22. 11. 27.

오후 2:10 Project Finance: How It Works, Definition, and Types of Loans

CORPORATE FINANCE

CORPORATE DEBT

Project Finance: How It Works,

Definition, and Types of Loans
By
ADAM HAYES
Updated August 20, 2021

Reviewed by
AMY DRURY

Fact checked by
DIANE COSTAGLIOLA

Investopedia / Sydney Burns

What Is Project Finance?

Project finance is the funding (financing) of long-term infrastructure, industrial
projects, and public services using a non-recourse or limited recourse financial
structure. The debt and equity used to finance the project are paid back from
the cash flow generated by the project.

Project financing is a loan structure that relies primarily on the project's cash
flow for repayment, with the project's assets, rights, and interests held as
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secondary collateral. Project finance is especially attractive to the private sector

because companies can fund major projects off-balance sheet (OBS).

KEY TAKEAWAYS
Project finance involves the public funding of infrastructure and other
long-term, capital-intensive projects.
This often utilizes a non-recourse or limited recourse financial
structure.
A debtor with a non-recourse loan cannot be pursued for any
additional payment beyond the seizure of the asset.
Project debt is typically held in a sufficient minority subsidiary not
consolidated on the balance sheet of the respective shareholders (i.e.,
it is an off-balance sheet item).

Understanding Project Finance

The project finance structure for a build, operate, and transfer (BOT) project
includes multiple key elements.

Project finance for BOT projects generally includes a special purpose vehicle
(SPV). The company’s sole activity is carrying out the project by subcontracting
most aspects through construction and operations contracts. Because there is
no revenue stream during the construction phase of new-build projects, debt
service only occurs during the operations phase.

For this reason, parties take significant risks during the construction phase. The
sole revenue stream during this phase is generally under an offtake agreement
or power purchase agreement. Because there is limited or no recourse to the
project’s sponsors, company shareholders are typically liable up to the extent of
their shareholdings. The project remains off-balance-sheet for the sponsors and
for the government.

Important: Not all infrastructure investments are funded with project

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Important: Not all infrastructure investments are funded with project
finance. Many companies issue traditional debt or equity in order to
undertake such projects.

Off-Balance Sheet Projects

Project debt is typically held in a sufficient minority subsidiary not consolidated
on the balance sheet of the respective shareholders. This reduces the project’s
impact on the cost of the shareholders’ existing debt and debt capacity. The
shareholders are free to use their debt capacity for other investments.

To some extent, the government may use project financing to keep project debt
and liabilities off-balance-sheet so they take up less fiscal space. Fiscal space is
the amount of money the government may spend beyond what it is already
investing in public services such as health, welfare, and education. The theory is
that strong economic growth will bring the government more money through
extra tax revenue from more people working and paying more taxes, allowing
the government to increase spending on public services.

Non-Recourse Financing
When a company defaults on a loan, recourse financing gives lenders full claim
to shareholders’ assets or cash flow. In contrast, project financing designates
the project company as a limited-liability SPV. The lenders’ recourse is thus
limited primarily or entirely to the project’s assets, including completion and
performance guarantees and bonds, in case the project company defaults.

A key issue in non-recourse financing is whether circumstances may arise in

which the lenders have recourse to some or all of the shareholders’ assets. A
deliberate breach on the part of the shareholders may give the lender recourse
to assets.

Applicable law may restrict the extent to which shareholder liability may be
limited. For example, liability for personal injury or death is typically not subject
to elimination. Non-recourse debt is characterized by high capital expenditures
(CapEx), long loan periods, and uncertain revenue streams. Underwriting these
loans requires financial modeling skills and sound knowledge of the underlying
technical domain.
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To preempt deficiency balances, loan-to-value (LTV) ratios are usually limited to

60% in non-recourse loans. Lenders impose higher credit standards on
borrowers to minimize the chance of default. Non-recourse loans, on account of
their greater risk, carry higher interest rates than recourse loans.

Recourse vs. Non-Recourse Loans

If two people are looking to purchase large assets, such as a home, and one
receives a recourse loan and the other a non-recourse loan, the actions the
financial institution can take against each borrower are different.

In both cases, the homes may be used as collateral, meaning they can be seized
should either borrower default. To recoup costs when the borrowers default,
the financial institutions can attempt to sell the homes and use the sale price to
pay down the associated debt. If the properties sell for less than the amount
owed, the financial institution can pursue only the debtor with the recourse
loan. The debtor with the non-recourse loan cannot be pursued for any
additional payment beyond the seizure of the asset.

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