PROJECT FINANCING PRESENT INSTRUMENTS AND APPLICATIONS
By Fred L H Farha, London September 1992
FINANCING PROJECTS: Traditionally the banking industry consider financing projects essentially a decision on its part to lend capital (loans) on other considerations than the quality of the project and its collateral value and further its proven ability to generate cash streams sufficient to meeting the required repayments of loans. The quality of the credit of the sponsor/ borrowers, personal and other relations, in almost all cases was the key to banks’ decision to lend or not to lend.
PROJECT FINANCING: On the other hand is concerned primarily with the quality of the project and its proven ability to generate sufficient and sustained cash-streams to meet operating costs and loan repayments. The experience and management quality of the project is the other key factor that determines the decision to lend or not to lend.
FUNDAMENTAL CHANGES IN WORLD CAPITAL MARKET- It is important to mention that world finance and capital markets have undergone tremendous changes in the past 20 years. A variety of new financial instruments and products of new-sophisticated structure have to a large extent displaced traditional banking. Banks in all the major lending countries, because they are required to put aside capital equal to 8% of their total assets and to maintain ratios and stronger balance sheets, resorted more to the use of – structured financing models – and other financial engineering techniques to meet their requirements to make capital available.
SHARING SAME RISK FACTORS – The two most popular current methods of project financing requiring innovative techniques involving ‘structured components’ are: Lease Financing and Built Operate Transfer “BOT” financing models. The original sources of those two models, intended to provide amongst other reasons a reference to understanding the required constitution of project economics and the nature of common risks associated with all project finance transactions and are, regardless of the finance method or model being considered, of special concern to lenders and investors.
BANKS AS A SOLE CAPITAL / LENDERS PROVIDERS: A broad look at the function of world capital markets would indicate that it is, to a large extent, driven by commercial banks and investment banking houses. It can be said that together they are the “market makers” and appear to be the sole capital/lenders providers. It is the contention that banks are the sole capital lenders providers that we at Fundmore take issue with. While it is difficult to identify the owners and sources of the world wholesale capital markets and its real size, it is nevertheless clear that the greater majority of all capital funds lie outside the direct control of both banking entities; albeit that banks at the present are the main market investment conduit for placement of capital funds and various types of securities in project equity/debt finance transactions.
DIRECT ACCESS TO WORLD CAPITAL MARKETS: To appreciate the finance and investment opportunities available by way of ‘direct access’ to world capital markets, is essential to differentiate between the capital markets functions and business interests of banks from that of the capital markets’ function and consistent efforts to reach for higher portfolio yield and growth. There is no better proof of this then the phenomenal and recent popularity gained by the various fund management companies with investors. It is by far the clearest manifestation of the capital markets readiness to forgo traditional banks as the ‘only conduit’ in pursuit of higher yields grade investments and capital growth opportunities.
NONE-BANKS BROKERS: Rising equity or debit financing on world capital markets can be achieved without the direct involvement of commercial or investment banks acting as sole underwriters or managers of a placement issue. A large number of various sizes brokerage firms, not owned by banks or linked to them, are capable to underwrite/ raise/ place and arrange equity and debit financing in both the private and the public capital markets. Experience would indicate that such brokerage firms
are less prone to utilize other than the required prescribed financing and investment criteria consideration applicable to a given project finance or capital lending.
LEASE FINANCING: The large majority of world leasing companies are either owned by banks or substantially connected to a bank. Like banks they must observe the same rules governing capital adequacy requirements. For example, they regard equipment leases as loans for the purpose of calculating their risk/asset ratio. To a large degree their decision must take into consideration: (a) the effect a financing transaction and method of financing will remove a lease transaction from the calculation of the leasing company risk/asset ratio and (b) the balance-sheet treatment of a none-recourse loan secured on lease receivables. Further the availability of transferable taxes, depreciation allowances and other incentives are crucial to the financieability of lease transactions and to the business strategy and growth of leasing companies.
BUILD-OPERATE-TRANSFER – BOT- BOO – BOOT FINANCE MODELS: In its classic form, BOT financing is a limited recourse form of financing of mainly infrastructure projects having no ability to generate hard currency. The project products are consumed locally. Lending is arranged against a project anticipated cash flow streams and limited amounts of guarantees from a project sponsors/owners. The borrower is a resident “joint venture” entity of the host country. The forward sale of the project of products to the host government will predetermine the project cash-flow stream in local currency, according to an agreed business formula with a host government entity. Payment for the project products by a government entity will translate its terms into a complex tariff formulas and conditions taking place in country. Payment terms are subject to a project operating according to an agreed business formula and predetermined efficiencies needed to achieve adequate cash-flows to meet the project operating cost, service debt borrowing and provide a reasonable return to the equity shareholders.
Political stability, fiscal and monetary polices of host government remains to have and on-going impact on the BOT transactions for the duration of the agreement.
AN OVERVIEW OF FUNDMORE FINANCIAL ENGINEERING SERVICES
Financial Engineering is a complex process of bringing together in a timely and orderly fashion, a number of financial disciplines, expertise and sophisticated analytical techniques to achieve an investment grade level or the equivalent of a bankable credit. Financial Engineers/ Architects are mainly concerned in preparing the credit enhancement instruments needed to allow shifting the (wrong) liability characteristics (also known as risks) of the subject project/finance situation to a number of other (right) characteristics (mitigated risks) that are compliant or closer to the acceptable criteria of lenders and investors.
World finance and capital markets have undergone tremendous changes in the past 20 years. A large variety of new financial instruments and products of new-sophisticated structures have to a large extent displaced traditional commercial banking. The introduction of new capital adequacy requirements on banks imposed great restraints and restrictions on capital available for lending. Consequently lenders and investors (mainly banks and associated leasing companies) resorted to the use of large varieties of financial engineering structures to meet the capital requirements of the world business community.
Asset-backed financing (which we pioneered 1969/70 see below) and or the theory of securitisation is relatively a new concept outside the US. It is now a major global financial tool being used to achieve a wide variety of financing goals for the purpose of creating new financial instruments and products. The Financial Times of London in its major (Survey Of Asset Backed Finance) June 19,1991 stated that “ in asset securitisation a bank or corporation removes assets from its balance sheet and replaces as bonds which are sold to investors. The range of assets which can be securitised has grown from mortgages, credit card debit, and car loans, to include increasingly diverse assets, such as trade receivables, leases and problem loans”
Fundmore Merchant Bank and its parent Fundmore International Capital Corporation – FICC, and CENCOR International S.A. are early pioneers of the ‘theory of asset securitisation‘as it may apply to resolving difficult to finance projects, especially in the emerging market countries.
The main premise of this dynamic theory is that any project, regardless of location, can be made financeable if:
- In a given project quality assets exists, and
- (b) Assurance can establish that adequate cash-flow stream can be generated from the efficient economic use of the asset (s) based on proper and efficient management of the assets.
Prepared and authorized for release by:
Fred L Farha – Founder President & CEO
London England September 1992.
