PROJECT FINANCE

BY MATTHEW BERNATH
 CONTENTS

WHAT IS PROJECT FINANCE? ---------------------------------------------------------- 1

PROJECT FINANCE BASICS-------------------------------------------------------------- 2

THE PROJECT FINANCE MODEL -------------------------------------------------------- 3

ACRONYMS TO MAKE US LOOK SMART ---------------------------------------------- 5

ITS ALL ABOUT CASH ------------------------------------------------------------------- 6

ANYTHING ELSE? ------------------------------------------------------------------------ 8

WHAT ELSE IS DIFFERENT FROM A TYPICAL CORPORATE FINANCE MODEL? --- 10

IS THAT ALL? WELL, NO, THERE IS MORE ------------------------------------------- 11

SUMMARY ------------------------------------------------------------------------------ 12

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WHAT IS PROJECT FINANCE?

To understand why project finance modelling is so complex, firstly we must understand Project
Finance - also sometimes known as Infrastructure Finance as infrastructure is what it typically
finances.

What is Project What differentiates it from Why does it suit infrastructure

Finance? corporate or leveraged finance? projects?

Figure 1: A large wind farm that was project financed.

WHAT IS PROJECT FINANCE? PAGE 1

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PROJECT FINANCE BASICS

• Project Finance revolves around the financing of long-term infrastructure
• It is typically limited or non-recourse finance
• It is therefore highly structured to ensure that risks are mitigated
• Debt and Equity are paid back from cash flow generated by the project, and only this cash flow
• The lenders’ recourse is limited to project assets, including performance and completion
guarantees and bonds
• Most large infrastructure projects are Project Financed as it enables long-term debt and
separation from a company which may not be able to raise that sort of finance on their own
accord
• So, what do we finance? A brand new SPV.

Figure 2: Project Finance generally finances Infrastructure.

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THE PROJECT FINANCE MODEL

Ok, how does this affect the modelling though? You will see a lot of the word ‘typically’ in the
descriptions below. This is because project financings are so unique that to generalise them is very
difficult. Each model is so different - hence the term 'Structured Finance'! That said, there are some
common characteristics that we will talk about below.

• Project Finance models are put together to assess the financial feasibility of a project to be
undertaken by a new entity - in other words, off-balance sheet lending
• These models assess the cash flows on a period by period basis and show returns for
shareholders
• They also show the banks that the projects are financially capable of repaying debt, with
enough room to spare
• Banks want to ensure that there is ‘breathing room’ in the project – what if operations are
disrupted and no cash flow is generated for some time?
• On the other hand, Shareholders want to ensure that returns are worth the risk of undertaking
large, often infrastructure related projects with long-term (15-20 years) payback periods
• Non-recourse debt is used, where the assets related to the project are at risk if there is an
event of default

Figure 3: The project finance model is a 20-30 year forecast of construction and operations.

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• By separating the "project" from the rest of the sponsor company enables a higher level of
gearing than would normally be acceptable to the company and the banks
• The level of debt can be anywhere from 50% to 85% depending on the project, the cover ratios
and the certainty of revenue and what guarantees may be in place
• There are certain metrics which measure the ability to repay the debt
• This includes DSCR, LLCR, PLCR on a Senior and Total Level (Senior for Senior debt and Total
for all debt in the project which may include subordinated debt)
• A project finance model is significantly different and often more structured than a typical
financial model.

It must ensure that:

• Money is reserved for ongoing Capex, debt payment and potential shortfalls
• Interest capitalised or paid during construction is funded as part of the initial capital raise
• Cash flows are sufficient to pay off debt and pay dividends to shareholders
• Cash flows over the life of the loan and the project provide breathing room in case of
performance issues

Figure 4: Solar farms are often Project Financed.

