Course: Credit Management (Module II: Credit Operations) NIBM, Pune

Module II: Credit Operations

Chapter 3: Project and Infrastructure Finance

Shri M. Balakrishnan
Objective
This chapter aims to provide a comprehensive view of project and infrastructure finance.
More particularly, it details the structures and relationships between various
stakeholders and their contracts drawn to manage the risks in a project.

Structure
1. Introduction to project and infrastructure finance
1.1. Introduction
1.2. Project finance – Definition, concept and features
1.2.1. Special purpose vehicle
1.2.2. Limited recourse financing
1.2.3. Features of project finance
1.3. Stakeholders of project finance
1.3.1. Sponsors
1.3.2. Government
1.3.3. Contractors
1.3.4. Feed stock providers and/ or off taker
1.3.5. Lenders
1.4. Project financing structures
1.4.1. BOT
1.4.2. BOOT
1.4.3. BOO
1.4.4. BLT
1.4.5. DBFO
1.4.6. DBOT
1.4.7. DCMF
1.5. Sectors for Project finance
1.6. Project identification, formulation and implementation process
2. Appraisal of infrastructure projects
2.1. Technical appraisal
2.2. Commercial appraisal
2.3. Economic appraisal
2.4. Financial appraisal
2.5. Managerial appraisal
2.6. Ecological appraisal

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3. Project economics
3.1. Assumptions in Project finance
3.2. Project cost estimation
3.3. Means of finance
3.4. Estimation of revenue
3.5. Analysis of financial viability
3.6. Project finance sources
3.7. Sources of debt finance
3.8. Phases in project life
3.8.1. Development phase
3.8.2. Construction phase
3.8.3. Operation phase
4. Project contract
4.1. Project agreement
4.2. Loan documentation and security
4.3. Project review and evaluation

Section 1

Introduction to Project and Infrastructure Finance

1.1. Introduction
Project and infrastructure finance forms a very important area of lending, particularly for
big banks. Through project financing, large-scale infrastructure projects are executed and
established. In developed countries, large scale public sector projects were financed by
public-sector debt and private-sector projects were financed by large companies raising
corporate loans. In developing countries, such as India projects were financed by the
government by sourcing debt finance from international banking market, multilateral
institutions such as the World Bank, or through export credits. Nowadays project
financing is undertaken in public private participation (PPP) mode where public stands
for government funding.
In India, infrastructure projects have been largely funded by the Public Sector from
budgetary allocations of Government and internal resources of public sector
infrastructure companies. In the recent years, Private sector has emerged as a significant
contributor for financing infrastructure projects as the demand for financing
infrastructure like roads, sea ports, airports and network industries like telecom and
power are growing. Government of India has put in place necessary regulatory and
institutional frame work to attract private investors and banks/FIs to participate through
the Public-Private-Participation (PPP) model for project financing. Private participation
is not possible unless bank loans are available for the same. Consequently, banks and
financial institutions in the country have started participating in project financing the last
two decades.

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1.1.1. Infrastructure Finance: As per RBI, a credit facility extended to a borrowing

company (SPV) engaged in developing, operating and maintaining any infrastructure
facility that is a project in any of the sectors such as the following is called infrastructure
finance.

Table: Details of infrastructure in different industries

Industry or Need Infrastructure

Transport Roads and bridges

Ports

Inland Waterways

Airport

Railway Track, tunnels, viaducts, bridges

Urban Public Transport

(except rolling stock in case of urban road transport)
Energy Electricity Generation
Electricity Transmission

Electricity Distribution

Oil pipelines

Oil / Gas / Liquefied Natural Gas (LNG) storage facility

Gas pipelines

Water & Sanitation Solid Waste Management

Water supply pipelines

Water treatment plants

Sewage collection, treatment and disposal system

Irrigation (dams, channels, embankments etc.)

Storm Water Drainage System

Communication Telecommunication (Fixed network)

Telecommunication towers

Social and Commercial Education Institutions (capital stock)

Infrastructure Hospitals (capital stock)
Three-star or higher category classified hotels located
outside cities with population of more than 1 million
Common infrastructure for industrial parks, SEZ,
tourism agriculture markets

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Fertilizer (Capital investment)

Post-harvest storage infrastructure for agriculture and

horticultural produce including cold storage
Terminal markets

Soil-testing laboratories

Cold Chain

Out of the above list of sectors, Agriculture infrastructure (like construction of storage
structures such as rural go downs, ware houses, cold storages, establishing common
market yards, silos) and Social infrastructure (like establishing educational
institutions, hospitals, sanitation facilities and water purification and distribution
facilities) have been brought under priority sector lending purview by banks up to a
credit limit of Rs.100 crores from 2015 onwards as per by RBI directives. Hence a
portion of such infrastructure activities have been brought under mandatory lending
by banks.

Box 1

Infrastructure investment estimate by CRISIL for next five year fiscal (2017-2022)

CRISIL infrastructure year book 2017 released in New Delhi on 26 th Oct 2017 estimates
infrastructure investments will grow to Rs. 50 lakh crores in the five fiscals to
2022.Infrastructure investments in the five fiscals before 2017 stood at Rs. 37 lakh crores as
per the agency which translated to Rs.7.4 lakh crore per year or 5.8% of GDP annually. This is
56% more than what was invested between fiscals 2008 and 2012.Five sectors –power, roads,
telecom, irrigation and railways accounted for about 83% of all such investments in the past
decade. In the next 5 years, CRISIL estimates infrastructure to grow to Rs. 50 lakh crores; given
the GDP growth stand at around 7 %. Infrastructure will account for around 5.5% of the GDP
and the private sector investment will remain subdued at around 28% of total investments in
infrastructure. The 7 Lakh crores stimulus announced by Finance Ministry is being hailed by
various players in the infrastructure as it will not only boost the economy but also pave the
way for the creation of jobs.

(Source: Business Line 27 10 2017)

1.2. Project finance – Definition, concept and features

Project finance refers to sourcing funds for long term capital intensive infrastructure projects
whose cash flow generated are used to pay back the financing procured. This form of
finance is different from corporate finance conceptually and structurally. In corporate
finance, a company can directly raise funds from equity and debt. It is liable to repay
the loan in full failing which, subject to agreements in place the owners and promoters
of the company may be liable to pay the shortfall. In project finance, lending is
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extended on a limited recourse basis to a borrower which is a Special Purpose Vehicle

(SPV) and the loans are raised. The companies and persons who invest in the equity
of a project company (also known as sponsor) forms a SPV to manage the funds
procurement and utilization. It is a unique feature of the project financing that the
liability of promoters is limited to the extent of their investment in the company and
lenders will not have access to the assets of other businesses of promoter if any.

1.2.1. Special Purpose Vehicle (SPV)

SPV is a limited company or a limited liability partnership established solely for the
purposes of a particular facility or project. During the execution of the project, the
funding requirements of the project are solely managed by the SPV. The purpose is to
insulate the sponsor or holding company that sets up the SPV from any risks arising
in the project.

