Project Financing in Chandigarh
SPA are providing consultancy regarding appropriate funding for large and small business / industry.
This Annex introduces some basic concepts of project finance and shows how they relate to the financing structure of projects. It is not meant to cover all the issues relevant to financing structures, which are many complex and often project-specific. Authorities should rely on the expertise of financial and legal advisers to understand the relevant trade-offs in project finance issues.
Projects are generally financed using project finance arrangements. In project finance, lenders and investors rely either exclusively (“non-recourse” financing) or mainly (“limited recourse” financing) on the cash flow generated by the project to repay their loans and earn a return on their investments. This is in contrast to corporate lending where lenders rely on the strength of the borrower’s balance sheet for their loans.
As outlined above by SPA, the financing of a PPP project consists principally of senior debt and equity (which may sometimes be in the form of junior shareholder loans). The financing structure may also include other forms of junior debt (such as “mezzanine” debt, which ranks between senior debt and pure equity) and in some cases grant funding.
SPA helps in PPP projects should seek to achieve optimum (as opposed to maximum) risk transfer between the public and private sector. But the allocation of risks among the private sector parties is also crucial. Financial structuring of the project relies on a careful assessment of construction, operating and revenue risks and seeks to achieve optimum risk allocation between the private partners to the transaction. In practice, this means limiting risks to senior lenders and allocating this to equity investors, subcontractors, guarantors and other parties through contractual arrangements of one kind or another.
SPA states that Senior debt enjoys priority in terms of repayment over all other forms of finance. Mezzanine debt is subordinated in terms of repayment to senior debt but ranks above equity both for distributions of free cash in the so-called “cash waterfall” (i.e. priority of each cash inflow and outflow in a project) and in the event of liquidation of the PPP Company. Since mezzanine debt’s repayment can be affected by poor performance of the PPP Company and bearing in mind the priority in repayment of senior debt, mezzanine debt typically commands higher returns than senior debt.
Debt to a PPP project is normally priced on the basis of the underlying cost of funds to the lender plus a fixed component (or “margin”) expressed as a number of basis points to cover default risk and the lender’s other costs (e.g. operating costs, the opportunity cost of capital allocations, profit).
SPA explains that equity is usually provided by the project sponsors but may also be provided by the contractors who will build and operate the project as well as by financial institutions. A large part of the equity (often referred to as “quasi-equity”) may actually be in the form of shareholder subordinated debt, for tax and accounting benefits. Since equity holders bear primary risks under a PPP project, they will seek a higher return on the funding they provide.
SPA will be able to advice on the likely sources of funding for a given project. They would also be expected to make an assessment of the anticipated costs and benefits of funding options. This will include an assessment of the debt tenors (the length of time to maturity, or repayment, of debt) likely to be available from various sources. This is particularly important if long-term funding is not available for the project and where the public sector may be drawn into risks associated with the need to refinance short-term loans (so-called “mini-perm” structures).
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