THE PROJECT FINANCE MODEL PAGE 4

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ACRONYMS TO MAKE US LOOK SMART

Project Financiers, like financiers in general, love acronyms. In a project finance discussion, you may
hear such terms as a PPA, DSCR, DSRA and PLCR or LLCR. These are the main ones you should know
about in a model:

CFADS Cash Flow Available for Debt Service, typically revenue less expenses and tax

DSCR Debt Service Cover Ratio (CFADS divided by Senior Debt Service)

LLCR Loan Life Cover Ratio to measure the cover in the loan life

PLCR Project Life Cover Ratio to measure the cover in the project life

Lenders Technical Adviser, who provides the lender with the assurance that the project
LTA
is technically sound

ECA Export Credit Agency who may assist in providing insurance on loans

Engineering, Procurement and Construction which is basically the party responsible for
EPC
the construction part of the project

O&M Operations and Maintenance during operations of the project

The P-Value that the plant is assumed to run at, typically for projects where a statistical
P-Value analysis of revenue can be performed and there is enough history to perform this
analysis!

Power Purchase Agreement for projects that generate power such as wind farms and
PPA
solar farms

Public-Private Partnership for projects that involve both government and the private
PPP
sector providing crucial infrastructure for public benefit

Figure 5: Project Finance is all about cash flow!

CASH FLOW

ACRONYMS TO MAKE US LOOK SMART PAGE 5

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ITS ALL ABOUT CASH

Other characteristics of project finance deals are:

Distinct construction and operation phases – during construction typically there is no revenue, so
interest on debt drawn down needs to be accrued or more debt needs to be drawn to pay the
interest!

The construction phase typically consists of:

• No revenue as the revenue generating asset (a wind farm or a public transport system has no
revenue being generated while it is built) is being built
• Cash Flows in multiple currencies – especially if equipment needs to be procured from other
countries and paid for in that country’s currency
• Set capital sources – project financing is characterised by a fixed amount of capital, and any
cost overruns need to be funded by equity
• Penalties for construction overruns (LDs and PPAs being shorter)
• FX and Interest Rate Hedges to mitigate risks of uses of funds exceeding sources of funds

Figure 6: Typically, there is no revenue during construction.

ITS ALL ABOUT CASH PAGE 6

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Operations consisting of:

• Sometimes certain revenue and sometimes revenue that can fluctuate with usage or
seasonality
• Long-term debt (double or longer the tenor of corporate debt)
• Multiple tranches of debt – senior and mezzanine debt that take on different risks depending
on where they sit in the capital structure
• Debt that is highly structured (e.g. capitalised interest, drawdowns, sculpted repayments)

A Financial Model that is:

• Up to 30 years’ time frame

• Monthly during construction but quarterly or semi-annual during operations
• Construction and operation phases which are very different
• Multiple scenarios, potentially Monte Carlo simulation

Figure 7: Project Finance models are intricate and structured.

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ANYTHING ELSE?
The financial model also needs to show clearly:

• Insurances
• Hedging Structures
• Senior Debt, Mezzanine/Subordinated Debt and Equity Returns
• Multiple scenarios and production/revenue stresses
• That delay LDs can cover debt repayments if required
• The cash flow waterfall shows the flow of cash as it comes in per period
• Revenues: Operating revenues and other income
• Expenses: Operating expenses and capital expenses
• Reserve Account Movements
• Tax
• Debt service: Principal repayments and interest paid
• Distributions: Dividends to Equity and Shareholder Loan Repayments
• Net movement in cash balance

Figure 8: Be prepared to negotiate every assumption in your project finance model!

