Project Finance Mechanics

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This 5-day course will give attendees a practical understanding of how to apply project finance techniques successfully to projects with a particular emphasis on risk analysis and management. The course is structured into interactive sessions covering all the tools of project finance. The course will begin with introductory comments about the skills and general objectives in project finance analysis with an emphasis on the difficulty in measuring and valuing risk. Financial statement analysis of project finance transactions will also be covered, as well as valuation and credit analysis. Participants will construct a basic project finance model to become familiar with the structure, equity ca…

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This 5-day course will give attendees a practical understanding of how to apply project finance techniques successfully to projects with a particular emphasis on risk analysis and management. The course is structured into interactive sessions covering all the tools of project finance. The course will begin with introductory comments about the skills and general objectives in project finance analysis with an emphasis on the difficulty in measuring and valuing risk. Financial statement analysis of project finance transactions will also be covered, as well as valuation and credit analysis. Participants will construct a basic project finance model to become familiar with the structure, equity cash flow and free cash flow. In addition, attendees will explore and discuss modelling mistakes, model layout and best practice spreadsheet conventions as a prelude to hands-­on work on a comprehensive model. Finally, the programme will address covenants and risk analysis, and mitigation in project finance. This in-depth course is designed to provide delegates with a thorough and working understanding of: Project finance transaction structure Financial statement analysis Valuation of project finance Probability of default and loss given default and credit analysis in project finance Basic mechanics of project finance models Interest during construction Use of project finance model Risk and analytical failures Market risk and contract risk in project finance Best practices for excel modelling Covenants in project finance, and An overview of project finance terms Who should attend This course is ideally suited for: Practitioners involved in project finance transactions Government/PPP Agencies Bankers/Investment Bankers Project Finance Modellers Financial Advisors Sponsors/Project Joint Venturers Business Developers Credit and fixed-income analysts Lawyers in banking, corporate or infrastructure Accountants Multilateral or bilateral agencies Public sector managers Project consultants Investment/portfolio managers
Day 1 Introduction to project finance The course begins with introductory comments about the skills and general objectives in project finance analysis with an emphasis on the difficulty in measuring and valuing risk. Project finance terminology, the structure of project finance debt, project contracts and other issues are discussed in the context of a case study and a completed project finance model. Subjects discussed in the first module include: Overview of project finance terms/project finance versus corporate finance Project finance definition and definition of selected terms Phases in project financing Structure and contracts in project financing Characteristics of project finance debt and debt service coverage Project finance analysis compared to traditional corporate finance Advantages and disadvantages of project finance sponsor Advantages and disadvantages of project finance Government/off-taker Excel Case exercise: simple project finance model Industry sectors and different risks in project finance Sectors that are not applicable (high-technology/innovation) Commodity pricing: oil and gas Commodity pricing: mining Take or pay contracts: electricity independent power and water Merchant power plants: electricity independent power Renewable energy and resource analysis Infrastructure with traffic risk Infrastructure, public finance and availability payments Case study risk identification and general terms in a project finance transaction Overview of transaction structure Reasons for use of project finance Risk classification – risks during different project phases; political, market Risk identification – description of different risks Risk mitigation – alternative techniques and limitations Risk coverage – break even analysis and debt service coverage Cash exercise: measurement of break even using DSCR Issues addressed in the first session include: What is the big deal about project finance and what makes project finance different from other forms of financing? Where does debt and equity money come from these days in project financing? What are the benefits of project finance relative to the high fees received by lawyers and bankers? Where has project finance been used and what have been the largest project financings? What type of risks should be evaluated in project finance to test when projects go bad? Day 2 Technical mechanics of project finance The second part of the course covers technical mechanics of project finance transactions as well as valuation and credit analysis. The valuation section addresses appropriate use of equity and project internal rate of return and net present value. The credit analysis describes use of debt service cover and other ratios to measure the credit risk and debt capacity of a project. Issues addressed in this part of the course include: General contract structure in project finance using case study Concession agreements and build own operate Relationship between contracts and back-to-back contracts Insurance and third party support Government guarantees Structuring special purpose vehicles - Structure of financing and dividends - Flip structures - Conflicts of interest and limits on negotiation - Case exercise with Excel: cash flow flip and risk transfer Concession contract/off-take contract - Applicability to different industries - Structure and Usage versus availability payments - Timing and costs of delay - Termination issues - Case exercise with Excel: bidding for contracts Construction ontract - Lump-sum fixed price versus cost plus - Limited recourse and responsibility for cost over-runs - Milestones and conditions precedent for draw down - Relationship with operation contract and off-take contract - Force majure and limitations on responsibility of contractor - Completion tests - Liquidated damages for performance - Liquidated damages for delay - Case Exercise with Excel: computation of liquidated damages for delay Operation and maintenance contract and supply contracts - Relation with construction contract - Incentives in operation contract - Responsibilities of operator - Take or pay supply contracts Political risk insurance - Basic three - Applicability to debt and equity - Additional risk insurance - Payment conditions for risk insurance - Development institutions and leverage Analysis of debt sizing, debt structuring and returns in project finance Bank loans versus bonds Debt structuring in tight transactions versus loose transactions Debt structuring Key Features - Timing of debt and equity draws during construction - Treatment of cost over-runs - Pricing of debt and changing spreads - Debt tenor and grace periods - Alternative debt repayment methods (level, annuity, sculpted) - Debt service reserve account - Covenants - Cash flow sweeps - Case exercise: Excel exercise with debt structuring and debt sizing Some of the issues addressed in this session include: How are project IRR’s and the equity IRR’s used in making investment decisions? What is the difference between equity cash flow, free