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BY MATTHEW BERNATH
CONTENTS
SUMMARY ------------------------------------------------------------------------------ 12
FINANCIALMODELLINGPODCAST.COM
1
• Project Finance models are put together to assess the financial feasibility of a project to be
undertaken by a new entity - in other words, off-balance sheet lending
• These models assess the cash flows on a period by period basis and show returns for
shareholders
• They also show the banks that the projects are financially capable of repaying debt, with
enough room to spare
• Banks want to ensure that there is ‘breathing room’ in the project – what if operations are
disrupted and no cash flow is generated for some time?
• On the other hand, Shareholders want to ensure that returns are worth the risk of undertaking
large, often infrastructure related projects with long-term (15-20 years) payback periods
• Non-recourse debt is used, where the assets related to the project are at risk if there is an
event of default
Figure 3: The project finance model is a 20-30 year forecast of construction and operations.
• By separating the "project" from the rest of the sponsor company enables a higher level of
gearing than would normally be acceptable to the company and the banks
• The level of debt can be anywhere from 50% to 85% depending on the project, the cover ratios
and the certainty of revenue and what guarantees may be in place
• There are certain metrics which measure the ability to repay the debt
• This includes DSCR, LLCR, PLCR on a Senior and Total Level (Senior for Senior debt and Total
for all debt in the project which may include subordinated debt)
• A project finance model is significantly different and often more structured than a typical
financial model.
• Money is reserved for ongoing Capex, debt payment and potential shortfalls
• Interest capitalised or paid during construction is funded as part of the initial capital raise
• Cash flows are sufficient to pay off debt and pay dividends to shareholders
• Cash flows over the life of the loan and the project provide breathing room in case of
performance issues
CFADS Cash Flow Available for Debt Service, typically revenue less expenses and tax
DSCR Debt Service Cover Ratio (CFADS divided by Senior Debt Service)
LLCR Loan Life Cover Ratio to measure the cover in the loan life
PLCR Project Life Cover Ratio to measure the cover in the project life
Lenders Technical Adviser, who provides the lender with the assurance that the project
LTA
is technically sound
ECA Export Credit Agency who may assist in providing insurance on loans
Engineering, Procurement and Construction which is basically the party responsible for
EPC
the construction part of the project
The P-Value that the plant is assumed to run at, typically for projects where a statistical
P-Value analysis of revenue can be performed and there is enough history to perform this
analysis!
Power Purchase Agreement for projects that generate power such as wind farms and
PPA
solar farms
Public-Private Partnership for projects that involve both government and the private
PPP
sector providing crucial infrastructure for public benefit
CASH FLOW
Distinct construction and operation phases – during construction typically there is no revenue, so
interest on debt drawn down needs to be accrued or more debt needs to be drawn to pay the
interest!
• No revenue as the revenue generating asset (a wind farm or a public transport system has no
revenue being generated while it is built) is being built
• Cash Flows in multiple currencies – especially if equipment needs to be procured from other
countries and paid for in that country’s currency
• Set capital sources – project financing is characterised by a fixed amount of capital, and any
cost overruns need to be funded by equity
• Penalties for construction overruns (LDs and PPAs being shorter)
• FX and Interest Rate Hedges to mitigate risks of uses of funds exceeding sources of funds
• Sometimes certain revenue and sometimes revenue that can fluctuate with usage or
seasonality
• Long-term debt (double or longer the tenor of corporate debt)
• Multiple tranches of debt – senior and mezzanine debt that take on different risks depending
on where they sit in the capital structure
• Debt that is highly structured (e.g. capitalised interest, drawdowns, sculpted repayments)
ANYTHING ELSE?
The financial model also needs to show clearly:
• Insurances
• Hedging Structures
• Senior Debt, Mezzanine/Subordinated Debt and Equity Returns
• Multiple scenarios and production/revenue stresses
• That delay LDs can cover debt repayments if required
• The cash flow waterfall shows the flow of cash as it comes in per period
• Revenues: Operating revenues and other income
• Expenses: Operating expenses and capital expenses
• Reserve Account Movements
• Tax
• Debt service: Principal repayments and interest paid
• Distributions: Dividends to Equity and Shareholder Loan Repayments
• Net movement in cash balance
There are some key project finance characteristics here that are crucial for the financial model:
• Cash Flow Available for Debt Service or CFADS is used for all cover ratio calculations such as
DSCR, LLCR and PLCR
• Cash flow before funding: This line is useful as a quick check against funding, to ensure that
initial construction costs are being met by debt or equity (i.e. the project has to be fully funded)
• Cash flow available for debt service reserve account (DSRA)
• Cash flow available to equity to calculate distributions
• Net cash flow - Usually zero, unless cash is being restricted from being paid to equity
• The debt service reserve account (DSRA) works as an additional security measure for lenders
• The DSRA is generally a deposit which is equal to a given number of months projected debt
service obligations (principal and interest).
• The purpose of a DSRA is to provide a cash buffer during periods where cash available for debt
service (CFADS) is less than the scheduled payments
• This buffer allows some breathing room for operational issues to be resolved and/or, in more
extreme situations, the debt to be restructured before the borrower defaults on the debt.
• When capital expenditure is lumpy and/or large it is common to need to consider and model
a major maintenance reserve account (MMRA)
• During the operational phase of a project, capital investment is required to ensure that the
project is able to continue operating as planned, this can even include minor maintenance and
upgrades
The MMRA is designed to accumulate funds to ensure the funds are there when they are needed,
instead of having a large cash requirement in that operating period
Figure 11: The lender also wants to ensure all the project risks are covered.
SUMMARY
To summarise a project finance model, it depicts a project in multiple Excel worksheets that show:
Still interested in project finance? Listen to the Financial Modelling Podcast episode where we
interview Dario Musso, head of Infrastructure Finance at Rand Merchant Bank, on the importance
of financial modelling for infrastructure projects.
Matthew
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