1.2.2. Limited Recourse financing

In project finance, repayments of loans are from the ‘internally generated cash flows
of the project’. Thus the recourse for lending is only cash flows of the project once the
project is established. In other words the principal lender security is the future cash
flows of the project itself. Hence, it is also termed as ‘cash flow lending’.

1.2.3. Features of Project finance

Project finance structures differ between from deal to deal and between various
industry sectors. However, there are certain common principles underlying the
project finance approach. Some typical features of project finance are:

• It is provided for a "ring-fenced" project (i.e., one which is legally and

economically self-contained) through a special purpose legal entity (usually a
company) whose only business is the project (the "Project Company").
• It is usually raised for a new project rather than an established business.
• Project finance is highly leveraged. The debt to equity ("leverage") could be as
high as 70 to 90%.The promoters do not, normally offer personal guarantees
as it would bind their other business to project losses if any. As such there are
no guarantees ("non-recourse "finance). In some projects there could be
limited guarantees ("limited-recourse" finance), for the project finance debt
from the investors in the Project Company.
• Lenders rely on the future cash flow projected to be generated by the project
for interest and debt repayment (debt service), rather than the value of its
assets or analysis of historical financial results.
• The main security for lenders is the project company's contracts, licenses, or
ownership of rights to natural resources. The project company's physical

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assets are likely to be worth much less than the debt if they are sold off after a
default on the financing.

1.3 Stakeholders in a project finance

A project usually comprises of a number of stakeholders such as Sponsors, Project

company/management (SPV), Procurer, Government, Contractors, Feedstock
providers and/or off takers (vendors and buyers) and Lenders.

1.3.1 Sponsors

The equity investors in a project are usually referred to as the Sponsors (or promoters
or developers), meaning that their role is one of promotion, development, and
management of the project. Sponsors undertake a feasibility study when initially
considering the project investment. Though the project finance debt may be
nonrecourse and have no guarantees from the Sponsors, the full involvement of the
promoters is important. Lenders look at the background of the Sponsors when
considering the decision to participate in a project financing.

• The equity investor(s) and owner(s) of the Project Company can be a single
party yet more frequently a consortium of Sponsors
• Subsidiaries of the Sponsors may also act as sub-contractors, feedstock
providers, or off taker to the Project Company
• In Public Private Partner (PPP) projects, the Government/Procurer may also
retain an ownership stake in the project and therefore could be a Sponsor

Sponsors may bring in other types of investors such as:

• Investment funds specializing in project finance equity

• Institutional investors, such as insurance companies and pension funds
• Shareholders in quoted equity issued by the Project Company on a local or
international stock exchange
• Governments, government agencies, or other public authorities
• Local partners
• Multilateral institutions, such as International Finance Corporation

1.3.2. Special Purpose Vehicle (Project Company)

Project finance requires a systematic and well-organized approach to carrying out a

complex series of interrelated tasks. The project activities and tasks usually involve-
• Engineering and construction
• Operation

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• Legal aspects covering site acquisition, Permits, Project Contracts, loan

documentation, etc.
• Accounting and tax
• Financial modelling and structuring

It is important that the project management is well coordinated to take care of all the
above activities. It is possible that Sponsors may agree on a Project Contract that is
commercially sound, but not acceptable from a project finance point of view: for
example, the fuel may be cheap, but the supply contract may not cover the loan
period. Similarly the EPC (Engineering, Procurement and Construction) Contract
may be at a low price, but the financial penalties on the EPC Contractor for failure to
build on time or to specification may not be not adequate for lenders. To overcome
multiple views of sponsors, all contractual and financial relationships in project
finance have to be contained inside a project company or the SPV “which cannot carry
out any other business which is not part of the project.
In view of the above, in most project cases a new company is incorporated specifically
to carry out the project. The corporate form of borrower (i.e., a Project Company) is
generally preferred by lenders for security and control reasons. The Project Company
is usually incorporated in the country in which the project is taking place, although it
may occasionally be possible and beneficial for tax purposes to incorporate it outside
the country concerned.

The Project Company should have no assets or liabilities except those directly related
to the project. In other words, a new company should be formed rather than reusing
an existing one that may have accrued liabilities. The Project Company also agrees
with the lenders not to take on any extraneous assets or liabilities in future.

The Project Company is often formed at a late stage in the project development
process (unless project permits have to be issued earlier or it has to sign project
contracts), because it normally has no function to perform until the project finance is
in place. The SPV is generally formed by different sources such as- Project sponsor or
Tax equity investor or Debt Provider or from any other sources which is illustrated
as under.

Project Sponsor Tax equity investor Debt Provider Other Sources

Special Purpose Vehicle

Project

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1.3.3. Procurer

This is relevant only for Public-Private-Partnership (PPP) projects. The Procurer

could be the municipality, council or department of State responsible for tendering
the project to the private sector running the tender competition, evaluating the
proposals and selecting the preferred Sponsor consortium to implement the project

1.3.4. Government

The government may contractually provide a number of undertakings to the Project

Company, Sponsors, or Lenders which may include credit support in respect of the
Procurer’s payment obligations (real or contingent) under a concession agreement.
The Government will also extend necessary permissions for issues such as pollution
etc.
1.3.5. Contractors

The substantive performance obligations of the Project Company to construct and

operate the project will usually be done through Engineering, Procurement and
Construction (EPC) and Operations and Maintenance (O&M) contracts respectively.
This will involve multiple parties.

1.3.6. Feedstock provider(s) and/or off taker

It is seen that in utility, industrial, oil & gas and petrochemical projects, generally, one
or more parties will be contractually obligated to supply/provide feedstock (raw
materials or fuel) to the project in return for payment. Similarly, one or more parties
will be contractually obligated to ‘off take’ (purchase) some or all of the product or
service produced by the project. The Feedstock/Off take contracts are typically a key
area of lender’s due diligence given their criticality to the overall economics of the
project (i.e. the input and output prices of the goods or services being provided)

1.3.7. Lenders
Lenders are usually one or more commercial banks and/or multilateral agencies
and/or export credit agencies and/or bond holders. The different stakeholders of the
project and the interlinking agreements/arrangements are diagrammatically shown
below.

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Shareholders

Lenders Grantor

Shareholders agreement

Loan agreement Concession

n Agreement

Operating Off take

Operator SPV -Project Company
Agreement Purchasee Offtake Purchaser
Agreement

Construction
Agreement Input supply agreement

Construction Contractor Input Supplier

1.4. Project financing structures

There are different models of project financing structures according to the design and
operating mechanism as per the concession agreement. They are abbreviated and
termed as - BOT, BOOT, BOO, BLT, DBFO, DBOT and DCMF. The details of each
structure are as under.

