PROJECT

FINANCING
• CS Abhishek V. Vidwans
• (Practicing Company Secretary, LLB Gold Medalist,
M.Com.)
 Course Overview
• Introduction to Project and Infrastructure Finance:
In this chapter we will study concept of project finance.
• Project Finance and PPP Markets:
In this we will study economics of public private partnerships (PPP) and learn
the fact that how project finance as a technique finds its maximum use in
funding large-scale infrastructure assets. We will also study in detail the sources
of finance available to fund infrastructure, both equity and debt.
 Course Overview
• Structuring the Project:
Here we will look at the framework for structuring a contractual bundle around
the project to ensure optimum risk sharing and mitigation.
• Valuing the Project and Project Cash Flows:
Here we will focus on studying creation of cash flow models. We will also study
techniques for valuing projects using free cash flow and capital cash flow
techniques. It lays down the framework for an initial assessment of project
viability and feasibility.
 Course Overview
• Due Diligence and Project Appraisal:
Here we will learn how to carry out due diligence and learn practical tips that will help
to understand several studies and reviews that are always a part of project
documentation. We will also discuss critical issues to keep in mind while preparing an
appraisal note. We will also discuss in detail project appraisal done by banks and
financial institutions and explains critical success factors.
• Managing Project Risks:
Here we will look at the generic strategies to mitigate risks in project finance and
discuss on interest rate risks, foreign currency risk, and use of derivatives and swaps to
hedge these risks.
 Course Overview
• Loan Syndication:
In this we will look at the syndicated loans to have a 360° understanding from the
point of view of bankers, corporate finance executives, and investment professionals.
• Credit Risk Management in Project Finance:
In this we will learn credit risk management, the key underlying concepts and the role
that bank capital plays to absorb risks. We will also have a look at Concepts of risk
based pricing of loans.
• Monitoring and Follow up of Project Loans:
We will focus on the key aspect of project monitoring, project implementation, and
reasons for delay.
 Course Objectives
• Provide an overview of features of infrastructure sector and overview of
financing trends in infrastructure
• Introduction to Project Finance
• Overview of Financial Analysis
• Characteristics of Project Finance markets
• Risk management in infrastructure projects
• Illustrations of projects financed in different infrastructure sectors
 What do we mean by Infrastructure?
• Provision of infrastructure services has an important bearing on economic
growth.
• Infrastructure plays an important role in our day to day lives.
• A definition of infrastructure can be, "The physical components of
interrelated systems providing commodities and services essential to enable,
sustain, or enhance societal living conditions.
• E.g. A bridge or a Highway.
 Ministry of Statistics and Programme
Implementation
• As per the ministry, the composition of infrastructure constitute the
following:
❖ Construction of real estate or industrial parks etc.
❖ Electricity generation, transmission and distribution
❖ Gas generation and distribution through pipes
❖ Water works and supply
❖ Non-conventional energy generation and distribution
❖ Railway tracks, signaling system and stations
 Ministry of Statistics and Programme
Implementation
❖ Roads and bridges, runways and other airport facilities
❖ Telephone lines and telecommunications network
❖ Pipelines for water, crude oil etc.
❖ Waterways
❖ Port facilities
❖ Canal networks for irrigation
❖ Sanitation and sewerage
 Economic Survey Definition of Infrastructure

• Railways: Revenue- earning from goods traffic and passenger;

• Ports: Cargo handled at major ports (Rent and demurrage charges)
• Civil Aviation: Cargo and Passengers handled at Airports Authority of India
(AAI) at airports (Rent from airline companies and user fees from
passengers);
• Roads: Length of roads and length of National Highways;
• Telecommunications: New telephone connections approved (direct exchange
lines)
 Economic Survey Definition of Infrastructure

• Power: Electricity Generation;

• Coal Production
• Petroleum Production: crude oil and refinery; and
• Cement Production
 Why is “Infrastructure Finance” important?

• Largely funded by Government in the middle of 19th century

• Increasing economic growth led to increasing demands for creation of infrastructure
capacities
• Need of Higher Economic Growth requires Higher Infrastructure Investments
• Government was not in a position to meet the demand post independence
• Private sector is being involved in the creation of infrastructure
• Getting private sector finance brings its own complexities (Adequate returns to private
sector)
• Studying infrastructure finance will help you in understanding the context of infrastructure
sector and how to attract private sector
 Types of “Infrastructure”
• Physical infrastructure
❑ Airports, roads, electricity, etc.
• Social infrastructure
❑ Schools, hospitals, etc.
• Institutional infrastructure
❑ Banking system, tax collection mechanism (IT/ MCA/ GeM Portal, MyGov) legal systems,
etc.
• Industrial Infrastructure
❑ Industrial Parks, SEZ’s, STP’s etc.
 Public Goods Characteristics dominate
infrastructure projects
• Characteristics of Public Goods:
Non-Excludability (Difficult to exclude somebody from consuming services e.g. Radio
Transmission, National Defense is for entire population)
Externalities (Indirectly effected parties who are not actually using services) e.g. Hotel,
Retailers, Cab services outside Airports, people living nearby airport etc.
Positive Externalities (Industrial and Tourism Development, Increase in real Estate values)
Negative Externalities (Noise pollution)
E.g. Lighthouse (Cost is same in case of provision service to one or many)
Non-rivalry (up to congestion limits) in consumption
 Features of Infrastructure Projects
• Natural Monopoly (e.g. Railways, Airports, Roads etc.)
• High-sunk costs (Substantial investments at start and cannot be used for any other
projects)
• Non-tradability of output e.g. Surplus power transmission without adequate
infrastructure
• Possibility of price exclusion (Increase demand by pricing adequately)
• Bestowing externalities (Good or Bad) on society
 Physical Characteristics of Infrastructure
Projects
• High Initial Costs (As compared with other projects other than infrastructure)
• Functioning as a network (e.g. Value of a single phone is 0 without receiver, Power Sector)
• Investments are lumpy (Incremental investments are not possible as increase in demand
like other sectors) e.g. A Flyover of four lanes, Economies of Scale as per future demand
• Asset specificity (No or less Alternative use)
• Limited Life (Additional investments for longer functioning)
• Inability to use stage commitment (Financing as per stage not possible)
 Infrastructure Access and Availability
• Access to infrastructure is needed and should be available for all sections of society
• Compulsory service obligation (Valid consumer cannot be refused from using the
service)
• Regulation is adopted to facilitate private participation in natural monopoly
industries
• Using markets in infrastructure provision: (e.g. Telecommunication)
• Competition 'in' the market and 'for' the market
• “For Market” means Competition at the bidding stage and “In Market” means
Competition at the Operation stage
 Summary
• Over the years, it has been recognized that provision and availability of
infrastructure plays an important role in economic growth
• The characteristics of infrastructure sector make it very different from other sectors
• With emerging countries experiencing higher rates of economic growth, the
challenges is to sustain these growth rates in the future
• Ensuring infrastructure access for all sections of the society will play an important
role in sustaining the growth
 Choose the odd one out
• Electricity Generation
• Telecommunication
• Civil Aviation
 Choose the odd one out
• National Thermal Power Corporation
• National Hydro Power Corporation
• Gas Authority of India Limited
• Adani Power
 Thought Questions
• Suppose the government is planning to build Express Highway for Pune to
Bengaluru what could be the externalities (Positive and Negative) associated with
this project?

• Suppose the government is planning to set up a Thermal Power Plant in Konkan

Coastal area what could be the externalities (Positive and Negative) associated with
this project?
 Basic Elements of Project Financing
Lenders

