 Terms and conditions of investment
agreements
 Amount of funding
 Drawdown conditions
 Pricing (interest rate or preferred dividend)
 The repayment schedule
 A grace period
 The term or maturity
 Security (collateral)
 Representations and warranties
 Conditions precedent to closing
 Restrictions on related party transactions
 Events of default
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 Issues in financing strategy for a project
 Debt service coverage ratio (DSCR) is the most important
ratio for debt investors. It is defined as the earnings before
interest, taxes, depreciation and amortisation divided by
the debt service (the payment of interest and repayment of
principal).

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Debt Structuring Strategies

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Financing Strategy 1: Longer term debt

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Financing strategy 2: Deferring principal payments
 The cash flow from revenues becomes sufficient to meet
debt service requirements.
 Lenders’ risk is increased leading to a higher interest rate.
 One form of deferring principals is to make a balloon
payment at the end of the term.

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Financing strategy 2: Moratorium

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 Financing strategy 3: Government guarantee
 A guarantee by a more creditworthy entity (e.g. government)
will lower the interest for the original life of the loan, thereby
reducing the debt service level to below the revenues
available for debt service.

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 Options for enhancing feasibility of a project

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 Funds flow: Waterfall method
 The waterfall method of demonstrating fund flows consists
of the cash inflows (revenues) and outflows (operational
and maintenance costs, debt service, and outflows of cash,
taxes and profits)

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 Enhancing feasibility: Strategy 1
 Increasing tariffs is one option for making the project
feasible. However, this may reduce the value for money
from a PPP project

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 Enhancing feasibility: Strategy 2
 Decreasing operating and maintenance costs may improve
the efficiency of the project, but may also undermine the
project if it is already operating efficiently or if such
reductions are mismanaged.

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 Enhancing feasibility: Strategy 3
 An increase in equity will reduce the amount of debt
financing required, but may also reduce the return on
equity to an unacceptable level, as noted above.

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 Enhancing feasibility: Strategy 4
 Establishing a reserve account for safety margin in debt
service may satisfy the lenders and reduce the cost of debt.
 Reserve accounts are created from the project’s revenue or
by additional contributions from equity holders. In either
case, this increases the overall cost of the project as the
funds in the reserve account could have been better
invested.

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 Enhancing feasibility: Strategy 5
 Finding another source of revenue within the project

Sell a by-product of project goods and services, or rent out space
within project buildings.

Some sources of other revenue are logical (selling by-products),
while others may indicate excess capacity in the project.

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 Enhancing feasibility: Strategy 6
 A third party guarantee, such as by a financial institution
This option has a specific cost that the project or government
will be required to pay either directly or indirectly.

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 Enhancing feasibility: Strategy 7
 Subordinate (mezzanine) debt can be created to reduce
the cost of senior debt.
 Although the cost of the subordinate debt is greater than
that of the senior debt, it may create the necessary
conditions for the senior debt holder to invest in the
project.

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