1.4.1. BOT (Build- Operate–Transfer)

The BOT model has extensive application in infrastructure projects especially in

public– private partnership. In this framework, a government or public utility
delegates a private sector entity the rights and obligations to design and building of
the infrastructure, as well as operation and maintenance of these facilities for a
certain period of time (called as the concession period). During this period, the
private party (the Project Company or operator) has the responsibility to raise the
finance for the project and build the same. It is entitled to retain all revenues
generated by the project as owner of the regarded facility. In such project, the Project
Company generally obtains its revenues through a fee charged to the utility/
government rather than tariffs charged to consumers. At the end of the concession
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agreement, the facility is transferred to the public utility without any further
remuneration to the private entity involved.

1.4.2. BOOT (Build- Own- Operate-Transfer)

A BOOT structure differs from BOT in that the private entity also owns the facility.
During the concession period the private company owns and operates the facility
with the goal to recover the costs of investment (for example toll charges in the case
of a bridge or road) and maintenance. The specific characteristics of BOOT make it
suitable for infrastructure projects like highways, roads, mass transit, and railway
transport and power generation.

1.4.3. BOO (Build-Own-Operate)

In a BOO project, ownership of the project remains with the project company
(example- a mobile phone network). Therefore, the private company gets the benefits
of any residual value of the project as well. This framework is used when the physical
life of the project coincides with the concession period. A BOO scheme involves large
amounts of finance and long payback period. An example of BOO projects is ‘water
treatment plants’.

1.4.4. BLT (Build-Lease-Transfer)

Under BLT, a private company builds a complete project and leases it to the
government. In this method, the control over the project is transferred from the
project owner to a lessee (Government). In other words, the ownership remains with
the shareholders but for operation purposes the facility is leased. After the expiry of
the lease, the ownership as well as the operational responsibility is transferred to the
government at an agreed price. For foreign investors taking into account the country
risk, BLT provides good opportunities because the project company maintains the
property rights while avoiding operational risk.

1.4.5. DBFO (Design-Build-Finance-Operate)

This project delivery method is similar to BOOT except that there is no actual
ownership transfer. Besides, the contractor assumes the risk of financing till the end
of the contract period. The owner assumes the responsibility for maintenance and
operations. Some disadvantages or risks of DBFO are the difficulty in maintaining
long term relationships and the threat of possible withdrawal of commitments due to
political changes. This model is extensively used in specific infrastructure projects
such as toll roads. The private construction company is responsible for the design and
construction of infrastructure for the government, which is the true owner. Moreover,
the private entity has the responsibility to raise finance during the construction and
the exploitation period. The cash flows serve to repay the investment and reward its
shareholders. The project company makes periodical payment to the government for

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the use of the infrastructure. The government has the advantage that it retains the
ownership of the facility and at the same time avoids direct payment from the users.
Moreover, the government avoids getting into debt and the need to spread out the
cost for the road over the years of exploitation.

1.4.6. DBOT (Design-Build-Operate-Transfer)

This funding option is common when the client has no knowledge of what the project
entails. Hence he contracts the project to a company to design, build, operate and then
transfer it. There is no risk of financing. Example of such projects is refinery
constructions.
1.4.7. DCMF (Design-Construct-Manage-Finance)
The DCMF model is used in projects for construction of prisons or public hospitals. A
private entity is built to design, construct, manage, and finance a facility, based on the
specifications of the government. Project revenue is the cash flows from the
government's payment for the rent of the facility. In the case of the hospitals, the
government has the ownership over the facility and has the price and quality control.
The same financial model could be applied on other projects such as prisons.

1. 5. Sectors for Project finance

Project finance is extended to the following sectors for the activities/process

mentioned against each.

• Finance for natural resources projects (mining, oil, and gas). It must be added that
these projects are the basis on which modern project finance techniques are
derived/ developed
• Finance for independent power projects ("IPPs") in the electricity sector primarily
for power generation
• Finance for public infrastructure (roads, transport, public buildings, water supply,
sanitation facility etc.) developed for public utilities
• Finance for worldwide growth in mobile telephone networks developed for
communication and other utility networks.

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Box 2
Why Choose Project Finance?

Why sponsors choose project finance to fund their projects? The following are some of
the reasons why project finance might be chosen .

• Project finance is invariably more expensive than raising corporate funding. Also,
it takes considerably more time to organise and involves a considerable dedication of
management time and expertise in implementing, monitoring and administering the
loan during the life of the project. Therefore, there are compelling reasons for sponsors
to choose this route for financing a particular project.

• The sponsors may want to insulate themselves from both the project debt and the
risk of any failure of the project
• A desire on the part of sponsors not to consolidate the project’s debt on to their own
balance sheets. This will, of course, depend on the particular accounting and/or
legal requirements applicable to each sponsor.
• There may be a genuine desire on the part of the sponsors to share some of the risk
in a large project with others. In the case of some smaller companies their balance
sheets are simply not strong enough to raise the necessary finance to invest in a
project on their own and the only way in which they can raise the necessary finance
is on a project financing basis
• A sponsor may be constrained in its ability to borrow the necessary funds for the
project, either through financial covenants in its corporate loan documentation or
borrowing restrictions in its statutes
• Where a sponsor is investing in a project with others on a joint venture basis, it can
be extremely difficult to agree a risk-sharing basis for investment acceptable to all
the co-sponsors. In such a case, investing through a special purpose vehicle on a
limited recourse basis can have significant attraction.

(Source: A Guide to Project Finance - dentons.com)

1.6. Project identification, formulation and implementation process

Projects are conceived, identified, selected and formulated for implementation based
on certain infrastructure need. Once the project is conceived and identified, it is
selected based on certain basic financial criteria as below.

• Payback period (PBP) – General rule is that if PBP is less than the project
period or internally set target period then the project can be accepted.
Payback period using discounted cash flows is a superior tool to evaluate a
project than the normal PBP.

• Accounting Rate of Return (ARR) – Project can be accepted if the ARR is more
than the target return.

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• Net Present Value (NPV) –NPV is arrived by discounting cash flows by a given
rate and as such if NPV is more than zero it shows that project gives a return
higher than the rate used for discounting the cash flows.

• Internal rate of Return (IRR) –IRR is that discount rate which gives a NPV
which is zero. This means the project gives a return equal to IRR. Project can
be accepted if the IRR is more than the cost of capital

• Benefit Cost Ratio (BCR) – General rule is that BCR should be more than one.
BCR is arrived by comparing the cash out flows and inflows over the entire
project period.
Various ratios to decide on the acceptability of the project for financing

Payback Period Time taken to realise the original investment

Benefit Cost Ratio: BCR Ratio of costs and benefits
Return on Investment Net Surplus as ratio of investment
Accounting rate of return Average profit divided by initial investment
FIRR: Financial Internal Rate of Discount rate at which net cash out flows and
Return inflows are equal
EIRR: Economic Internal Rate of Discount rate at which net cash flows and
Return economic benefits are equal to net cash outflow
NPV: Net Present Value Net cash flow from the project after discounting
the cash flows at specific rate say, cost of funds
Once the project is selected, suitable financing arrangements are to be made. There
are two broad sources of finance for a project namely equity and debt. The equity
(Shareholders fund) consists of paid up capital, share premium and retained earnings.
The debt consists of loan funds mostly term loans. After firming up the financing
arrangements detailed project is formulated.
Project finance cycle
Project finance involves the following steps and procedures.