Loan Debt Service

Funds Repayment

Supplies Output

Suppliers Assets comprising the project Purchasers

Supply
Contracts Purchase
Equity Funds/ Agreements
Other forms of Returns
credit support
Equity Investors/
Sponsors
 Different Types of Sources of Finance
• Equity:
✔ Internal: Promoter Investment/ Sponsor Equity
✔ External: Individual/ Companies Investment/ IPO/ Angel Investors/ PE/ VC
• Debt:
✔ Long Term & Short Term
✔ Bank Financing or Inter-Corporate Deposits
✔ Debentures
 Need for Finance
• Finance is life blood of any business organization
• Organizations require finance to meet basic objectives
• To set up, modernize, expand business activity i e to acquire fixed assets for
facilitating productive endeavor
• To meet the day to day working capital requirements i.e. operating cycle
• To meet the former, long term finance is required and the latter, short term finance
due to their inherent difference in life of assets
• A portion of current assets is to be met through long term sources for having long
term stability, liquidity etc. in the event of exigencies
 What is Project Finance?
• Project finance is a long term financing of any business venture including
infrastructure and industrial projects based upon the projected cash flows
of the project rather than appraising the financial statements of its stake
holders/ sponsors
• Project Finance is a process of evaluating and selecting long term
investments that are consistent with the goal of shareholder’s (owners)
wealth maximization
 What is Project Finance?
• According to Nevitt and Fabozzi (2000), project finance is the financing of a
particular economic unit in which a lender is satisfied to look initially to the cash
flow and earnings of that economic unit as the source of funds from which a loan
will be repaid and to the assets of the economic unit as collateral for the loan’.
• As per Standard & Poor’s Risk Solutions (2002), ‘A project company is a group of
agreements and contracts between lenders, project sponsors, and other interested
parties that creates a form of business organization that will issue a finite (limited)
amount of debt on inception; will operate in a focused line of business; and, will
ask that lenders look only to a specific asset to generate cash flow as the sole source
of principal and interest payments and collateral’.
 Basic Characteristics of the Project Financing
Method
• Project finance leads to creating a separate entity popularly known as special
purpose entity (SPE) or special purpose vehicle (SPV). The SPV has a defined
objective and definite life.
• It shows an equity holding pattern, which may involve three or four equity
sponsors.
• It consists of a non-recourse debt, which implies that the debt component provided
by lenders is of nonrecourse nature and the lenders have no claim on the equity
sponsors for the repayment of debt service, but fully rely on the project cash flows
for the debt service.
• It has a high leverage and complex contractual structure (creating a win–win
situation for all project parties).
 Project Financing
• In simple terms, for a lender, Project Financing means:
✔ the process of appraising the commercial/ economic viability of the project;
✔ identifying risks and mitigation of the same;
✔ tying up of funds through equity and long-term loans for implementing the
project; and
✔ monitoring the implementation, operation, and debt servicing of the project.
 Project Financing
• Credit appraisal is based where the source of repayment is the projected
revenue/cash flows from operations of the facility rather than general
assets or the balance sheet of the sponsor.
• Reliance is placed on the assets of the project facility, including
revenue-producing contracts and other cash flows generated by the facility as
collateral for the debt e.g. Express Highway, Airport.
• Debt terms including interest rate are not based on the sponsor’s balance
sheet, or value of physical assets but depends on the expected cash flows
from the project and looks whether the cash flows can support the
debt-service burden.
Some of the Important Financing Institutions in
India
• Housing Development Finance Corporation (HDFC) for Housing and Township Projects.
• Various state financial corporations e.g. Maharashtra State Financial Corporation (MSFC)
• Various state industrial development corporations
• Small Industries Development Bank of India (SIDBI) for SME sector
• Indian Renewable Energy Development Limited (IREDA) for non thermal energy projects
• National Bank for Agriculture and Rural Development (NABARD) for rural agriculture
projects
• Power Finance Corporation for power related projects
 Project
• A project can be defined as ‘A scheme of things to be done during a
specified period in future for deriving expected benefits under certain
assumed conditions’
• A project may be in the nature of setting up a new industrial unit,
infrastructure, its modernization, expansion, diversification and promotion of
R&D
 Project
• Because of complexity and uniqueness involved, a capital project needs to be
launched by
✔ Analyzing past environment
✔ Studying existing environment
✔ Forecasting future environment
 Project
• A project financing structure involves a number of equity investors, known
as sponsors, as well as a syndicate of banks that provide loans to the
operation
• The purpose of term assistance is to meet a part of the capital expenditure of
a project
• Where promoters of a project are unable to meet the entire capital
expenditure out of their own resources, Term Loans are sanctioned to
supplement the promoters’ contribution
 BIS
• BIS stands for Bank for International Settlements is an international financial
institution which is owned by member central banks. It is based in Basel
Switzerland with representative offices in Hong Kong and Mexico City.
• Its primary goal is to foster international monetary and financial
cooperation while serving as a bank for central banks.
• There mission is to support central banks' pursuit of monetary and financial
stability through international cooperation, and to act as a bank for central
banks.
 BIS
• It is a forum for a dialogue and broad international cooperation where
they can freely exchange information, forge a common understanding
and decide on common actions.
• The BIS members are central banks of 63 jurisdictions: 34 in Europe, 16 in
Asia, 5 in South America, 3 in North America, 3 in Africa, and 2 in Oceania.
• Some of the examples can be Central Bank of Brazil, Central Bank of
Argentina, Reserve Bank of Australia, Central Bank of Iceland, Reserve Bank
of India and many more.
 BIS Services
• They also promotes international cooperation in the area of financial
stability through its Financial Stability Institute, which supports central
banks and other financial authorities in the implementation of global
regulatory standards and sound supervisory practices.
• Provides a platform for responsible innovation, and the Cyber Resilience
Coordination Centre enables central banks to protect themselves from the
associated risks.
• Supports central bank cooperation and provide an independent voice to
sound policymaking.
 BIS Services
• Producing in-depth research and statistical analysis which is made freely
available to the public is also one of the function.
• Acting as a Bank and offer financial services exclusively to central banks,
monetary authorities and international organizations, mainly to assist them in
the management of their foreign exchange assets.
• Offer sound and competitive financial services to central banks around
the globe and around the clock.
 Specialized Lending (Basel II Guidelines)
• Project finance is called as specialized lending (SL)
• It is different from Corporate finance or other types of finances
• There are four separate sub-classes of SL which are as follows:
❖ Project Finance:
This involves financing for large, complex, and expensive installations (e.g., power
plants, mines, transportation, and infrastructure).
❖ Object Finance:
This includes methods of funding for the acquisition of physical assets (e.g., ships,
aircrafts and satellites).
 Specialized Lending
❖ Commodities Finance:
This is structured short-term lending to financial reserves, inventories, or
receivables of exchange-traded commodities (e.g., crude oil, metal, or crops),
where the exposure is repaid from the proceeds of the sale of the commodity
and the borrower has no independent capacity to repay
❖ Income-producing real estate:
This involves financing real-estate projects.
 Characteristics of Capital Expenditure
Decisions
• Growth of the Firm is linked to allocation of resources
• Allocation is done in anticipation of future benefits
• Resource Allocation should turn in “Good” investment decision rather than “Bad”
to maximize firm’s value
• Capital expenditure decisions are considered as strategic business decision due to its
long term impact
• Capital expenditure decision determine the future destiny of the firm
• Have impact not only on the Firm but also on the Communities and Nation, where
project is established and operated
 Recent Trends and Developments
✔ Public Private Participation (PPP) Model for Infrastructure Financing
✔ Special Purpose Vehicle (SPV) based Project Structure
✔ Transition from Asset-based Lending to Cash Flow Based Lending Models
✔ Project Finance has moved from mere ‘viability’ to ‘bankability’ of projects.
Stiff Term Sheets with new age financial covenants on cash sweeps, TRA etc.
✔ Contractual Structures with new features such as Concessions, Competitive
Bidding, Negative Grants, Viability Gap Financing etc.
 Importance of Project Finance Decision
✔ Irreversible in nature
✔ Impact long term profitability of the business
✔ Impact on competitive position of the business
✔ Impact on risk perception about the company
 Process of Project Finance
• Planning:
✔ basic analysis to determine whether a project is worthwhile to justify a
feasibility study.
• Analysis:
✔ economical, commercial, technical, ecological, marketing analysis.
• Selection:
✔ final selection on he basis of findings in the analysis. Analysis of results of
NPV, IRR, Payback period, sensitivity analysis, etc.
 Process of Project Finance
• Financing:
✔ Debt or Equity
• Implementation:
✔ Project & Engineering Designs
✔ Approvals & Permissions
✔ Negotiations & Contracting
✔ Construction
✔ Training
• Plant Commissioning
• Review: Periodic review once the project has commissioned
 What is Special Purpose Vehicle?
• During Project Financing, a Special Purpose Vehicle (SPV) is appointed to
ensure that the project financials are managed properly to avoid
non-performance of assets due to project failure.
• Since this entity is established especially for the project, the only asset it has
is the project. The appointment of SPV guarantees the lenders of the
sponsors' commitment by ensuring that the project is financially stable.
 Various stages of Project Finance
• Pre-Financing Stage
Identification of the Project Plan:
This process includes identifying the strategic plan of the project and analyzing
whether its possible or not. In order to ensure that the project plan is in line
with the goals of the financial services company, it is crucial for the lender to
perform this step.
 Various stages of Project Finance
• Pre-Financing Stage
Recognizing and Minimizing Risk:
Risk management is one of the key steps that should be focused on before the
project financing venture begins.
Before investing, the lender has every right to check if the project has enough
available resources to avoid any future risks.
 Various stages of Project Finance
• Pre-Financing Stage
Checking Project Feasibility:
Before a lender decides to invest on a project, it is important to check if the
concerned project is financially and technically feasible by analyzing all the
associated factors.
 Various stages of Project Finance
• Financing Stage
Arrangement of Finances:
In order to take care of the finances related to the project, the sponsor needs to
acquire equity or loan from a financial services organization whose goals are
aligned to that of the project

Loan or Equity Negotiation:

During this step, the borrower and lender negotiate the loan amount and come
to a unanimous decision regarding the same.
 Various stages of Project Finance
• Financing Stage
Documentation and Verification:
In this step, the terms of the loan are mutually decided and documented
keeping the policies of the project in mind.
Payment:
Once the loan documentation is done, the borrower receives the funds as
agreed previously to carry out the operations of the project.
 Various stages of Project Finance
• Post Financing Stage
Timely Project Monitoring:
As the project commences, it is the job of the project manager to monitor the project
at regular intervals.
Project Closure:
This step signifies the end of the project.
Loan Repayment:
After the project has ended, it is imperative to keep track of the cash flow from its
operations as these funds will be, then, utilized to repay the loan taken to finance the
project.
 Motivation of Project Finance
• Advantages:
✔ Risk Sharing Motivation
✔ Reduced under investment problems
✔ Reduced costly agency conflicts
✔ Structured risk mitigation
✔ Reduced overall cost of financing
 Disadvantages of using Project Finance
• Disadvantages:
✔ Huge third party costs
✔ Time consuming process
✔ Stringent covenants
THANK YOU
 PROJECT
FINANCING
• CS Abhishek V. Vidwans
• (Practicing Company Secretary, LLB Gold Medalist,
M.Com.)
 Capital Expenditure Decisions
• Growth depends on Resource Allocation
• Capital expenditure or resource allocation should result in good investment
• Definition of Capital Expenditures narrow in Accounting practice
• Decisions are known as Strategic decisions rather than tactical decisions
• Decision itself is risk and involve significant changes in company’s expected
profits
• The project always has a risk profile
 Capital Expenditure Decisions
• these decisions decides future destiny of the firm
• have impact on decision makers as well as communities and nations where
they are established and operated
• have potential to improve social and economic conditions but at the same
time can also cause disasters for the nations
• considered as an act of “commitment” and classified as bet-the-company
• Irreversible nature of capital investments
 Capital Expenditure Decisions
• Main objective is to invest current resources in view of anticipated future benefits
• Project finance is used for industries and infrastructural projects such as toll roads,
power plants, mines, pipelines, oil fields and telecommunications
• It is riskier for a single firm to finance
• Riskier as it depends on political will, involves complex contractual relationships
among various parties
• project requires expert legal and financial assistance
 Traditional on Balance Sheet/ Corporate
Financing
• Financing is done on whole balance sheet of the company
• Lender looks at cash flows and assets of the whole company rather than only
at project
• Loan account is opened in favor of the corporate and not on particular
project
• In case of default lender have full claim on the total assets of the parent
company including new project assets
 Traditional on Balance Sheet/ Corporate
Financing
• Lenders have full recourse on parent company for the repayment of the debt
• Financial credibility and standing of the parent company plays major role
• Poses additional financial risk to shareholders
• Lenders look to the corporate’s entire existing asset portfolio to generate
cash flows to get repayment of loan
Difference between Corporate Finance &
Project Finance
Corporate Finance
Corporate Financing and Project Financing
• In Project Financing, project is considered as distinct legal entity
• It may be a good idea to arrange finance on basis of project assets in case of
large capital intensive and risky assets
• Finance should match the assets that is funded and expected cash flows e.g.
Kingfisher Case
• In case of failure of project, win-win situation for both that is existing
shareholders and debt providers
 Corporate Financing and Project Financing
• Infrastructure assets are essentially ‘utilities’ and can work as ‘monopolies’
• cash flow is guaranteed to a large extent, as there will be a definite demand
and offtake of the infrastructure services, and the technological risk is low.
• Advantages of Debt funding:
✔ A tax shield on the interest
✔ Increased discipline of debt
✔ Lower cost of capital
Corporate Financing and Project Financing
• Cash flows are generally guaranteed e.g. Toll on roads/ highways etc.
• Many infrastructure companies funded by debt
• Low probability of distress ideally reduces cost of capital
• In FMCG product offtake is not a utility, therefore cash flows depend on so
many factors, hence company should have debt finance kind of funding
• Project financing structure allows optimum risk sharing, allocation and
mitigation
Corporate Financing and Project Financing
• Lenders take control of project assets and cash flows through trust and
retention escrow accounts
• Knowledge of risk and structures of project finance to handle risk are
paramount in achieving best deal for the company and lenders
• Requires careful financial engineering to allocate the risks and rewards among
the parties
Why should banks use Project Finance to fund infrastructure
assets, as too much of debt may increase default risk?