cash flow and cash flow for debt service? What debt service coverage ratio is appropriate for various types of projects? Why do bankers use the LLRC and PLCR in measuring the credit risk of a project? Day 3 Understanding project finance models and financial statements After the introductory discussion, participants construct a basic project finance model to become familiar with the structure of a project finance model, equity cash flow and free cash flow. The model is then used to demonstrate how interest during construction, multiple equity sources and target debt service cover can be added to a model. Once the fundamental model is built, it is used in the context of simple applications involving debt capacity, contract pricing, debt structuring, break-even analysis and probability of default. Construction of a simple model involves the following: Objectives of project finance models Structuring and tight DSCR projects Computation of contract prices and other contract terms Risk analysis and sizing in downside cases Development of assumptions and alternative scenarios Key parameters in project finance models Analysis of models and evaluation of key decisions Project finance models versus other kinds of models Mechanics of project finance models Setting-up project phases in model Sources and uses of funds statement during the construction period Debt schedule and connection with cash flow statement for sweeps, traps, defaults, and DSRA Income statement to compute income taxes Cash flow statement and cash flow waterfall Computation of model outputs – equity IRR, DSCR, LLCR, and debt IRR Avoiding bad practices in modelling Best practice objectives Inputs and organization Transparent calculations Simple formulas Auditing, balance sheet and model checks Technical issues after construction Computation of tax depreciation and amortisation of fees Cash flow waterfall mechanics and issues - Debt service reserve account cost and benefits - Working capital facilities - Cash flow sweeps - Cash flow trap covenants - Subordinated debt - Maintenance reserve accounts Alternative computation of debt service coverage ratio Equity cash flow and free cash flow Project finance valuation with models Cash flow as basis for valuation Project IRR to screen projects Equity IRR to structure projects Modified IRR and NPV versus unadjusted IRR Payback and other valuation metrics Reading and interpreting models Re-creating models Testing models for extreme changes in key variables Computation of equity IRR Some of the issues addressed in this session include: What basic components should be included in a project finance model? How should the model be developed to assure flexibility in debt terms? How can a project finance model be used to compute the debt capacity of a project? What techniques should be used in computing the financial ratios for a project? How can a project finance model be used in determining contract prices? How can interest during construction be incorporated in a model? Day 4 Risk analysis in project finance This part of the course involves discussion of modelling mistakes, model layout and best practices spreadsheet conventions as a prelude to hands-on work on a comprehensive model. Lectures address the objectives of project finance models, mistakes that have been made in project finance models, how models should be laid out and best practices in programming a model. The objective is to explain the fundamental structure of a project finance excel model and excel techniques that create efficient, robust and stable project finance models. Evaluation of project finance statements Accounting issues in project finance – depreciation, interest during construction, income taxes, dividends Equity cash flow, project free cash flow and cash flow available for debt service Importance of cash flow in project finance relative to income Cash flow waterfall Balance sheet changes over time Analysis from sponsor perspective Cash flow as basis for valuation Project IRR and pre-tax IRR versus equity IRR Feasibility study and project IRR versus interest rate to screen projects Development costs and show stoppers Value for money analysis in PPP projects Equity IRR requirements and equity IRR adjustments Modified IRR and NPV versus unadjusted IRR Payback and other valuation metrics IRR and risk sharing in PPP projects Equity returns and valuation in case study Risk and credit analysis in project finance Risk classification, risk mitigation and risk allocation matrix Understanding alternative fundamental business risks in project finance -Risks from statistical analysis in renewable resource - Risks of commodity prices, volatility and long-term prices - Risks of traffic studies and track record of forecasts - Risks of unconventional technology - Off-taker risks Why DSCR is the central measure of risk for lenders in project finance Construction of realistic downside case assumptions Sizing of debt using DSCR in base case versus downside case Case study of risk and return Risk allocation in the PPA Construction risk Operation risk Risk mitigation Some of the issues addressed in this session include: What have been analytical mistakes in project finance failures? What are examples of risks that have cause major projects to fail such as Eurotunnel, Euro Disney, U.S. merchant electric plants and Enron’s Dabhol LNG plant? How should risks be classified and mitigated in project finance? What are some of the excel rules that guide accurate and efficient development of models? How can project finance models be audited to check errors that we will make? What should we do to incorporate alternative debt structures and interest during construction into the model? Day 5 Re-financing, covenants and risk mitigation in project finance This part of the course involves performing analysis with the case study. The course module addresses effectiveness of covenants, cash flow traps, and alternative levels of senior and subordinated debt issues. In addition, the model includes cash flow waterfalls, covenants, defaults and cash traps. The analysis deals with how risk and return can be gauged through equity IRR and debt service cover. Issues covered in analysis of the case study include: Re-financing in project finance Theory of re-financing Benefits from re-financing Effects of re-financing for different types of projects Mechanics of re-financing and dividends Re-financing and measurement of equity IRR Re-financing in Chad Cameroon and Cape Verde case studies Measurement of risk and return Risk analysis using break-even points on debt IRR and risk with different senior and junior debt IRR and risk with different cash flow trap structures Debt service reserve accounting and modelling Accounting for debt service and other reserves Illustration of impacts in project model Circularity problems Interest income Covenants in project finance Positive and negative covenants Project finance covenants versus corporate covenants Covenants and risk analysis of projects Examples of covenants Some of the issues addressed in this session include: What types of covenants are included in project finance transactions? Is it more important to trap cash during good times or develop covenants that prevent cash from leaving the project when times are bad? How much safer is senior debt than junior debt? Should cross defaults be included in the transaction? What is the appropriate level for various covenants and what financial ratios should be used in the covenants? How can we model inflows and outflows from a debt service reserve? What complications arise from modelling senior and subordinated debt tranches? Can we really quantify the cost and benefits of covenants and cash flow traps? What should we do to the model when a debt payment default occurs? Course summary and close
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