• Identification of project
• Fixing eligibility criteria for private corporate for making their equity
investments
• Bidding process
• Inviting tenders
• Inviting pre-qualification bids
• Submission of bids
• Issue of detailed tender
• Finalising the bidder
• Award of contract to the successful bidder
• Expected commencement of construction phase

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• Formation of SPV- equity sponsor o Estimation/finalisation of

total project cost
• Sourcing of finance
• Project Appraisal by lenders o Preliminary project assessment
by lenders
• Due diligence by lenders
• Issue of Letter of Intent
• Resolution of due diligence issues
• Issue of Term Sheet
• Term Sheet negotiations
• Term Sheet signing
• Financing by lenders o Drafting of financing documents o
Project loaning o Financial Closure
• Implementation of project – construction/ operation phases
• Monitoring phase
• Project completion
• Debt Servicing

The above Project finance steps are sequentially indicated as under.

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Project finance is taken up after assessment of feasibility. Project finance involves credit
evaluation by lead financial organisation, selection or roping in other financial
institutions, firming up terms of finance, facilities etc.

Project Finance Framework

Credit Evaluation
Term Sheet
Negotiation

Financial
Institutions
Financially
Project Company Feasible Project Financing
Project

Project
Finalized

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Section 2
Appraisal of Infrastructure Projects

Introduction

Project appraisal is the evaluation of projects by the lending institutions in terms of its
technical, commercial, economic, managerial, environmental and social viability. Before
lending money every lending institution would like to make an objective assessment of
the various propositions of the project. If it is found satisfied that the project is
economically viable and socially acceptable, banks will lend finance to the project.
Appraisal of projects for lending is discussed in the following pages.

2.1. Technical Appraisal

This is gathering information for analysing the technical and engineering aspects of
the project and also assessing the process involved in the project for evaluating the
same to ensure the accomplishment of the project objective. The major aspects
analysed are:
• Location of the project unit. The project location should be suitable suitability for
the project environment and coverage
• Size and capacity of the plant that will be used for the process and the process
used: The size and capacity should be optimum. It should be possible to make full
utilization of capacity. Size should be neither short nor more.
• Type of technology used: The technology and techniques used in the project
should exist locally or globally. There must be alternative methods available in an
eventuality of failure
• Skills: Skills should be locally to design and implement the project. Similarly
technical support should be available for after sales service
• Adequate number of quality of labour force should be available for the project
work and suitable administration personal for execution
• It should be possible to comply with various statutory compliance like company
laws, labour laws, environment and pollution laws, waste disposal, etc.
• There should be easy availability of all inputs like raw material, power, water,
technical support etc. required for project execution
• Scope for scaling up of activities (when going for expansion whether the present
situation gives room for the same) is important.
• Work schedules should be drawn in tune to the target period
• Government Policies and support for the project should be evaluated for
compliance as also preparedness.
• Is there any User/ consumer acceptance risk for the project output should be
studied to ensure good customer acceptance.

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2.2. Commercial appraisal

This analysis is about the demand for the product/service the project is going to
produce/provide, the extent of acceptability/profitability of the project and its
sufficiency in relation to the repayment obligations pertaining to term finance. The
following information is to be collected and analysed.
• The target customers for products / service: Scope should be adequate.
• The nature of the product essentials – comforts – luxury – benefits
• The sustainability of the product for future
• The nature of selling/ collection process for tariff in cash terms
• In case of necessity the scope for diversification / modernisation of products/
services
• Any ancillary is envisaged and the marketability of the same

2.3. Economic Appraisal

It is also known as economic benefit analysis. This refers to Cost-benefit analysis which
is the main technique for public sector project appraisal. It quantifies in monetary terms,
the economic costs and benefits of particular projects or programmes to all. The basic
rationale behind cost-benefit analysis is the idea of maximising economic efficiency for
the spending of public money which has competing alternative uses. The main plank of
cost benefit analysis is the concept of opportunity cost which gives the real cost of
withdrawing resources from other uses.

Cost-benefit analysis is generally used before projects are undertaken (ex-ante) but can
also be used to evaluate the costs and benefits of particular projects after the money has
been invested (ex-post). As cost-benefit analysis values costs and benefits using a
common monetary value, it can help with the ranking of different alternatives for projects
within sectors, once the public money has been distributed to various sectors. The
methods/performance matrixes used in the economic appraisal are:

Net Present Value Method (NPV): The Net Present Value (NPV) is the sum of the
discounted cash flows over the period. This criterion is simply based on whether the sum
of discounted benefits exceeds the sum of discounted costs.

Benefit Cost Ratio (BCR): This is the ratio of discounted benefits to discounted costs. If
the benefit cost ratio is greater than one the project may be accepted as there are more
benefits than costs. However this method does not take the size of the project into
account so the results can be misleading. Generally a BCR of greater than 1:1 is an
indicator that a proposal’s benefits exceed the costs. As with the other performance
indicators, a positive BCR does not automatically mean a proposal is accepted as other
issues are relevant such as affordability constraints and qualitative factors.

Internal Rate of Return (IRR): The internal rate of return is the maximum rate of
interest that a project can afford to pay for the resources used which allows the project

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to cover the initial capital outlay and on-going costs and still break even. It can also be
described as the discount rate that equates the present value of benefits and costs. The
IRR is generally compared to a hurdle rate of return (normally the test discount rate for
public investment appraisal) which corresponds to the opportunity cost of funds.

Box: Comparison of assessment of NPV and IRR method

Assessment of NPV & IRR Method

NPV IRR
Theoretical Considerations:-
a) Does the method discount all cash Yes Yes
flows?
b) Does the method discount cash flows Yes No
at the opportunity cost of funds?
c) From a set of M.E. Projects, does the
method choose the project which
maximizes shareholder wealth? Yes No

Practical Considerations
:-
a) Is the Method Simple? Yes Yes
b) Can the method be used with limited
information? No No
c) Does the method give a relative measure? No No

2.4. Financial Appraisal

It is used to determine the accuracy of cost estimates, suitability of the envisaged pattern
of financing and general soundness of the capital structure. Financial Appraisal is a
method used to evaluate the viability of a project by assessing the value of net cash flows
that result from its implementation. It focuses on cash flows as opposed to economic
flows and in particular considers sustainability and profitability. The steps involved in
financial appraisal are-
• Identify the time horizon based on the useful economic life of the asset
• Identify the incremental cash inflows and outflows for each option
• Cash outflows include investment costs, operating costs, start-up costs,
maintenance and lifecycle costs and decommissioning costs whereas cash inflows
could include operating revenues, residual values, and dividends. The analysis
should take account of both direct and indirect flows associated with the proposal.
• Quantify the Costs - This process often requires accountants, economists,
engineers and other specialists to accurately estimate the costs. Estimates should

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be as realistic as possible and presented in constant or current prices, allowing for

sector specific price changes.
• Identify the pattern and discount the cash flows. The real discount rate for
economic appraisals is set by the Department of Public Expenditure
• Sensitivity Analysis - analysis of the most critical cost and revenue variables
• Reporting - The results of the analysis should be reported in Financial Analysis
highlighting areas that are likely to cause cash flow or financial difficulty at any
stage during the projects/programme life cycle.