• Looking at the present magnitude and growth clearly indicate very strong and
positive future prospects of project finance

• Higher probability of providing the expected and targeted results in financial

and operational scenarios
 Plus and Minus of Project Finance:
Plus Side

• attract large debt with minimum risk;

• set up and run several projects simultaneously;
• limit or eliminate the recourse nature of the financing;
• attract debt financing and credit enhancement that is available to the project
itself, but unavailable to the project sponsor as a direct loan;
• In giant projects, project financing might be the only alternative. This applies
especially for projects in the extractive and energy industries;
 Plus Side

• obtain a higher degree of involvement from third parties;

• increase involvement of guarantors;
• isolate the project's assets and liabilities, which enhances accounting legibility;
• advance quasi-equity (Mezzanine Debt);
• make the project entity the main supplier of securities;
 Plus Side

• lenders lend more money and at lower interest rates;

• legal limitations and regulations to the sponsor may be circumambulated by
allocating undertakings to project entities;
• investments in international projects may be protected by forming
joint-ventures with international partners, thus lessening the sovereign risk;
• more favorable working contracts may be formed by separating the operation
from other activities of the sponsor;
 Plus Side

• Risk sharing motivation;

• Reduced costly agency conflicts;
• Reduced overall cost of Financing;
• Structured risk mitigation;
• Reduced Underinvestment Problem.
 Minus Side

• Time consuming process: They require complex documentation. Project

financings involve many participants with diverse interests. The tension
between lender and sponsor about degree of recourse, between contractor
and sponsor about nature of guarantees etc. often result in extensive and
time-consuming negotiations, that can be quite costly;
• projects are new enterprises and lack history and reputation;
• sponsors run the risk of loosing control over the project;
• The lender's risk in project financing is not insignificant. This may result in
higher fees;
 Minus Side

• Huge third party costs;

• Stringent covenants.
 Favorable sectors for Project Financing

• Project finance may work for some sectors and may not work for some. It
depends on nature of assets.
• Project finance works where assets produces cash flows and have guaranteed
offtake (buyer).
• Avoid project finance in sectors where the offtake is not guaranteed and the
promoter may do well not to lose control on assets.
 Favorable sectors for Project Financing

• Sectors where project finance may not work:

❑ Manufacturing-
Where products are for domestic market only and/or multiple competitors and
ease of entry into the market exists
❑ Real Estate Property-
Residential houses, hotels, theme parks, etc.
 Favorable sectors for Project Financing

• Sectors where project finance may not work:

❑ Mining-
• Industrial minerals (where market = quality)
• Environmental issues
❑ Pharmacy-
Low entry barriers
 Favorable sectors for Project Financing

• Sectors where project finance may not work:

❑ Consumer products-
• Market is retail
• Sectors where project finance may work:
❑ Power-
Utility status and the presence of PPAs ensures cash flows. Repowering existing
plants by adding gas turbines.
 Favorable sectors for Project Financing

• Sectors where project finance may work:

