profits. There is often a trade-off between the two. The following two basic arrangements used to put Project Finance in place illustrate some of the trade-offs involved:
Long-term lenders may finance the installation, supply, erection and commissioning of the facility as well as an agreed number of years dur- ing operation. In this case, there is only one set of lenders and financing
Short-term loans are provided by one set of lenders to finance construc- tion of the facility up through its commissioning, and are then "taken out" by long-term lenders, as shown in Figure 3.1. The construction lenders could be the or banks; the long-term finance could be provided through banks or project bonds. This introduces three pos- sible outcomes for the trade-off between lower financing costs and prof- itability:
When the provides the short-term financing, if more than one sponsor is involved, each borrows its share of the required construction financing directly from commercial banks, and then on-lends such funds to the project. Following commissioning, the project arranges long-term financing partly on the basis of contrac- tual arrangements that exist for the sale of project output. The project will then repay its borrowings from the out of the proceeds of the long-term financing. This approach makes the
directly responsible for all the completion risk (to the extent that is not transferred successfully to the EPC contractor). Project completion risk, together with its transfer t o third parties, is discussed in Chapters 5-6 and 8-9.
Upon refinancing their position and depending upon the fi- nancial markets, the may be able to negotiate somewhat longer door-to-door tenors or even higher leverage during the op- erating period. Its willingness to absorb 100% of the financing risks during construction improves its negotiating position with regard to the second set of lenders and, ultimately, may result in extended tenors, perhaps lower interest rates and enhanced project returns during the operating period. This result may be attained, even with a higher level of transaction fees, arising from two sets of lenders having to be compensated for their participation the project. When the commercial banks provide the short-term a special purpose finance corporation (SPFC), organized by the issues short-term promissory notes with the objective of on-lending the proceeds to the project vehicle. In this case, the project vehicle borrows money from the SPFC under terms sub- stantially identical to those under which the latter has borrowed funds. Security for the lending institution will consist of the same completion undertaking and other contractual arrangements that long-term lenders will rely on for security in connection with the permanent financing. The will pick up the development costs and negotiate (with both sets of commercial bank lenders) to convert a reasonable portion of these inro equity.
3 DEVELOPMENT
Figure 3.1 Construction Financing3
contractor
Steps:
1. The agrees with the construction intermediary trust to purchase a facility built to certain specifications. The purchase price and time for delivery are established. 2 . The agrees to build the facility at a price and on terms consistent with the
contract between the and the construction trust or corporation.
3. A loan agreement is entered into between the construction intermediary trust and the construction lenders.
4. The construction trust assigns a security interest in its assets to the construction lenders. The contractor enters into an agreement a bonding company to provide a bond sufficient to guarantee performance and provides rhe bonding company with a guarantee and an assignment of its rights under the construction contract as security.
6. The bonding company provides a performance bond. ( A performance bond may not be available at a price, in which case the lender must look to the financial re- sources and reputation of the contractor.)
7. Construction loan funds are advanced as needed and progress payments are made to the contractor.
8. The facility is completed to the specifications called for in the contract; the permanent financing is arranged by the the construction loan is repaid; title passes to
Its ability to increase financial leverage or tenor, through the take-out financing, depends very much on the host country involved, robustness of the project, the length of the construction period and the state of the international financial markets at time the two loans are negotiated.
In this case, a higher level of financing costs will almost cer- tainly be involved given the presence of two sets of lenders, but it is not clear that an overall longer repayment schedule will be secured. When the intent of the is to arrange take-out from the bond market, the project vehicle borrows money directly from banks or SPFC, as described above. A public offering to take out the con- struction lenders will occur after commissioning; however, the take- out must be backstopped by firm commitments from credible fi- nancial institutions, otherwise the construction lender will not par- ticipate. Such commitments are usually in the form of standby loan facilities from commercial banks. The commitments obligate the banks to provide funds if the public offerings are not consummated as planned. If the take-out is subsequently handled through the bond offering, the is able usually to negotiate consider- able longer tenors (if the project is located in an investment-grade- rated country) and even higher leverage than any of the other alter- natives discussed above. The advantages to the gained through this structure in extension of loan tenors, have to be weighed against three sets of transaction costs: construction banks, bond issuance and the standby commercial banks.