The following items should not be included as part of the financial appraisal.
• Depreciation –which is an accounting transaction and not a cash flow;
• Cash Reserves
• Sunk Costs – these can be omitted from the analysis but note should be made in
the business case of quantum of sunk costs to date and
• Value Added Tax (VAT) - in the event that additional VAT revenue is generated as
a result of the scheme, this revenue can be included but only if it is additional and
net of deadweight

About NPV and project decision.

 The Net Present Value (NPV) of a project alternative relative to the without
project alternative is the sum of the discounted annual net benefits.
 The Internal Rate of Return (IRR) is the discount rate at which the NPV is zero.
 If the NPV is positive, for the chosen discount rate, then the alternative is
acceptable. In these cases IRR will be more than the chosen discount rate.
 If the NPV is negative, for the chosen discount rate, then the alternative is
unacceptable. In these cases the IRR will be lower than the chosen discount rate.
 If the NPV is zero, for the chosen discount rate, then the alternative is indifferent
to the without project alternative. In this case IRR will be equal to the chosen
discount rate
 Discount rate is the cost of capital or opportunity cost of fund or expected
threshold yield.

Types of Cash flows in a Financial Appraisal

Outflows
• Investment Costs - The initial capital outlay
• Operating Costs - On-going running costs for a project e.g. utilities, labour,
material, accommodation costs, administrative costs, including renewals costs
• Start-Up Costs - Preparatory studies, consulting, training, R&D, design, planning
• Decommissioning Cost - Costs associated with removing an asset from use

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Inflows
• Operating Revenues - Revenue from charges or tolls / dividends
• Residual Value - The value of an asset at the end of its useful life or at a point in
time, usually a once off value. The residual value of an asset should usually be the
discounted value of net future revenue after the time horizon. It can also be
considered as the value of the asset in its best alternative use e.g. scraps.
Dividends

2.5. Managerial Appraisal:

This is the assessment of the promoter company to ascertain whether competent men
are behind the project to ensure its successful implementation and efficient
management. The following points are enquired and ascertained in managerial
appraisal.
• The past experience of the borrower company ( SPV) in executing the project
• Acumen of SPV in carrying out the project
• Financial background of Sponsor – whether it is having sufficient equity capital
and the source to bring the same
• Sponsors managerial qualities like leadership, team work, negotiation skills,
endurance, marketing skills, problem solving ability, meeting untoward incidents
etc.
• What is the interest of Sponsor and stake in the project– whether seriously
interested in the project or for availing concessions given by the government –
whether putting its’ full energy
• Sponsors knowledge about the project, competitors, other products etc.
• Information about the proposed project plan and is he able to achieve the same
• What is the succession plan for the project and road map for meeting the project
targets
• What is the size and prospective growth of market for the product /service
• Demand supply position of product / service – how the market forces affect the
product’s / services- present status and future prospects
• The demand for the product/service depends on the pricing policy/ tariff adopted
for the product/service
• Marketing / delivering strategy – how the different channels of marketing is to be
used – terms of payment and concessions allowed

2.6. Ecological appraisal:

This is done particularly for projects which have significant ecological implications such
as –power plants, irrigation schemes, sewerage projects etc. The major aspects analysed
are- the likely damage caused by the project to the environment and the restoration
measures envisaged to contain the damage within the acceptable limits.

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Section 3

Project Economics

The objectives of the chapter are to discuss the assessment of project economics and to
explain the various phases in project life cycle and the risks in each phase. There is a need
for assessing the viability and sustainability of projects before committing funds in the
projects. The main objective of analysing project economics is not only to assess the
viability and sustainability of projects but also to select projects that can contribute to the
wellbeing of the society at large. Project economics involves an analysis of the financial
outcome of a project using various parameters.

3.1. Assumptions in Project finance

Project financing, unlike lending to a corporate borrower, has no business record to serve
as the basis for analysis to arrive at a lending decision. Lenders have to be confident based
on certain underlying assumptions like
(a) The project can be completed on time and on budget,
(b) The project is technically capable of operating as designed, and
(c) There will be enough net cash flow from the operation of the project to cover the debt
service adequately.

Lenders have to take a pragmatic view whether the loan dues will be repaid, after taking
into account the additional risk from the high level of debt inherent in a project finance
transaction. This means that they need to have a high degree of confidence on the project

Project economics also need to be robust enough to cover any temporary problems that
may arise. Thus the lenders need to evaluate the terms of the project's contracts insofar
as these provide a basis for its construction costs and operating cash flow and quantify
the risks inherent in the project with due care. They need to ensure that project risks are
allocated to appropriate parties other than the Project Company, or, where this is not
possible, mitigated in other ways.

3.2. Project cost estimation

The project cost is estimated based on the sum of the outlays of the following.
• Land and site development – cost of land and development cost
• Building and civil works – kind of structures required for the project
• Plant and Machinery- based on the latest available quotation- provision for cost
escalation
• Technical know-how /loyalty for technical know-how and engineering
fees/charges
• Expenses towards training the technicians involved in the project
• Miscellaneous fixed assets which are not part of project- furniture /fixtures-
expenses towards patents, licences, trademarks, security deposits made

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• Preliminary and Capital issue expenses – expenses towards market survey,

preparing the feasibility report, drafting bye-laws of the SPV etc.
• Pre-operative expenses- establishment expenses, rent, taxes, travel expenses,
insurance etc.
• Margin money for working capital- for meeting the capital cost over runs Initial
cash losses – cash loss provisions in the initial years

3.3. Means of finance

The cost of the project is met by

• Share capital –Equity
• Term loans- Commercial borrowing from Banks/Financial Institutions
• Debenture capital- through instruments for raising debts
• Incentive sources- from Government
• Miscellaneous sources- by way of unsecured loans, public deposits, leasing and
hire purchase financing

3.4. Estimation of revenue

This is based on the capacity utilisation of the project assets created and the selling
price/tariff of goods/services provided by the project after meeting the major
operation/maintaining expenses incurred in capacity utilisation of the project. The cash
flow projections of the project are arrived at and the profitability estimates are prepared
based on this.

3.5 Analysis of Financial viability of project

The financial viability is analysed to ascertain whether the proposed project will be
financially viable to meet the burden of servicing the debt and whether the project will
fetch the expected return to those who provide the capital. The cash flow, breakeven
point and the projected profitability are analysed for this purpose.

One of the important aspect is repayment. Project cash flow is not fully available for
repayment as there are a number of claimants to the project cash flows. As such the
repayment of loan happens after meeting other claims. This way of cash flow
management in project is often called Water flow arrangement

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Project cash flows how utilised- Water flow diagram

Project Revenues

Operating cost

Renewals

Taxes

Service Interest

Service Debt

Reserves

Available for Equity

3.6. Project finance sources

The project finance is extended to Public Sector as well as Private Sector.