ANYTHING ELSE? PAGE 8

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There are some key project finance characteristics here that are crucial for the financial model:

• Cash Flow Available for Debt Service or CFADS is used for all cover ratio calculations such as
DSCR, LLCR and PLCR
• Cash flow before funding: This line is useful as a quick check against funding, to ensure that
initial construction costs are being met by debt or equity (i.e. the project has to be fully funded)
• Cash flow available for debt service reserve account (DSRA)
• Cash flow available to equity to calculate distributions
• Net cash flow - Usually zero, unless cash is being restricted from being paid to equity
• The debt service reserve account (DSRA) works as an additional security measure for lenders
• The DSRA is generally a deposit which is equal to a given number of months projected debt
service obligations (principal and interest).
• The purpose of a DSRA is to provide a cash buffer during periods where cash available for debt
service (CFADS) is less than the scheduled payments
• This buffer allows some breathing room for operational issues to be resolved and/or, in more
extreme situations, the debt to be restructured before the borrower defaults on the debt.

Figure 9: CFADS is used to cover ratio calculations.

ANYTHING ELSE? PAGE 9

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WHAT ELSE IS DIFFERENT FROM A TYPICAL CORPORATE FINANCE MODEL?

Other unique project finance features:

• When capital expenditure is lumpy and/or large it is common to need to consider and model
a major maintenance reserve account (MMRA)
• During the operational phase of a project, capital investment is required to ensure that the
project is able to continue operating as planned, this can even include minor maintenance and
upgrades

Examples of the above include:

o the resurfacing of a runway

o a planned lane widening on a toll road
o software upgrades
o replacement of wind turbines or solar panels

The MMRA is designed to accumulate funds to ensure the funds are there when they are needed,
instead of having a large cash requirement in that operating period

Figure 10: There are numerous examples of railway PPPs.

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IS THAT ALL? WELL, NO, THERE IS MORE

• A general Liquidity Reserve Account (LRA) can give the project breathing room
• An LRA can be used for working capital or to fund other shortfalls not foreseen
• Remember: We want to avoid a default at all costs or even a strain on the Debt Service Cover
Ratio (which may lead to a technical default or a lockup on dividends)
• Financing the DSRA is particularly complicated as it is funded out of both debt and equity, but
increasing the debt to fund the DSRA means increasing repayments, which the DSRA needs to
cover, so the DSRA needs to increase, which increases the debt which partially funds the DSRA
and so on

WHAT ABOUT THE UNCERTAINTY IN REVENUE?

• A big risk for renewable energy developers is the lack of resource! A cloudy day can mean NO
revenue
• To protect developers and lenders, we use P50 and P90 figures in the model
• Debt covenants will be measured on a P90 basis, while Sponsor IRR is measured on a P50 basis
• A P99 requirement of 1.00x is not unheard of!
• From a lender’s perspective, they need to ensure that the debt service is adequately covered
per period (DSCR) and over the life of the loan (LLCR) and the project (PLCR)
• The lender also wants to ensure all the project risks are covered (especially during
construction!
• From a borrower’s perspective, they want to ensure the project will provide adequate returns
and be cash generative while covering most of their risks.
• Remember that a plant that has been 95% constructed is not able to generate revenues or
service debt!

Figure 11: The lender also wants to ensure all the project risks are covered.

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SUMMARY
To summarise a project finance model, it depicts a project in multiple Excel worksheets that show:

• Period by period analysis for up to 20 years

• A standalone entity with or without parent company guarantees
• Tax complications - differences between tax and accounting depreciation
• Often extended drawdown periods for debt (power plants and public transport systems take
a long time to build!)
• Often extended payback periods / tenors
• Government, parent company guarantees
• Cross country political and other risks
• Extended project contracts
• Sometimes variability in revenues as in projects such as renewable energy and tolls roads
revenues will not be consistent throughout the year.
• In some cases, reliance on a single off taker to pay back debt
• Construction and Operation phases with distinct sets of risk that need to be mitigated

Still interested in project finance? Listen to the Financial Modelling Podcast episode where we
interview Dario Musso, head of Infrastructure Finance at Rand Merchant Bank, on the importance
of financial modelling for infrastructure projects.

Good luck and happy financial modelling!

Matthew

Figure 12: Matthew Bernath - Excel Lover and Financial Modeller.

SUMMARY PAGE 12