❑ Transportation-
Toll roads air airports
❑ Telecommunications-
Fiber optic cable services and towers
❑ Oil and Gas-
• Water treatment—If a contract is there with off-taker
• Mining—If quality and offtake are certain
THANK YOU
 PROJECT
FINANCING
• CS Abhishek V. Vidwans
• (Practicing Company Secretary, LLB Gold Medalist,
M.Com.)
 Public-Private Partnership (PPP)
• Large and complex infrastructure assets requires long term sources of funds
• In India, long term sources of finance are limited
• Project requires high up front investment, long gestation period and complex
covenants (such as Debt Service Coverage Ratio (DSCR), Loan-to-Value Ratio
(LTV), Minimum Equity Contribution, Cash Flow Waterfall, Insurance etc.)
• Pension and Insurance funds are ideally suited
• However, in India small % savings actually get invested in pension & insurance
funds
• These funds do not look at investment because of high risk
 Public-Private Partnership (PPP)
• It is bank finance that funds these large assets
• Infrastructure deficit-the most glaring deficit
• For economic growth and poverty reduction physical infrastructure is important
• Governments are no longer able to finance infrastructure projects solely or even
predominantly from the public purse
• Roles of the private sector and PPPs in enhancing infrastructure facilities have become
critical due to huge infrastructure investment needs, governments limited resources,
managerial constraints in the public sector etc.
 Public-Private Partnership (PPP)
• According to the Secretariat for the Committee on Infrastructure,
Government of India, a “Public Private Partnership (PPP) project means a
project based on a contract or concession agreement between a
Government or statutory entity on the one side and a private sector company
on the other side, for delivering an infrastructure service on payment of
user charges.
• PPP is defined as 'the transfer of investment projects that traditionally have
been executed or financed by public sector to the private sector’.
 Public-Private Partnership (PPP)
• A PPP refers to a contractual arrangement between and by the public
government agency and a private sector entity that allows for greater private
sector participation in the delivery of public infrastructure projects
through concession agreements, which lay down the performance
obligations to be discharged by the concessionaire.
• PPPs refer to the long-term, contractual partnerships between the public
and private sector, agencies, specifically targeted towards financing,
designing, implementing, and operating infrastructure facilities and
services that were traditionally provided by the public sector.
 Public-Private Partnership (PPP)
• These PPP projects depend on the expertise and capacity of the project
partners.
• Project parties are bound by contracts and the principle risk allocation and
mitigation based on returns.
• The principle behind a PPP is the development and operation of public utilities
and infrastructure by private sector under terms and conditions agreeable to both
the government and the private sector.
• The PPPs offer significant advantages in terms of attracting private capital to
create public infrastructure and enhance efficiency in the provision of services to
users.
 Public-Private Partnership (PPP)
• They bring in sources of capital for public infrastructure projects.
• Completed in time on schedule and on budget too
• Leads to cost saving, lower construction cost, reduced life cycle cost and
lower risks
• Better consumer service
• Collection of user charges/ tolls considered as revenue
• Have strong incentive, therefore superior consumer service
Potential Sources of efficiencies from PPP
• Resource allocation efficiencies: Efficiencies are gained from the private
sector's ability to allocate more effectively. The Private sector's motivation is
on the completion of the project resources standards.
• Production efficiencies: Resources from specific applications can be used
more effectively. The construction and operation may be completed in less
time.
• Economic and Social efficiencies: Many projects will have access to more
capital. There will be a more efficient movement of goods and people.
 Public-Private Partnership (PPP)
• Success depends on the ability of the public authorities to provide enabling
arrangements to not only attract private investment but also ensure
safeguarding public interest.
• During the last 15-20 years, infrastructure was developed through increasing
investments by the private sector account.
• Dedicated website: (https://www.pppinindia.gov.in/)
 Advantages of PPP
• Investments by private firms may be quick and prompt and the waiting
time is shorter compared to traditional government funding, thus ensuring
early completion of construction.
• Through increased investment and greater focus on customer services, In
case of project of any local authority, the private firm will be able to ensure
adequate sewerage facilities and better services.
• With enormous potential for expansion of the facilities, the private firm can
enhance the efficiency of services.
 Advantages of PPP
• Users are kept informed by the publication of performance data.
• Private firms are more flexible in their approach to solve related problems.
• The private firm does not have the constraint of working within yearly
budgetary allocations, (which is usually a critical factor in public sector
funding) and can borrow money as required, which can be spent efficiently
and in a timely manner
• There could be a gradual change in work culture of the employees resulting
in a more flexible structure that allows individuals to show more initiative.
 Challenges and Issues
• In the process of private partnership, there may be a natural aversion to
changes from the people themselves or from public representatives.
• The utility and the consumers/users may have fears that they will have no
control over the pricing of the services to be provided by the private firm.
• The employees may have fears in respect of their existing benefits as
government employees like pension rights, retrenchment, salary cuts and
more importantly, the loss of identity of a government servant or civic
employee.
 Challenges and Issues
• The utility should give sufficient thought to all aspects and properly assess
how it is doing the job and can improve the services with available/
government funds
• High upfront cost and long payback period
• Uncertainties involved in regulation and pricing
 Challenges and Issues
• The taking over of part of a public service by the private sector will require a
well-defined contract in order to safeguard all parties, including
government, but primarily the user, who would be the main beneficiary. The
hand-over process at the end of a private sector arrangement needs to be
defined, at least in outline, when the initial deal is made.
• Since the utilities depend on the governments for provision of funds for
providing services, the responsibility for providing this basic service has
shifted from government to utility.
 Challenges and Issues
• Regulatory environment: Earlier India did not have an independent regulator
for the PPP sector. Land acquisition, environmental clearances and lack of
coordination among departments are the key hurdles.
• Project Development: There is an acute shortage of key professionals for project
development. Detailed feasibility report, land acquisition, clearances, and
providing utilities are not given due importance. This results in mispricing and
delays by the private developer.
• Lack of institutional capacity: There is a lack of institutional capacity at central,
state and local government levels that hinders the translation of targets into
projects.
 Challenges and Issues
• Lack of information: There is no comprehensive online database to provide
complete information regarding agreements, feasibility report, status of
clearances, etc., to the existing or prospective bidders.
• Risks to bankers: The private sector is dependent on commercial banks to raise
debt for PPP projects. Further as the lending is non-recourse or limited recourse
to developers’ balance sheet, the banks look at only cash flows from the project
repayments.
• The risks that project finance bank loans carry have led to several defaults in the
recent years.
 Distinguishing Features of a PPP Project
• High priority, government-planned project:
The project must have emerged from a government-led planning and
prioritization process.
The project must be such that, regardless of the source of public or private
capital, the government would still want the project to be implemented quickly.
• Genuine risk allocation:
Shared risk allocation .
The private sector must genuinely assume some risk
 Distinguishing Features of a PPP Project
• Mutually valuable:
• Value should be for both sides that is government should also genuinely accept
some risks and not transfer the entire risk to the private sector, and vice versa.
Participants: More than one entity.
Relationship: Partnership should be enduring and relational. Even if a Public
sector body were to use the same supplier year after year, this pattern would not be
regarded as a partnership.
Resourcing: Each party must bring something as resource.
 Infrastructure Funding Practices
• Environmental consequences and safety issues of infrastructure provision are
unlikely to be fully anticipated and incorporated in the market allocations.
• Infrastructure projects usually involve large investments that would be difficult
for private firms to raise.
• Private players may deprive the poor from getting needed infrastructure services.
• It would be difficult for private firms to have a nationwide and long-run
planning on infrastructure constructions.
 Common Forms of PPP Models
• Modified Design Build Turnkey Contracts :Time and cost savings, efficient risk sharing
and improved quality. The turnkey approach with milestone linked payments and
penalties or incentives can be linked to such a contract. Streamlined and Efficient
Project Execution, Risk Management, Customization
• Build Operate Transfer Models: User fee based BOT models. Commonly used in
medium to large PPPs in energy and transport sectors. Annuity based BOT models.
Commonly used for projects not meant for cost recovery through user charges.
• Performance based Management/Maintenance Contracts: PPP models that lead to
improved efficiency are encouraged in an environment that is constrained by
availability of economic resources. Water supply, sanitation, waste management, road
maintenance etc. and education sector.
 Common Types of PPP Models
• Management Contract: Supplies management services to the utility in return for a
fee. Responsibility is to provide management services to the utility. Ownership of
operating and infrastructure assets lies with Contracting Authority.
• Affermage: Runs the business and retains a fee based on the volume of utility
sold but does not finance investments in infrastructure assets. Employing staff,
operating and maintaining utility is the responsibility of the operator. Ownership
of operating assets lies with Operator and infrastructure assets lies with
Contracting authority.
 Common Types of PPP Models
• Lease: Runs the business, retains revenue from customer tariffs and pays a lease fee to
the contracting authority but does not finance investments in infrastructure assets.
Employing staff, operating and maintaining utility is the responsibility of the operator.
• Concession: Runs the business and finances investment but does not own the
infrastructure assets. Employing staff, operating and maintaining utility, financing and
managing investment is the responsibility of the operator.
• Divestiture: Runs the business, finances investment and owns the infrastructure
assets. Employing staff, operating and maintaining utility, financing and managing
investment is the responsibility of the operator. Ownership of operating and
infrastructure assets lies with operator.
 Sectors covered under PPP Projects
• Transportation: PPPs are being used to finance, build and operate many different types
of transportation infrastructure.
Examples: roads, bridges, tunnels, airports, seaports, railway systems and public transit.
• Power and Energy: PPPs have been used to finance and construct electricity
generation plants (including nuclear).
Examples: electrical transmission lines and natural gas pipelines.
• Water and wastewater:
Examples: PPPs have been used to finance, design, construct and operate water
treatment plants, desalination plants and sewer systems.
 Sectors covered under PPP Projects
• Telecommunications: PPPs have been used to fund broadband networks and
other telecommunications infrastructure rollouts.
• Healthcare: PPPs have been used to finance the construction of hospitals, clinics
and other healthcare facilities.
• Education: PPPs have been used to finance the construction of educational
facilities such as schools, colleges and universities.
• Social Infrastructure: PPPs have also been used to finance the construction of
prisons, courthouses and other social infrastructure.
 Why India need PPP?
• Better infrastructure: Private players leave no stone unturned when it comes to
the quality of the projects. Below the quality standard was a common problem
with projects done solely by the government. The entry of private players keeps
the quality in check.
• Risk sharing: The risk is shared by two parties, and hence neither suffers a
considerable loss. Also, the government’s resources are more wisely used owing
to better resource allocation by private companies.
• More scope for innovations: Private companies are known for their innovative
processes, products, and techniques that help solve a problem more efficiently.
 Why India need PPP?
• Funds not blocked: Government funds can be utilized to solve more social
problems when private players take up certain projects.
• Catalyst for economy: It is advantageous for private entities too to invest in
public projects. In the long-term, they can garner huge profits for them. For
example, if a private company builds a highway, then after a while, it can start
making profit from the toll collection.
 Project Types
• B-O-T (Build-Operate-Transfer):
✔ It follows a standard PPP paradigm where the private partner is in charge of
designing, constructing, operating (during the agreed-upon period), and handing
back the facility to the public sector.
✔ The project’s private sector partner must provide the funding and assume
responsibility for its construction and upkeep (usually a greenfield project).
✔ The public sector will permit business partners to charge users for services.
✔ A key illustration of the BOT concept is the national highway projects that NHAI
has leased out under the PPP form.
 Project Types
• B-O-O (Build-Own-Operate):
✔ According to this approach, a private entity will retain ownership of the newly
constructed facility.
✔ The public sector partner consents to “buy” the goods and services delivered by
the project on mutually acceptable terms and circumstances.
✔ Asset is perpetually owned by the operator.
 Project Types
• B-O-O-T (Build-Own-Operate-Transfer):
✔ Same as BOT, except that the asset is perpetually owned by the operator and
sold to the government for either a nominal or pre-agreed fixed sum or at
market value with a cap.
 Project Types
• B-O-O-S-T (Build-Own-Operate-Share-Transfer):
✔ Here Same as BOOT, except that the revenue is shared with government agency