3.6.1. Public-sector debt is provided to projects as a kind of subsidy, often on a

subordinated basis1 to that provided by the commercial financing markets. Repayment
in such cases, as with any subordinated debt, will come in second place to the senior
lenders. Alternatively public-sector grants may be provided to the Project Company these
may be without any obligation for repayment (so long as the money is in fact used for the
project), or may be repaid if the project reaches an agreed level of success (e.g., as
reflected in its cash flow). Where there is no obligation for repayment, or repayment is
highly contingent in nature, such grants may be considered by commercial lenders as
equity rather than debt.

3.6.2. Private-sector project finance debt is provided from two main sources
commercial banks and bond investors. Commercial banks provide long-term loans to
project companies; bond holders (typically long-term investors such as insurance
companies and pension funds) purchase long-term bonds (tradable debt instruments)
issued by project companies. Although the legal structures, procedures, and markets are
different, the criteria under which debt is raised in each of these markets are much the
same. Commercial banks are the largest providers of project-finance. NBFCs too play a
part in project financing such as infrastructure financing. There are NBFCs that specialize
in financing infrastructure. Certain sector specific NBFCs finance in the Government

1
Subordinated debt is a loan or security that ranks below other loans and securities with regard to claims on a
company's assets or earnings.

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Sector. The flow of bank finance to infrastructure sector has manifold around 100 times
in the past 15 years. The outstanding bank credit to the infrastructure sector, which stood
at Rs. 9500 crores in March 2001, increased to Rs.9,85,300 crores in March 2016, a
compound annual growth rate (CAGR) of 39.31 percent over the last 15 years.

3.7. Sources of debt finance

There are a variety of debt finance products which can be applied in a project financing
but the specific mix of products available to a project will depend on the sector,
jurisdiction, project size, Sponsor profile, transaction risk profile and source of capital
equipment. Because of the inherent benefits of leverage and tenor to a project’s
economics, Sponsors will invariably be drawn to the most liquid and long-term
instruments available for a given project. The principle sources of debt finance for a
Limited Recourse, Greenfield project are:

Commercial bank loans: Although traditionally structured as syndicated loans with large
initial underwrites, Sponsors look to build clubs of banks for projects following the
collapse of the syndicated loans market during the Global Financial Crisis. Commercial
funding for projects can be sourced both from international and local banks.

Export credit agencies (ECAs): ECA finance was historically more relevant for financing
projects in emerging markets due to the political risk cover obtained by commercial
lenders utilising ECA cover. This picture has changed somewhat in the wake of the Global
Financial Crisis and ECA finance is a major source of global project lending.

Multilateral agencies: Multilateral agencies are established by intergovernmental

agreements and unlike ECAs are independent of the interests of any single country
member or recipient government – they are designed to promote international and
regional economic co-operation. They can provide direct lending, political insurance to
other lenders and even equity participation. Because they are developmental in nature,
they are predominantly emerging markets focused and will seek a strong socioeconomic
developmental rationale for a project to consider support.

Additionally, bond financing has been used widely in project financing. The bond market
is an attractive option for project financing due to the availability of long tenor, fixed rate
funding and there have been notable issuances recently in the market. Moreover, bonds
present an attractive alternative source of liquidity for refinancing existing project
finance loans.

3.8. Phasing of Project life

The life of a project can be divided into three phases:

i. Development: This is the period during which i) the project is conceived, ii) the
Project Contracts are negotiated and signed , iii) the equity and the project finance
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debt are put in place and available for drawing. The end of this process is known
as "Financial Close" (or the "Effective Date").
ii. Construction: This is the period during which the project finance is drawn and
the project is built. The end of this process is known as the "commercial operation
date" (or COD).
iii. Operation: This is the period during which the project operates commercially
and produces cash flow to pay the lenders' debt interest and principal
repayments and the investors' equity return.

3.8.1. Development phase - Initial tender process for project finance

Banks commonly provide letters of intent (or letters of interest) to Sponsors initially in
the development of a project. These letters confirm the banks' basic interest in getting
involved in the project. If the letter requires the Sponsors to deal exclusively with the
banks concerned, this may amount to a Lead Managers' mandate letter. Alternatively, the
Sponsors may collect such letters from different banks. Letters of this nature provide the
Sponsors with initial reassurance that the financing market is interested in their project
and help to give the Sponsors credibility with other prospective Project Contract
counterparts, such as fuel suppliers, product purchasers, governments, and etc. Such
letters should not be regarded as any kind of commitment on the banks' part. Banks issue
these letters without undertaking the formal internal credit approval procedure in
general. This follows the tender process.

The tender process steps involved are as under.

Request for Expressions of Interest (RFEOI) – It refers to sampling of the potential

companies who are interested in principle to tender for the project

Request for Qualification (RFQ) – This is first stage tender document released to all
companies which have expressed interest to tender for the project

Request for Proposals (RFP) - This is second stage tender document released to all
companies’ documents which outline complete financial, legal and technical bid details
required to be provided by the bidders and the terms/conditions of the tender
competition

Bid submission- Each bidder is required to submit their tender documents to the
procuring authority on a specified date. It gives the details of tender prices i.e., the cost of
implementing the project, the NPV of total required revenues over the life of the
concession. Each bidder is ‘fixed’ at this stage, subject to any agreed price.

Bid evaluation- The procurer and its advisors will undertake a detailed financial,
technical and legal evaluation of each bidder’s compliance with the tender evaluation
criteria specified in the RFP which is termed as bid evaluation.

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Bidder selection, final commercial negotiations and ‘Commercial Close’ of project

agreements- Commercial Close represents the finalisation and signature of the ‘head
contract’ namely the concession contract and the supporting project documentation such
as shareholder’s agreements and sub-contracts.

Negotiation of financing documents, signature of financing agreements and

Financial Close- Financial Close has been achieved when all the conditions precedent to
the financing documentation have been satisfied and the Project Company is therefore
able to draw down debt to fund construction of the asset.

After the tender process, a thorough and full due diligence process, a detailed financing
package, credit approvals and stipulated and agreed documentation with the successful
bidders will be made by Banks to demonstrate that the financing can be provided to the
project to commence the project without delay.

3.8.2. Construction phase

This is the phase wherein the project finance is drawn and the project is built. Since the
project finance is capital intensive it may require more than one bank to underwrite the
financing. When several banks are involved as Lead Managers, they normally divide up
responsibilities for various aspects of the transaction, which enables them to use their
resources more effectively.

