Project Finance: Lenders Viewpoints

 

Project Finance: Lenders Viewpoints and Evolution Tendency.

The past few years have brought a flood of new Project finance options to the power and infrastructure. And that has finally put infrastructure financing — particularly in the emerging markets — onto solid footing.

The wellsprings of the flood are varied: a sustained period of low interest rates; the emergence of institutional capital targeting infrastructure as an asset class; the rise of local currency financing; the growth of sustainable investment vehicles. Together, they all add up to a swell of new financing options becoming available to infrastructure projects.

Project finance lenders employ rigorous credit analysis methods to minimize risk when dealing with issues including stringent financial regulatory requirements, new biomass-to-energy power project sponsors, new independent power producer rules, and new biomass technologies and fuel sources. 

This article outlines the credit analysis process and provides insight into a typical lender’s credit rating methodology, with a focus on biomass-to-energy projects.

                      Project Finance: Lenders Viewpoints and Evolution Tendency.

Lenders Viewpoints
Corporate finance quantitative analysis commonly uses internal rate of return and net present value as evaluation methods. These methods are useful in evaluating mutually exclusive projects-projects whose costs and economics are independent from one another-from the perspective of the project sponsor.

Both internal rate of return and net present value evaluation techniques require a basic understanding of the cost of capital, which is the opportunity cost of future cash flows made by the firm. For example, if the cost of capital to a firm is 10 percent, the firm can either reinvest future cash flows in other projects that yield a 10 percent return, or it can repay capital originally borrowed at 10 percent interest. Cost of capital is also known as opportunity cost of capital or investment hurdle rate.

Project Finance Credit
The elements of determining credit risk for a project finance transaction can be used to attract favorable lending to projects, particularly in the biomass-to-energy power sector.

Credit that makes sense to project sponsors can be difficult to obtain. Insufficient experience and an incompletely defined project may attract loans only from local banks with expensive interest rate terms. A properly defined project that can pass rigorous due diligence, however, can attract more favorable lending terms from international banks.

Credit risk assessment of a project special purpose vehicle is addressed by the Bank for International Settlements Basel Committee on Banking Supervision Publication 118. The publication is the guideline for the Basel II accord, the principles that govern overall capital markets regulation. Annex 6 of the document addresses evaluation criteria for specialized lending, including project finance.

A project feasibility study performed by a consultant specializing in biomass-to-energy projects typically identifies basic transaction characteristics. A more advanced consulting approach is usually required to identify other supervisory criteria. In addition, legal counsel is commonly engaged to draft basic security terms, and supply and offtake contract terms.

Challenges to financing biomass-to-energy projects include providing evidence of sponsor strength and comprehensive offtake contract terms. Sponsor strength with common fossil fuel power plants is readily obtainable in most cases: legacy utility companies usually have an established regional presence and a deep management structure with relationships in the region. Biomass-to-energy power plants, on the other hand, are usually smaller, more entrepreneurial ventures whose sponsors may have little or no experience in running a small-scale utility business. Two factors are paramount for seeking biomass project finance. The first is transparent ownership. The project sponsor must have a corporate structure with registered capital that can be readily reported to lenders. The project sponsor must also clearly identify board members, equity contributors and key management to satisfy banks’ Know Your Customer rules.

Project Evolution Tendency
Two key trends pertinent to biomass-to-energy project development are discussed below. The first is power infrastructure in emerging economies. Emerging economies, particularly in Asia-Pacific nations, are continually challenged by insufficient power supply to meet demand. The problem is magnified in nations where rural electricity is limited by physical barriers or political challenges.

Accordingly, many nations have established independent power producer frameworks that promote smaller, private-sector-owned power plant development while guaranteeing a connection to the national power transmission grid. These applications, typically limited in size to approximately 10 to 50 megawatts, create many opportunities for small power producers. In heavy agricultural regions or in countries with national biofuels policies, the availability of biomass fuel sources and the promise of independent power producer policy may create the ideal climate for investing in biomass-to-energy projects.

The second key trend is in project finance markets. The first quarter of 2008 saw the highest-ever volume of project finance transactions worldwide, with more than 125 transactions totaling $56.4 billion, according to the Thomson Financial First Quarter 2008 Global Project Finance Review. Recently, two subsets of the global project finance market have demonstrated consistent strength: the Asia-Pacific region and the power sector. Although Europe, the Middle East and Africa lead the world in volume (67 issues, $26.7 billion in loans), the Asia-Pacific region, with $23.3 billion in volume, has been beating its own quarter-by-quarter records. In fact, the region’s rate of increase in project finance transactions is the highest in the world.

In contrast, the Americas trail the global project finance market, with only $6.4 billion in loans. The important conclusion is to recognize that developing nations with relatively stable political climates, as in much of East Asia, are leading the deployment of project finance capital.

The most active sector in recent quarters is the power sector. In the first quarter of 2008, project finance transaction volumes in the power sector increased by 7.2 market share points relative to other sectors (total borrowed volume of $23.4 billion).

Despite the overall downturn in credit, Havelet Finance Limited is still waxing stronger in all related project financing needs especially in the biomass-to-energy project financing.

Havelet Finance Limited as Project finance lenders alongside specialty consultants’ use of the analysis methods discussed herein have ensured that financing for biomass-to-energy ventures will continue to provide stable returns on investment, particularly in the booming Asia-Pacific- EU- and African region.

https://www.havelet-finance.com/renewable-energy-fianancing
credit@havelet-finance.com