• B-O-L-T (Build-Own-Lease-Transfer):
✔ The government grants the right to finance and build a project which is then
leased back to the government for an agreed term and fee. The facility is
operated by the government. At the end of the agreed tenure, the project is
transferred to the government. E.g. IT Parks, real estate etc.
 Project Types
• D-B-F-O-T (Design-Build-Finance-Operate-Transfer):
✔ The contractual agreement under this criteria will enable the private sector to
perform the following for a new facility:
✔ Design
✔ Build
✔ Finance
✔ Operate
✔ These activities are performed for a particular period of time or a long. Once the
period is over the property is given back to the public sector.
 Project Types
• B-T-O (Build-Transfer-Operate):
✔ Private operator transfers to the government and leases it back and collects
revenue.
✔ Private partner realizes a reasonable return on its investment by charging a user
fee. Ownership of the facility is transferred to the government upon completion
of construction, and the concessionaire is granted the right to operate the
facility and gain return on the investment.
 Project Types
• B-B-O (Buy-Build-Operate):
✔ Buy an existing facility and modernize, operate and collect user fees.
✔ This publicly owned asset is legally transferred to a private-sector partner and
then built and operated by the private partner.
 Project Types
• O-M-T (Operate-Maintain-Transfer):
✔ Operated during the concession period and transferred back to the government
agency.
✔ Under this model, the private party typically operates the facility, performs
routine and non-routine maintenance and also provides training in the
operation and maintenance of the facility until the role can be handed over to
the government.
 Project Types
• Operation License:
✔ The private-sector partner is granted a license or other expression of legal
permission to operate a public service, usually for a specified term.
 Project Types
• R-O-O (Rehabilitate-Own-Operate):
✔ This type will turn over the existing facility to the private sector to perform the
refurbishment.
✔ Once the work is complete, the operations can be performed by the private
entity without any time limit or ownership.
✔ Till the time the franchise is not violated, the facility must be operated
permanently.
 Project Types
• R-O-T (Rehabilitate-Operate-Transfer):
✔ In the case of ROT, the private sector is permitted to undergo the following
activities on an existing facility:
✔ Refurbish
✔ Operate
✔ Maintain
✔ These activities will be performed for a specific period of time after which the
title will be transferred back to the government.
 Project Types
• HAM (Hybrid Annuity Model):
✔ 60% of the investment is made by the private entity and 40% by the
government. The private entity is responsible for construction and management.
The ownership remains in the public hands. (Combination of EPC and BOT)
• EPC (Engineer-Procure-Construct):
✔ The private entity is involved in the construction part, but it plays no role in
managing it once the construction is over and has no right over the revenues
either. It receives a fixed, predetermined sum of money from the government
for its services over a fixed duration.
 Project Types
• E.g. NTPC's Solar Projects at Khavda: NTPC Renewable Energy has issued an EPC
tender for developing solar projects with a cumulative capacity of 795 MW at
the Khavda Renewable Energy Power Park in Gujarat. This project is part of
NTPC's broader renewable energy expansion strategy.
• Construction of 6 laning from Belgaum to Sankeshwar bypass from km 515+000
to km 555+017 of NH-48 in the state of Karnataka on EPC mode under
Bharatmala pariyojana.
 Source of Funds for Large Projects
• Domestic Commercial Banks:
✔ Non-banking finance companies (NBFC) such as Asset finance companies, loan
finance companies and investment companies. Have higher risk appetite.
Organizational flexibility, quick turnaround, better response time and
tailor-made services.
• Insurance Funds:
✔ Stringent guidelines provided by IRDA in respect of credit rating criteria.
 Source of Funds for Large Projects
• External Commercial Borrowing (ECB):
✔ ECBs are commercial loans raised by eligible resident entities from recognized
non-resident entities and should conform to parameters such as minimum
maturity, permitted and non-permitted end-uses, etc.
✔ These parameters apply in totality and not on a standalone basis.
✔ The share of ECB in total infrastructure investments has been recording a
decline.
 Source of Funds for Large Projects
• Track I: Minimum maturity of 3-5 years. Following type of sectors are allowed to
borrow under this:
✔ Manufacturing companies, Software companies, shipping and airlines, SEZs,
SIDBI and Exim Bank, IFCs, AFCs (e.g. GlobexWallet, Shriram Transport Finance
Company, Sigma Consultants).
• Track II: Minimum maturity of 10 years. Following type of sectors are allowed to
borrow under this:
✔ Infrastructure Investment Trusts (InVITs), Real Estate Investment Trusts (REITs)
regulated by SEBI.
 Source of Funds for Large Projects
• Track III: Indian Rupee (INR) denominated ECB with minimum average maturity
of 3/5 years. Following type of sectors are allowed to borrow under this:
✔ All entities listed under Track II above plus NBFCs (MFIs), Section 8 Companies,
Societies, Trusts, Cooperative Societies. NGOs, Companies engaged in R&D,
infrastructure, providing logistic services.
 Source of Funds for Large Projects
• REITs/InVITs:
✔ REIT have to ensure that at least 80% of the assets are invested in completed
and income-generating properties. Further, they cannot invest more than 20% of
the assets in under-construction properties or debt instruments of a real estate
company or shares of listed companies deriving an operating income of less than
75% from real estate activities/government securities/money market
instruments. REITs/ InVITs Index launched.
✔ Example: Embassy Office Parks REIT, Powergrid Infrastructure Investment,
Mindspace Business Parks REIT, India Grid Trust etc.
 Source of Funds for Large Projects
• Infrastructure Development Finance Company (IDFC):
✔ Providing finance and advisory services for infrastructure projects, asset
management and investment banking.
• Infrastructure Leasing and Financial Services Limited (IL&FS)
• India Infrastructure Finance Company Limited (IIFCL):
• Sectors eligible for financial assistance from IIFCL include transportation, energy,
water, sanitation, communication, social and commercial infrastructure.
 Source of Funds for Large Projects
• Bond Markets: e.g. IIFC bond, SBI Infrastructure Bond etc.
• International Agencies:
✔ Asian Development Bank (ADB)
✔ International Finance Corporation
✔ New Development Bank
✔ Asian Infrastructure Investment bank, International Monetary Fund (IMF)
✔ International Development Association: It provides concessional loans and
grants to governments of the poorest countries.
 Government Incentives for PPPs
• Viability Gap Funding Scheme (VGF):
✔ Viability Gap Funding of up to 40% of the cost of the project can be accessed in
the form of capital grant
• India Infrastructure Project Development (IIPDF):
✔ Schemes supports the Central and State governments and local bodies through
financial support for project development activities (feasibility studies, project
structuring, environment impact studies, financial structuring, legal reviews and
development of project documentation, demand assessment etc.) for PPP
Project.
 Government Incentives for PPPs
• IIFCL: Long term debt for financing infrastructure projects that typically involve
long gestation periods since debt finance for such projects should be of a
sufficient tenure which enables cost recovery across the project life, as the
Indian capital markets were found deficient in long term debt instruments, IIFC
was set up to bridge this gap.
• Foreign Direct Investment (FDI): Up to 100% FDI in equity of SPVs in PPP sector
is allowed on the automatic route for most sectors.
THANK YOU
 PROJECT
FINANCING
• CS Abhishek V. Vidwans
• (Practicing Company Secretary, LLB Gold Medalist,
M.Com.)
 Structuring the Project
• Challenge before Banker- Evaluating viability and Bankability
• Proper Appraisal process has to be followed
• Successful project appraisal- Passed through stringent appraisal process and risk
evaluation (Concept analysis-Project organization-estimations and evaluations,
financial, cost-effectiveness and feasibility analyses-Project approval)
• Understand importance of right structure and documentation
• Documentation- Considered as Second line of defense
• Stages of a project- Conceptual and Development stage to financing,
implementation and construction and finally to operation
 Structuring the Project
• Involvement of several project parties
• Important to identify several parties and get bind by contractual framework
• Important to know whether project documentation is capable of mitigating
the risks
• Let us see various project parties and their roles
• Various documentation and contractual structures
• Project documents, financing documents and security documents
 Project Parties
• 1. Project Sponsors:
❖ Also referred as Promoters, developers, business group.
❖ Responsible for converting a concept into a project
❖ Crucial role in setting up project vehicle (Either Existing Corporate or SPV)
❖ Responsible for identifying and recruiting right managerial talent, providing clear
mandate to such talent, subscribing to portion of equity
❖ Implementation involves mobilization of various resources including finance and
management, EPC contract engagement, legal experts, sector domain experts etc.
 Project Parties
❖ Management team should have relevant experience in project area
❖ Sponsors can also infuse additional equity if the project gets into cost/ time
escalation
• 2. Project Vehicle:
❖ Infrastructure projects involves a SPV
❖ SPV is responsible for evolving and developing bankable project, implementing the
project and operating of the same
❖ It selects and appoints all project contractors, negotiates and executes the contracts,
raises the financing, supervises construction and commissioning and operates the
project either directly or through the operations and maintenance contractor
 Project Parties
❖ Non-infrastructure projects may involve SPV or could be an extension of an
existing capacity or integration
• 3. Project Lenders:
❖ Provides debt to finance the construction of the project
❖ Lenders could be either banks or institutions or lenders/investors in
securities.
❖ Supplement the equity/loan brought in by the sponsors/ promoters for
constituting the project margin
 Project Parties
❖ Consortium of project lenders lead by a lead bank
❖ Lead bank deals with project company, disburses debt and is responsible for
monitoring construction, performance and operation of project
❖ Bankers do no normally interfere in day to day activities/ operations
❖ In case of default, enforcement rights of lenders are triggered
❖ Lenders have right to take recourse to legal action for recalling the dues and
enforcement of security by foreclosure (taking possession of a mortgaged
property) of mortgage, sale of shares pledged etc.
 Project Parties
• 4. EPC Contractor:
❖ Designs the project, procures all engineering skills and equipment;
❖ Construct project, erects all project facilities;
❖ Ensures that test and trial runs are completed and finally commissions the project,
all on a ‘fixed time, fixed price’ basis.
❖ Key objective is to deliver a project as per pre-defined specification within a certain
cost and time frame.
❖ Provides performance guarantees, to the SPV
❖ Example: Larsen & Toubro Limited, Patel Engineering Ltd., Hindustan
Construction Co. Ltd.
 Project Parties
• 5. O&M Contractor:
❖ Responsible for operating and maintaining plant in line with industry best practices.
An O&M contract defines the performance parameters
❖ Provides managerial skills and operation experience
• 6. Government:
❖ Key project party under PPP Project
❖ Provides concession to the SPV and ensures that a proper legislative and regulatory
framework exists to compete on level playing field along with existing, possibly
government owned, entities in the same field
 Project Parties
❖ In certain cases, state government guarantees the performance of off take
obligations of State government owned entity and in certain cases central
government counter guarantees the performance of the sate government.
• 7. Suppliers:
❖ Plays a critical role in project development stage
❖ Usually, EPC contractor ties up with suppliers before construction phase.
❖ For procuring raw material, equipment etc. suppliers are critical
❖ Sometimes huge delay can incur huge loss
 Project Parties
❖ Delay in in supply may cause delay in starting the project or commissioning of the
same
• 8. Off-takers (Customers):
❖ In the infrastructure sector, there are two types of projects in terms of off-takers
❖ First type is where off-takers cannot be defined e.g. roads, ports and telecom
❖ In this demand projections depend on historical tariff/ studies
❖ Second is where off-takers are defined, e.g. in power sector it is State Electricity
Board) SEB
 Project Parties
❖ Take or pay kind of agreement under which certain pre-defined payment will
be made even if the off-taker is not able to buy the infrastructure output
❖ In case of non-infrastructure off-takers are generally not defines, e.g. textile
or logistics where product is sold to ultimate consumer or in retail markets.
Key Transaction Documents and Contracts
• From Banker’s point of view documentation will be the primary evidence in
case of any dispute
• Useful to prove Bank’s claim/ charge against legal representatives,
liquidators, official receivers etc.
• Signifies bank’s prior charge against government, other creditors etc.
• Helps in proving bank’s claim against the defaulter in court of law
• Helps in monitoring the project during the construction and operational
stages as it makes terms and conditions for operational performance legally
binding
 Key Transaction Documents and Contracts
• Project Finance may not be suitable for projects that involve complex or
unproven technologies
• Three types of Documents in Infrastructure or Non-infrastructure projects:
❖ Project Documents
❖ Financing Documents
❖ Security Documents
 Project Documents
• Concession/License Agreement (Infrastructure Projects):
• This is the first agreement that the project SPV signs through bidding or a
tender system
• Agreement with government, granting right to SPV to develop the project
• Concession Agreement in road project
• Licensing agreement in telecom project
• Operations, maintenance and development agreement in case of airport
privatization
 Project Documents
❖ Memorandum of Understanding in case of Power projects
❖ Delivers the project site to private developer.
❖ Government/public body agrees to meet the rehabilitation and resettlement expenses
❖ It specifies the term of the agreement and also the termination rights in case of end of
concession period or force majeure closure in the event of political/non-political
disturbance
❖ It lays down technical specifications and terms and conditions for any direct agreement of
the state with SPV called as the State Support Agreement (SSA) which mitigates political
risk
❖ Clearly list down procedure for land handover, substitution agreement, termination
benefits etc.
 Project Documents
• Shareholders’ Agreement:
• It is an agreement between all the shareholders of the SPV
• Establishes shareholding pattern, shareholders’ representation in
management, terms of conversion of PE investors debt into equity, exit route
for PE investors, control on management, post closure obligations, minority
protection rights etc.
• Need arises when there are other equity partners such as PE investors apart
from Sponsors/ promoters
 Project Documents
• Has relevance in both Infrastructure as well as non-infrastructure projects
• It clearly establishes decision making process
• From banker’s point of view, it clearly defines the cash calls and remedies available
against funding defaults
• Agreement defines a shareholder’s exit process and right of first refusal (ROFR) to
other shareholders
• ROFR is exercised when one of the promoter wants to sell its equity stake to
outsiders
• ROFR ensures other partner gets the first right to buy the equity stake
 Project Documents
• It ensures that equity funding is fully tied up and available to SPV as per its
financing requirements
• It ensures smooth functioning of the SPV and that certain decisions are made with
concurrence of all shareholders as opposed to the simple majority of the SPV’s
board
• Lays down simple process by which a shareholder can monetize its shareholding
and the rights of other shareholders
• Helps banker in clearly resolving disputes between shareholders once the SPV
starts getting profits.
• Prevents project from suffering losses because of shareholder apathy as it defines
rights and responsibilities clearly
 Project Documents
• EPC Contract:
• It’s a contract between SPV and EPC Contractor
• Establishes EPC contractor’s sole responsibility in designing, procuring,
constructing, testing and finally commissioning the plant/facility according to
specifications laid down in the contract within specified date and certain cost
• Lays down guaranteed and minimum performance parameters
• Fixes responsibility of the contractor to rectify the plant if it fails to meet