Typical divisions of roles among the banks are:

• Risk analysis and identifying risk mitigation measures
• Documentation, in conjunction with the banks' lawyers (perhaps with banks
subdividing between Project Contracts and the financing
documentation);normally however, unless there are more banks involved, all the
banks in the transaction want to be closely involved in this area.
• Engineering (in liaison with the Lenders' Engineer)
• Financial modelling
• Insurance (in liaison with the insurance adviser)
• Market or traffic review (in liaison with the banks' market or traffic advisers)
• Preparation of the information memorandum
• Syndication
• Loan agency

Construction phase risks and risk mitigation

Certain risks are foreseen in a project during the construction phases which are as under.
• Completion delay
• Failure of completion for ancillary infrastructure
• Cost overrun

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• Force Majeure (unforeseen circumstances that prevent someone from fulfilling a

contract)
• Sponsor credit risk
• Feedstock supply
• Sales
• Operations and maintenance
• Political (e.g. war, regulatory)
• Cash flow
• Currency and Inflation
• Interest rates

The risk mitigation measures suggested for the probable risks are given below.
Risk Risk Mitigation
Completion delay Engaging experienced, credit worthy construction contractor

In contract agreement including a clause for financial penalties payable

from the contractor to the Project Company to cover loss of revenues due
to completion delay

Failure of completion The risk that ancillary infrastructure which is required to operate the
for ancillary project is not completed on time, is usually born by the government
infrastructure under a PPP framework (e.g. utilities, feedstock supply etc.)

Cost overrun A lenders’ technical consultant will confirm the adequacy of the project
budget

Making standby debt and equity available from Lenders/Sponsors

Force Majeure Usually extension of time and relief from liability

(unforeseen
circumstances that Project Company will also seek financial protection from insurers
prevent someone from
fulfilling a contract)

Sponsor credit risk Lenders will assess the credit worthiness of Sponsors and require letters
of credit sufficient to cover Sponsor equity commitments

Feedstock supply It is generally mitigated through a robust, long term feedstock agreement
with a credit worthy counterparty

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Sales Contracted sales through an offtake agreement which clearly specifies

agreed volumes/capacity/pricing

Non-contracted sales where market risk is a factor are supported by an

independent market study and appropriate financial structuring to
ensure sufficient downside protection
Operations and Engaging experienced operator with a strong track record of operating
maintenance assets of a similar nature and size. Contract to include liquidated
damages in case of poor performance.

Long term maintenance agreements, typically with the original

equipment manufacturers

Political (e.g. war, Procurer risk in most PPP frameworks, with financial relief availed to the
regulatory) Project Company

Contractual relief agreed between JV shareholders in non PPP

transaction

Cash flow Robust project model with significant granularity at both the operational
and financing levels

Cash flows stress tested under a number of downside scenarios (e.g.

reduced demand, increased input/output pricing, macro-economic
shock)

Model audited on behalf of lenders by an independent auditor

Additional project cash flow protection through lender cash reserve

accounts

Currency & Inflation Currency risk either born by the government (if a PPP framework) or
through matching the currency of revenues and debt financing

Inflation risk can either be contractually passed on through sales or

mitigated through creating sufficient headroom in the project economics

Interest rates Interest rate risk typically largely hedged as a lender requirement

3.8.3. Operation phase

Subsequent to the risk analysis as above, suitable financial model has to be developed for
executing the project during operational phase. The development of the financial model
should ideally be a joint operation between the Sponsors and the Financial Adviser or

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Lead Manager of participating banks. Although the Sponsors should have already
developed their own model at an early stage of the project’s development to assess its
basic feasibility, it is better to have an exclusive model for the project so that all concerned
are working from the same base.

The Lead Managers prepare a package of information to facilitate this syndication

process, which is an information memorandum. This final information memorandum
("FIM) used for syndication may be based on a preliminary information memorandum
("PIM") originally prepared by the Sponsors or their Financial Adviser to present the
project to prospective Lead Managers.

The FIM provides a detailed summary of the transaction, including:

• A summary overview of the project, its general background,

• The Project Company, its ownership, organization and management
• Financial and other information of Sponsors and other major project parties,
including their experience in similar projects and the nature of their involvement
in and support for the current project
• Market situation (the commercial basis for the project) covering aspects such as
supply and demand, competition, etc.
• Technical description of the construction and operation of the project
• Summary of the Project Contracts
• Project costs and financing plan
• Risk analysis
• Financial analysis, including the Base Case financial model and sensitivity analyses

A detailed term sheet for the financing, in other words, the information memorandum
provides a synopsis of the structure of the project and the whole due-diligence process,
which speeds up the credit analysis by prospective participant banks

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Section 4

Project Contract

The objectives of this chapter are to discuss the key contracts to be signed in case of
infrastructure projects.

4.1. Project Agreement

Subsequent to due diligence process through FIM/PIM, the project contract will be
executed. The Project Contracts provide a basis for the Project Company's construction
and operation of the project. The most important of these is the Project Agreement (i.e.,
a contract that provides the framework under which the Project Company obtains its
revenues). The only types of projects that do not operate under a Project Agreement are
those that sell a product or service to private-sector buyers in a commodity-based or
open competitive market, such as mining or telecommunications projects, or “merchant"
power plants although they usually have some form of license to allow them to do this in
lieu of a Project Agreement.

There are two main models for a Project Agreement.

• An Off take Contract, under which the Project Company produces a product and
sells it to an off taker
• A Concession Agreement, under which the Project Company provides a service to
a public authority or directly to the general public

Under concession agreement, Infrastructure assets are created, maintained and operated
to provide some public goods/services to the citizen and the economy. Such
goods/services are fundamental to a reasonable life and hence it is a basic obligation for
the state to secure for the citizen. Invariably all infrastructure facilities involve some
concessions granted by State to the operator. Both award of projects, as also performance
of utilities (publicly and privately owned) are tested and evaluated in context of the
public nature of the facility.

Infrastructure projects involve significant upfront capital investments in creating;

expanding or refurbishing the asset comes at a price (cost of capital).

Infrastructure contracts predominantly are long term arrangements spanning 10-30

years. They are not amenable for writing ‘perfect’ contracts defining ex-ante the
contingencies likely to occur during the lifecycle of an infrastructure project covering all
situations and developments during its life-cycle. Hence the fact that something
unforeseen will come up during the 30 to 60 year life cycle of an infrastructure facility is
as foreseeable. 75% to 85% is debt finance (from banks who lend citizens’ savings)
available for a tenure between 8 to 15 years only (against an asset life of 30 to 60 years)
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to be repaid with interest within this period. The cost of capital has to be serviced from
the tariff / charges levied and recovered from consumers over the project life unless
offset by subsidy paid by government from tax-payer funds. Underlying the economics of
all infrastructure facilities are duly owed to the consumers of the facility and to the tax-
payers. Business principles apply to public utilities as much as they do to commercial
ventures.

Once invested in an infrastructure asset, the key attributes of private capital get
significantly regulated / controlled, being:
(i) Investment decision (how much to invest, in what asset and at what location);
(ii) Production decisions (quantity and quality);
(iii) Pricing decision and line-of-credit decisions (whom to sell and on what terms);
and
(iv) Return on investment/capital distribution decision.

Being essential facilities with invariably no substitutes, the availability of the

infrastructure facility must not be disrupted even if there are disputes during
implementation. As such, infrastructure contracts must be a robust framework for:

(i) Allocating roles, responsibilities and foreseeable risks amongst the contracting
parties at different phases of design, construction and operation of the project.
(ii) Tackle unforeseen developments which threaten to impair the sustainable
operations of the facility

All the above aspects are taken while finalising the concession agreement. There are
certain fundamental provisions of key project contract which are given in the table below.