guaranteed performance parameters and specifies penalties/ liquidated
damages
 Project Documents
• Liquidated damages are also used against time overruns
• Time overrun is a situation in which projects due to some factors related to
contractors, clients, consultants, and others fail to be completed in the contractual
or agreed period
• Typically liquidated damages are capped at 20% of the EPC contract value
• If any defect in design of road/ plant is found in the post commercialization
period, EPC contractor is liable to pay a defects liability
• A well laid EPC contact protects the project against time and cost escalation
particularly in case of fixed time, fixed price contract
• Limited cost overrun support is sought by bankers
• The selection of the EPC contractor is critical
 Project Documents
• It is advisable to select qualified EPC contractor through an international
bidding route
• In road projects generally EPC contract is awarded back to one of the
sponsor
• Generally in road projects sponsors are construction contractors
• Seeking warranties from EPC contractor ensures that for an adequate defect
liability period, spare parts are available and repairs are carried out by
experienced personnel at zero or low cost
 Project Documents
• O&M Contract:
• Its an agreement between SPV and the O&M contractor
• Establishes responsibility of the O&M contractor to operate the plant/ facility
• Clearly defines maintenance obligations that will ensure that the project/facility is
maintained as per the industry best practices
• Specifies bonus payments to the O&M contractor for exceeding predetermined
performance parameters and penalties for underachievement
• It ensures a certain level of mitigation of operating and performance risks
 Project Documents
• Power Purchase Agreement (In case of Power Projects):
• Most important document in case of sale of electricity and cash flow generation
• Establishes power-sale obligations
• Several types of PPA
• Take-or-Pay is best choice in case bulk power is sold to a public sector utility
• Take-or-Pay means there is a contractual obligation to make periodic payments in
future for an agreed off-take of power at a set price and purchaser must make
specified payments even if it does not require the power at a particular time and the
agreement can be cancelled only by mutual consent
 Project Documents
• Some other provisions of PPA are as follows:
❖ Nature of the plant
❖ Base load the (permanent minimum load that a power supply system is required to deliver)
❖ Tenure
❖ Conditions for the PPA to come into effect
❖ Interconnection facilities
❖ tariff determination
❖ Fore majeure clause
❖ Termination payments
 Project Documents
• Fuel Supply Agreement and Fuel Transportation Agreement:
• Ensures a reliable and confirmed fuel supply.
• Terms match with terms of PPA
• Contains evidence of the existence and dedication of fuel reserves sufficient
to meet project requirements for the duration of the agreement
• Some of the key provisions of the agreement are:
 Project Documents
❖ Obligation to sell and purchase coal
❖ Quality of the coal
❖ Liquidated damages
❖ Purchase price for fuel
❖ Payment terms
❖ Force majeure
❖ Settlement of disputes
 Project Documents
• List of Clearances that may be required in case of Power Projects:
• Water availability: Water Resources Department, State Government
• Pollution clearance: State Pollution Control Board
• Environment and Forest Clearance: Ministry of Environment and Forests,
Government of India
• Land availability: State Government
• Fuel Linkage: Standing Linkage Committee, Department of Coal
 Project Documents
• Transportation of Coal: Ministry of Railways
• Foreign Investment Promotion Board Clearance: Foreign Investment Board
• ECB/ FDI Clearance: Reserve Bank of India (RBI), Automatic and Govt.
Route
• For each project both infrastructure and non-infrastructure projects the set of
approvals required needs to be identified with the help of the
sponsor/promoter
• The primary responsibility for identifying the set of approvals required should
be pinned on the sponsor/promoter
 Financing Documents
• Documents that govern financing of the project as agreements
between the SPV and the project lenders are referred to as financing
documents. These include following:
• Loan Agreement:
• It is 1st among all financing agreements
• It is also called as facility agreement, rupee facility agreement etc.
• It defines the amount and purpose of the loan and terms of the loan or
repayment schedule
 Financing Documents
• Normally in infrastructure loans payment schedule is a balloon kind or step
up repayment schedule with a defined moratorium period based on gestation
period, expected time frame for stabilization of commercial production, debt
service coverage ratio trend etc.
• The loan agreement specify the interest rates, which, because of the long
tenure of the project, are generally floating interest rate capped to a
benchmark, such as base rate of the lead bank or average base rate of the top
4-5 lenders to the project
 Financing Documents
• In case of foreign currency loans, London Inter Bank Call Money Rate (LIBOR) is
used
• Generally interest rates come with reset clause. This allows the lender to review the
interest rate and reset it after a certain number of years, so that it is in line with the
prevailing interest rate. This clause allows lenders to increase interest rates
according to the increase in market rates
• This clause provides a hedge to project lenders
• Nowadays it is also a common practice to include a clause for repayment or
refinance at the time of date of commencement of commercial operations or
interest rate reset
• The loan agreement defines that prepayment and pre-disbursement conditions
 Financing Documents
• The drawdown schedule or disbursement schedule is prepared in
consultation with all lenders and it is stated separately or in the loan
agreement
• The loan agreement clearly state the debt fees/service, representation and
warranties and the conditions that may be deemed as events of default and
the dispute resolution procedure to be followed in case of default
 Financing Documents
• Inter Creditor Agreement:
• Where there is a huge project loan requirement whether in case of
infrastructure projects or in case of non infrastructure projects such as steel
and cement the project loan is arranged by the process of debt syndication
• In loan syndication an agreement is put in place among all the lenders
• This is critical and facilitates coordinated action and harmony of terms and
covenants for all the lenders
• It also prevents action by any single lender
 Financing Documents
• This agreement preserves the right of each individual lender against the borrowers
by writing a procedure for the same in the agreement
• The agreement specifies lenders of facility agents if appointed and their rights and
responsibilities are clearly spelled out
• The project documents and financing documents along with the key contacts are
called as transaction documents of a project
• The strength of the transaction documents forms the basis of project appraisal by
the bankers
• If all the project parties are bound by crystal clear contracts and all risks are plugged
in then there is a little chance of project not being successful
 Financing Documents
• Substitution Agreement:
• Lenders normally sign a substitution agreement with the sponsors and SPV
as part of the loan documents
• It gives them step in rights such as conversion of debt into equity, pledge of
sponsors' equity, appointment of nominee director, change of management
structure etc.
• In this lenders can resell the equity to a third party which can carry forward
the project profitability
 Financing Documents
• It is a specialty of infrastructure projects that are implemented under a
concession agreement such as roads and ports and will require the approval
of the party granting the concession such as NHAI and port authority
• It also facilitates change of management in case of corporate debt
restructuring
 Security Documents
• An important part of financing documents
• They protect the lenders in the event of default by the borrower
• It defines the claim of senior leaders over the subordinate ones
• In terms of crisis it allows lenders to assume control over the project assets
• The assets that are available for security are land, building, plant and
equipment of the SPV or the project assets besides receivable, book debt and
other contractual rights and intangible assets
 Security Documents
• Mortgage Document/ Deed of Hypothecation:
• Assets that are available to be offered as securities are as follows:
• Project assets under concession agreement with government department;
• Land and building;
• Plant and machinery;
• Equipment;
• Receivables of projector assets;
• Sponsors or promoters shareholding either full or partly
 Security Documents
• Assignment of license, brand, key contracts and so on should be explored
and negotiated
• Lenders also derive rights under the concession agreements such as
substitution
• In case of service projects creation of tangible project assets may not happen
to the full extent of the project loans disbursed such as in ITES
• Collaterals such as pledge of sponsor or promoter shareholding and personal
guarantee or corporate guarantee should be explored
 Security Documents
• Share pledge agreement/ Negative lien:
• Normally, the bank insist on pledging of equity of sponsors in the project SPV. Negative
Lien’ is an undertaking obtained by the banker/financer, from the borrower that his assets
(e.g land, building, machinery, stocks, etc.) mentioned are free from any charge or
encumbrance and he would not create any charge or encumbrance on any of these assets
in favour of third parties during the period of bank finance.
• Assignment of key contracts:
• Concession agreement, licensing agreement, insurance contracts, off take agreements,
construction contracts and so on are assigned to the banker
• In the light of lack of tangible security the assignment assumes importance in certain types
of infrastructure projects
 Security Documents
• Various guarantees are sought for mitigating risk, they are as follows:
• Completion guarantee from sponsors or promoters
• Termination payments from concessioning authority
• Force majeure guarantees from insurance company
• Construction guarantee from project contractor
• Performance guaranteed from supplier
• The deed of assignment of contracts will attract ad valorem samples
• Assignments are included as part of English mode
 Security Documents
• Security Structure:
• Mitigation of the payment risk by SEB/off-takers is critical for ensuring the
viability of the power projects
• In addition to direct payment, security package, in the form of letter of credit
(LC) and a escrow agreement, serves as a temporary measure for
enhancement of creditworthiness of SEBs/ off takers
• The money in the escrow account is flow-in and flow-out and the cash in the
account will be trapped only in the event of default
 Security Documents
• Direct Payment:
• The project company would raise the invoice on a monthly basis, that is after
generating and supplying the power to SEB's/off-takers for a period of one
month
• Letter of Credit (LC):
• The SEBs/off takers Shall also maintain an irrevocable, standby,
unconditional LC issued by an acceptable creditworthy bank in favour of the
project company
 Security Documents
• The LC will be opened in favor of the project company for an amount
prescribed in PPA in case of power project from the date when the project
company starts selling power
• State government guarantees:
• The state governments have been providing guarantees with a view to attract
investment into their respective States
• This has been the practice and over a period of time the state government
guarantee was recognized by lenders and sponsors as a part of the security
package
 Security Documents
• However lately state governments have not been extending their guarantees
and most of the power projects are being funded without their guarantees
• This is because of the keener interest shown by promoters in setting up
power projects and also because the lenders now feel that securing the
receivables of the power project is a better security than the state
government guarantee
• Trust and Retention Account:
• The project company opens and maintains a TRA and deposits all the cash
flows of the company into the said account and the proceeds are utilized in
the manner and according to the priority decided by the lenders
 Security Documents
• A TRA attempts to discipline the utilization of the cash flows entering a
project company
• A TRA can be at two stages:
• Implementation Stage:
• This TRA structure requires that during the implementation stage all project
funds be placed into it
• The main account is designated as the proceeds account, which captures all
the revenues
 Security Documents
• Based on implementation schedule, during the implementation phase, funds
from this account are transferred to the construction account for meeting
construction expenses and to the interest service account for meeting the
interest payments during construction expenses
• Withdrawals from this account are permitted on the basis of an approved
project implementation plan that is permitted by the project lenders on the
basis of project status reports and certification regarding achievement of
various milestones as agreed upon at the outset
 Security Documents
• Such a mechanism is considered to be of Paramount value to the project
lenders for ensuring end use of funds and monitoring project
implementation
• It can serve as a useful tool for taking mid-course corrections, especially in
the case of long gestation infrastructure projects
• Operational stage:
• Once the project is fully implemented and starts generating revenue from its
operations the entire revenue continues to be captured in the trust and
retention accounts while the construction and interest service accounts
opened earlier are no longer required
THANK YOU
 PROJECT
FINANCING
• CS Abhishek V. Vidwans
• (Practicing Company Secretary, LLB Gold Medalist,
M.Com.)
 Valuing the Project and Cost of Capital
• Value is calculated by deducting the expected costs or investment of a project from
its expected revenue and then dividing this (net profit) by the expected costs in
order to get a return rate. Other factors such as inflation and interest rates on
borrowed money may be factored into ROI calculations.
• To maintain health of the Company we need to make a proper cash flow model
• In project finance cash flows remains the focus of all attention
• Assets that are financed are long term, the expected cash flows must justify the
initial investment
• Creating such a financing plan for the project so that funds will be available at the
lower costs
 Valuing the Project and Cost of Capital
• Credit officer should perform following:
• Review the project summary quickly to understand the deal
• Examine the project information/ studies to systematically identify each
risk item one by one and in the process get sense of uncovered items
• Start modelling, projecting or scrutinizing the model developed by others
• A DPR (Detailed Project Report) will be the starting document
• Credit officer can avail the services of banks technical appraisal team or
external agencies having expertise in sector
 Valuing the Project and Cost of Capital
• Obtain operating cash flows (EBIT) from operations report
• Non cash items such as depreciation, goodwill and amortization should be
added back to EBIT
• Operating expenditure (Opex) components are raw materials, labour, energy,
maintenance, freight, insurance, royalty etc.
• Forecasted Gross revenues to be considered, e.g. in case of roads traffic
estimates and PPA in case of power sector
 Valuing the Project and Cost of Capital
• Gross Revenue:
• In case of road projects forecasted annual revenue may be derived from
traffic estimates, in case of power sector power purchase agreement etc.
• The quantity of off-take needs to be clearly specified over the term of the
project financing and beyond
• Operating Expenditure:
• Covered by long term supply contracts
• Fluctuating cost of some raw material
 Valuing the Project and Cost of Capital
• Identify which cost are variable and fixed
• Labour costs are mostly fixed
• Royalties are generally ad valorem
• Opex contingencies should be examined to see if they are “to be spent” or
simply surplus.
• Net working capital:
• NWC is the difference between short term assets and liabilities
• Short terms assets: Inventory and account receivables etc.
 Valuing the Project and Cost of Capital
• Short term liabilities: Bills Payable
• Increase in the net working capital year on year denotes a decrease in cash
flow and a decrease in networking capital means an increase in cash flow
• Capital Expenditure:
• Capex estimates are also developed in detail from the engineers' technical
feasibility report as well as from the quotes and tender bids by prospective
constructors.
• Engineering firms can give a bandwidth of accuracy of the estimate based on
the status and depth of study and quotes
 Valuing the Project and Cost of Capital
• An accurate estimate of construction and commissioning time table and the
potential for delay has a direct impact on the calculation of cost of the project.
• The underlying capex may also face overruns from changes in equipment and
construction cost.
• The construction industry is very cyclical and if conditions are tight the
construction cost increase by 20 to 50%.
• Common causes of cost overruns come from poor estimation of local
construction cost freight and handling charges.
• Any additional capex is a decrease in cash flow
 Valuing the Project and Cost of Capital
• Salvage Value:
• After end of the project earth moving equipment or plant equipment or
deploy them somewhere else
• When the project comes to an end Earth moving equipment or plant
equipment can be sold or deployed somewhere else
• If the equipment is sold then payment of taxes has to be done on the
difference between sale price and the book value of the Asset
• Salvage value represents a positive cash flow to the firm
 Valuing the Project and Cost of Capital
• Free Cash Flow to the project:
• Under these cash flows are estimated with earning before income tax that is
operating income
• This is then multiplied by historical marginal tax rate to calculate post tax
operating income
• Non cash items such as depreciation amortization and Goodwill return of
should be added back to EBIT
• These cash flows are free from any charge of debt and can be called as free
cash flows. Financing cost are yet to be recovered from the above cash flows. This
means interest is not detected or dividends are not paid off
 Valuing the Project and Cost of Capital
• Financing Costs:
• Such as up front fees, commitment fee on the unused part of the loan during
the availability period, margin above interest rate base, facility agent’s fee on
p.a. or upfront, fee for independent report (generally environment), fee for
lender’s independent engineer on percentage or per visit basis, valuer fees
etc., legal documentation fee.
• A credit officer should stick to the bank guidelines with respect to pricing
including rate of interest, commission on guarantee/ LC and other fees such
as appraisal and syndication
 Valuing the Project and Cost of Capital
• DSRA:
• Good knowledge of the main protocols for generating principal repayment, interest
and reserves is natural prerequisite to structuring the optimum repayment profile
• The best example of this is Debt Service Reserve Account (DSRA)
• If there is a problem, then DSRA may provide a cushion of so many months
• DSRA are usually expressed in months of debt services
• DSRA will not be used until interest can be paid and project cash flows have not
deteriorated long term
 Valuing the Project and Cost of Capital
• Principal repayments:
• In project finance, principal repayments are usually structured either annuity
or EMI
• In initial years low principal amount is recovered and it steadily increases
• There are number of interest rate bases for any financing, not just project
finance.
• Interest rate can be used of lead bank or group of top banks or MIBOR etc.
 Valuing the Project and Cost of Capital
• Another structuring tool is cash trap, where the cash flow is reserved if the
projects performance is at or below a threshold
• In this case the money cannot be distributed to equity shareholders until a
release mechanism is satisfied, which shows that the project will go back up
above the level and stay there in the foreseeable future
• The cash trap money is usually in addition to the various reserved money
 Valuing the Project and Cost of Capital
• Reserve styles:
• Creation of optional reserves insurance repayment in times of stress.
Maintenance reserves are for specific project activities such as future capex
or maintenance
• It is also ideal to double check on agreed level of liquidated damages (LDs).
LDs are split into delay and underperformance.
• Following are the periods selected for project finance models:
• Annual or semi annual during the repayment period
• Quarterly during construction
 Valuing the Project and Cost of Capital
• sometimes monthly during construction is too tough
• Cost of capital to a Company is the minimum rate of return expected by the
providers of the fund
• It is the rate of return that a Company has to offer long term fund providers
to hold on to a financial asset.
• Hence it is minimum acceptable return on any current average risk project
under consideration today
• Cost of Capital is an opportunity cost as it depends on where the money goes
and not where it comes from
 Valuing the Project and Cost of Capital
• The primary goal of financial management is ‘maximization of shareholders’
wealth’.
• Hence, all decisions of management are directed towards such wealth
maximization.
• There are three basic functions of financial management, viz. investment
decisions, financing decisions and dividend decisions.
• The investment decisions are dependent on the project profitability and the
financing decisions are based on the available sources of finance.
 Valuing the Project and Cost of Capital
• Generally, there are two basic sources of funds –
• Shareholders’ Funds (Equity Capital)
• o Equity Share Capital
• o Preference Share Capital
• o Retained Earnings
• Borrowed Funds (Loan Funds)
• o Debentures Issues
• o Loans from Financial Institutions
• o Deposits / Bonds etc.
 Valuing the Project and Cost of Capital
• The main aim is to find an optimal mix of owned and borrowed funds so as
to maximize shareholders’ wealth
• The decision regarding feasibility of a project is taken on the basis of cost of
capital
• In other words, cost of capital is the cost of obtaining funds, i.e. the cost
borne by a company for collecting funds from various sources
• Securities analysts use Cost of Capital in valuation and selection of
investments.
 Valuing the Project and Cost of Capital
• Investors use Cost of Capital as a tool to decide whether or not to invest
• Cost of Capital is used for evaluating investments plans, compare with ROI.
• Types of Cost of Capital:
• Explicit and Implicit Cost
• Average and Marginal Cost
• Historical and Future Cost
• Specific and Combine Cost
 Valuing the Project and Cost of Capital
• Factors determining Cost of Capital
• General Economic conditions
• Market Conditions
• Operating and Financing Decisions
• Amount of Financing
 Valuing the Project and Cost of Capital
• Controllable Factors:
• Debt-Equity Ratio
• Dividend Policy
• Capital Investment Policy
• Uncontrollable Factors:
• Interest rates,
• Tax rates,
• Inflation rates
 Valuing the Project and Cost of Capital
• Optimal Capital Structure of A Project:
• Project finance creates value when used for large and risky assets particularly
in sectors that have characteristics of utility
• Utilities are monopolistic in nature, have more or less assured cash flows and
use mature technologies
• Infrastructure projects particularly in PPP model with defined off-takers, at
least theoretically, exhibit the characteristics of utilities
• When corporate decides to take funding for a project on project finance basis
it essentially takes three decisions
 Valuing the Project and Cost of Capital
• The first one is a financing decision
• Debt as a source of finance has two advantages it lowers cost of capital and
brings discipline to companies decision making
• Too much of debt increases bankruptcy cost
• While structuring a project finance deal to finance deal risk is shared by
various project parties
• Risk is also mitigated by writing counterparty contracts
• The second is an organizational decision
 Valuing the Project and Cost of Capital
• The corporate creates bankruptcy remoteness for project assets by
sponsoring equity in a new company that will develop and maintain the
project assets
• In a way it is good for existing shareholders of the corporate as the riskier
project assets are unbundled from the existing Assets of the corporate
• As the corporate only sponsors a new companies the high debt ratios of the
project vehicle does not disturb its existing ratings
• The third is a governance decision
 Valuing the Project and Cost of Capital
• As the fund providers get their returns only from Project cash flows the
sponsoring corporate creates a project specific management or governance
structure that helps reduce the Agency cost of managerial actions
• Contractual bundle, control on cash flows, creation of reserves and
monitoring by the Syndicate of lenders shares and mitigates the risk of the
project
THANK YOU
 PROJECT
FINANCING
• CS Abhishek V. Vidwans
• (Practicing Company Secretary, LLB Gold Medalist,
M.Com.)
 Due Diligence
• Due diligence is an investigation of a business or person prior to signing a
contract, or an act with a certain standard of care.
• It can be a legal obligation, but the term will more commonly apply to
voluntary investigations.
• Facilitates informed decision making
• It is a way of preventing unnecessary harm/hassles to either party
involved in a transaction.
• Legal due diligence, Operational Due diligence, IP, Tax, IT Due diligence etc.
 Due Diligence
• Required at two stages:
• Pre-sanction Appraisal: to determine the bankability of each project
proposal
• Post-sanction Appraisal: to ensure proper documentation, follow up and
supervision
• The sponsors approach the bank with a Detailed Project Report (DPR) and
it helps the Lead Bank to prepare an Initial Information Memorandum
• This information memorandum forms the best document as the bank
arranges funds for the client
 Due Diligence
• Sometimes the scope of the project may have to be changed to suit the
way the bank will go about arranging the funds rather than usual financial
engineering practice of tailoring the financing to fit the Corpus of the project
• Let us first see some of the core principles of bank lending
• Lending is a basic function of banks which involves process of making loans
and advances
 Due Diligence
• In Infrastructure Projects the loan amount is often credited to trust and retention
account
• A banker is always concerned that the loan repayment must come back
• Principle of safety of funds: Depends upon Willingness, Integrity, Honesty and
Financial Standing of the Borrower
• Principal of profitability: To earn sufficient income, Cost of money raised and
operation
• Principle of liquidity: If repayment not done Liquidity crunch may be faced
• Principle of purpose: Purpose of Loan and End Use is important
• Principle of risk spread: Lending to Variety of Sections of Society
 Due Diligence
• Principal of security: Backed up by Third Party Guarantee or Asset
• Timely sanction
• Let us see some of the tips for lending:
• Be alert and sensible
• Be wise about the borrower and his business
• Take Holistic approach
• Ensure safety in lending
 Due Diligence
• Commit only if convinced
• Believe in teamwork
• Be bold to reject loan
• If deciding to lend then except full responsibility and do not go back and be
customer friendly
• Understand loan policy
 Due Diligence
• Now let us see what is loan policy?
• The banks are allowed to formulate their own loan policy
• The basic purpose of loan policy document is to ensure orderly credit growth
• It encloses norms of
• credit methodology
• interest rate fixation
 Due Diligence
• review/reporting system
• restructuring of loans
• time limits set for disposal of loan applications
• The policy also deals with asset liability management and risk management
• Major elements of loan policy are as follows:
• Exposure/ceiling of loan:
• This is linked to the total capital funds (Tier I and Tier II) of banks
recognized for calculating the capital adequacy
 Due Diligence
• Various exposure norms such as,
• individual exposure
• group exposure
• sector-wise and industry-wise exposure
• Sensitive unsecured loans etc.
• These exposure norms are prescribed to mitigate concentration risk,
which the bank is expected to manage by dispersing credit across different
industries sectors and borrowers within the overall ceiling prescribed in the
loan policy document.
 Due Diligence
• Delegation of powers:
• The loan policy document contains:
• lending powers delegated to different authorities for different purposes,
• powers to grant temporary finance in case of emergency requirements
• relaxation in interest rates/ service charges at different levels
• reporting and monitoring mechanisms to ensure the use of lending powers in
a systematic and orderly manner.
 Due Diligence
• Appraisal standards:
• The loan policy document has to state the appraisal standards
accepted by the bank with respect to the:
• methodology for calculation of permissible bank finance
• fixation of margin
• fixation of rate of interest through risk grading
• benchmark/ standards for current ratio, debt-equity (D:E) ratio, debt service
coverage ratio, internal rate of return (IRR) and relaxation terms, current
ratio, and other ratios.
 Due Diligence
• Security Norms:
• security norms are important prescriptions for the lending process.
• Banks are required to lay down norms for:
• primary/collateral security and third-party guarantee, relaxation/waiver of
security/third-party guarantee for priority and other sectors
• minimum asset coverage ratio, etc., through the loan policy document.
 Due Diligence
• Norms for disposal of loan application:
• The RBI has laid down norms for the disposal of loan proposals falling
under the priority sector. These norms include:
(a) time limit set for disposal of a proposal
(b) power to reject a proposal
(c) maintenance of loan application received and disposal register
(d) Inspection of register by controlling officer/ inspecting officials to ensure
compliance
 Due Diligence
• Size of credit:
• This depends upon lendable resources, stipulated credit, deposit ratio and
business plan
• Composition of credit:
• This covers both funded and non-funded projects and their composition
• Quality of credit:
• This deals with rating of borrowers and loan pricing policy
 Due Diligence
• Credit administration:
• This includes a wide range of items such as procedures for managing the loan
portfolio, lending powers, maximum maturity of loans, reporting system,
internal control, loan review credit schemes etc.
 Due Diligence
• Others:
• Definition of wilful defaulters
• KYC
• Restriction imposed by RBI for sanctioning loan to directors and their
relatives
• Policy for taking over the loan from other banks
• Restructuring and rehabilitation of sick units
• Re-schedulement of loans on occurrence of natural calamities
 Due Diligence
• Under due diligence credit officer should obtain various information
documents in respect of group (borrowers) and project
• Generally, the sponsor/promoter commissions the preparation of a detailed
project report (DPR) for the project to be taken up
• The DPR should contain all the above information and documents
• Some of the information may also be given as annexures to the DPR or even
separately
 Due Diligence
• There could be supplementary reports, such as market study, demand
forecast, and traffic study, based on which the DPR is prepared
• It is possible that the sponsor/ promoter is not ready to part with some
information/documents due to non-disclosure agreement with technical
collaborations or shareholder agreement signed with equity partners
• For a lender, project appraisal begins with preliminary discussions with the
sponsor/promoter, followed by vetting of DPR
• The client usually avails services of an industry expert to prepare the DPR
 Due Diligence
• The lead arranger prepares the Project Information Memorandum (PIM)
based on:
• the DPR
• discussions with the client
• vetting of certain contents of DPR, such as technology and market
• Thereafter, the lead arranger circulates the PIM to various
banks/institutions for syndication of the debt
• For the participating lenders in the syndication/consortium, the PIM serves
as the main document for credit decision.
 Due Diligence
• As a credit officer appraising a project, it is essential for him/her to
• understand the DPR contents
• map the risks/mitigation
• structure the facilities
• arrive at the credit decision parameters such as exposure and pricing
• stipulate documents and covenants
 Due Diligence
• Discussion with Promoters on due diligence:
• Once the above information is collected, the next step would be to meet the
sponsors. The meeting should broadly discuss issues before the lender can start
the appraisal such as:
• Scope of project
• level of the project & Sector constraints
• Location aspects
• Engineered cost estimates
• Funding requirements
• Detailed design estimates
 Due Diligence
• Systematic review of assumptions:
• After the KYC documents, balance sheets, cash flow statement, and all other
documents are received from the client, a systematic review of risk aspects
which neither identified nor structured optimally will comfortably get
determined
 Due Diligence
• Selection of Experts/ Engineers (Lender’s Independent Engineer/Lender’s
Legal Counsel)
• Background check of experts etc. is done and thereafter these experts/
engineers do following review:
• 1. Customary Reviews:
• Legal review
• Taxation review
• Accounting and Construction review
• Insurance review
• Environmental review
 Due Diligence
• 2. Road Projects: Traffic Studies
• 3. Road Projects: EPC/ Construction Cost Audit/ Vetting
• 4. Power Sector: Due Diligence on Assumptions
• Telecom: Subscribers studies
 Due Diligence
• Start of Appraisal: Feasibility Check
• To start it is important to keep the basics of appraisal in mind. There are two key
fundamentals:
• 1. Five Cs of Credit Analysis
• Character
• Capacity
• Capital Structure/Cash
• Collateral
• Coverage Conditions
 Due Diligence
• 2. Obtaining and sharing Confidential Credit Report