Project Contents Objective

Contract
Shareholders Agreement between all of SPV’s To ensure that equity
agreement shareholders. It establishes funding is fully tied up
• Shareholding pattern and available to the SPV
• Shareholders’ representation in as per its financing
management requirements
• Minority protection rights if any
• Decision making process in certain To ensure smooth
functioning of SPV
reserved matters
• Proposed pattern of cash calls and
To ensure the decisions
remedies available against funding
are made with the
defaults if any from any
concurrence of all
shareholder
shareholders
• Shareholders’ exit process and
right of refusal to other
shareholders

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EPC Agreement between the SPV and EPC. It To reduce the risk of time
(Engineering, establishes and cost escalations for
Procurement the SPV
and • EPC contractors’ roles and
Contractor) responsibilities according to the To ensure selection of
Agreement specifications of the contract proper contractor for the
• Guaranteed and minimum project
performance parameters
• Responsibility of the contractor to To seek warranties from
rectify the failure if any in the the contractor in case of
course of constriction default and rectification
thereof at zero or low
cost
Project Loan Agreement between the SPV and the To ensure that conditions
agreement Project lender. It establishes under which the loan is to
be drawn
• Certain conditions precedent on
fulfilment of which the approved To ensure that the
loan is to be drawn by SPV security and credit
• Terms and conditions of loan – enhancement mechanism
quantum of loan, loan tenor, are documented and
moratorium, repayment terms, enforceable
interest rate etc.
• Security and credit enhancements To ensure that lenders
• Events of default and remedies to have additional rights in
lenders the operation and
management of the
• Sponsor covenants in full
company under
recourse/ limited recourse
conditions
financing conditions

O & M contract Agreement between the SPV and O & M To ensure certain level of
contractor. It establishes mitigation of operating
and performance risks
• Responsibility of the O & M
contractor to operate
• Maintenance obligations
• Bonus payments to the O & M
contractor for exceeding
predetermined performance
parameters and penalties for
under achievement.

4.2. Loan documentation and security

Projects are commonly funded using multi-sourced debt financing structures. A number
of individual facility agreements will therefore be included under a Common Terms

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Agreement, acting as a common inter-creditor agreement for all lenders. This common
agreement outlines the common terms therein. A core element of this will be the
exhaustive list of events of default and would typically include safety clauses such as
penalty for failure and breaches of contractual terms and warranties made by the Project
Company.

The security provided for under the financing documentation is a key issue as Lenders’
only collateral is the project’s assets (both tangible and intangible). Taking security
allows the Lenders to take control of the project if necessary. A typical security package
will therefore have a suite of Direct Agreements which allow Lenders to ‘step-in’ to the
project agreements. Without these, security over the project’s assets themselves is of
little value.

Additional forms of security may include pledge of the Project Company shares, mortgage
over the project site and its assets and a charge over the Project Company’s bank accounts
and project insurance.

Project Financing Documentation is broadly as under.

• Lending documents - Loan Agreements with Banks/Export Credit

Agencies/Multilaterals

• Project/ Special Purpose Vehicle shareholder/ Sponsor documents---

Predevelopment Agreements/ Shareholders’ Agreement/ Sponsor Support
Agreement

• Security documents - Documents covering all project assets

• Project documents --Construction Agreement, Operation and Maintenance

Agreement, Fuel Supply Agreement, Sales/Off take Agreement

4.3. Project Review and evaluation

Project review and evaluation is undertaken periodically to have a control on the

progress of the project. Network techniques like PERT 2 (Programme Evaluation Review
Technique) and CPM (Critical Path Method) are helpful in project review. Project
reporting becomes easy with these techniques. These reports are helpful to the project
implementing Company to take corrective actions at appropriate time to ensure the
successful completion of the project. The project performance evaluation is done in terms
of Economic Rate of Return (ERR) or Book Return on Investment (Book RoI).

2
PERT (Programme Evaluation Review Technique) and CPM (Critical Path Method) are project management
techniques, which have been created out of the need of Western industrial and military establishments to plan,
schedule and control complex projects.
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The ERR for a given year is arrived as under.

ERR = Cash flow + Change in present value / Present value at the beginning of the year

The Book RoI is normally used for evaluating existing businesses and projects on a
continuing basis. It is arrived as given below.

Book RoI= Cash flow + Change in book value / Book value at the beginning of the year

Select Glossary of Terms related to Project finance

BOT Project - A project structure involving a concession granted by a government (or

government entity) under which a facility or project is built, owned and operated by the
project company and transferred back to the government at the end of the concession
period

Concession Agreement -An agreement (called as licence or lease) under which the
grantor confers on the project company the right for an agreed period to develop,
construct and operate for a profit a facility or project.

Financial Close -The date when all documentary and other conditions precedent to first
drawing under a project loan agreement are satisfied or waived

Joint Venture -An arrangement between two or more persons set up for the purposes of
undertaking jointly a commercial venture and being an arrangement which is not a
partnership

Limited/Non-Recourse - Expressions used to define the extent of rights of recourse and

remedies that a lender will have against a project company or sponsor usually only
against a particular project’s assets.

Multilateral Agencies -Agencies jointly set up or established by a group of countries for

the purposes of promoting international or regional trade and economic cooperation, e.g.
the World Bank, IFC, Asian Development Bank

Performance Bond -A bond (guarantee) given by one person (usually a bank or

insurance company) to secure (by means of payment not performance) all or an agreed
part of another person’s obligations under a contract, e.g. contractor’s obligations under
a construction contract

Present Value -The current value of a future stream of cash flows. This is achieved by
applying a discount factor to those future cash flows.

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Course: Credit Management (Module II: Credit Operations) NIBM, Pune

Private Finance Initiative or PFI or PPP -An initiative of the Government under which
the provision of certain public services, together with many of the associated risks of
providing those services, as well as the funding requirements risks are transferred to the
private sector

Special Purpose Vehicle -A vehicle (usually a limited company or a limited partnership)

established solely for the purposes of a particular facility or project.

Sponsor -A person who is involved in originating and structuring a project and who will
be a shareholder or owner of all or a part of the facility or project

Turnkey Construction Contract- A construction contract under which the contractor

assumes responsibility for the design, procurement, construction and commissioning of
a facility or project.

References

• Public Private Partnership projects in India- Compendium of case studies – By

Ministry of Economic affairs
• Projects– Planning, analysis, selection, financing, implementation and review- By
Prasanna Chandra
• A Guide to Project Finance- By dentons.com
• Country case study- India- By PPIAF-
• Principles of project finance- By E. R. Yescombe
• Financing Infrastructure – By IDFC
• RBI Master circular - Prudential norms of RBI for infrastructure projects
• Project Finance in India- By Rashi Anand Suri, SNG Partners, India Project Finance
–By David Gardne

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