• Fundamentals of Appraisal by Banks

• 1. Management Appraisal (Past track record, group performance,
managerial competence, financial strength and project team)
• 2. Technical Feasibility (Availability and appropriateness, reputation and
basis of selection of equipment suppliers, scope of terms of supply, RM
adequacy, implementation schedule feasibility and single point responsibility)
 Due Diligence
• 3. Commercial Viability (Marketing arrangements, demand-supply projections,
price trends, level of competition)
• 4. Financial Appraisal
• The steps taken in conducting a financial appraisal are as follows:
• Cost of the project:
• The bank has to determine the accuracy of cost estimates, suitability of the
envisaged pattern of financing and general soundness of the capital structure. The
following aspects have to be analyzed for impact:
• Itemized cost of the project
• Means of finance
 Due Diligence
• 5. Economic Appraisal
• It is different from financial appraisal as a financial appraisal essentially views
investment decisions from the prospective of organization undertaking
investment including lenders.
• It therefore measures only the direct effects of an investment decision on
the cash flows of the organization
• Whereas economic appraisal considers not only the impact of the project but
also the external benefits and costs of the project for other government
agencies, private sector enterprises, individuals
 Due Diligence
• With examples let us look at the impact on each stakeholder:
• Banker/Lenders
• Employees
• Customers
• Complementary products and additional services
• Suppliers, Competitors and new entrants
• Community
• Taxes, Subsidies, Import Tariffs/ Export taxes or subsidies
THANK YOU