Project Finance Terminology

Project finance is the funding (financing) of long-term infrastructure,  industrial projects, and public services using a non-recourse or limited  recourse financial structure. The debt and equity used to finance the project are paid back from the cash flow generated by the project. 

Project financing is a loan structure that relies primarily on the  project's cash flow for repayment, with the project's assets, rights,  and interests held as secondary collateral. Project finance is  especially attractive to the private sector because companies can fund  major projects off-balance sheet (OBS). 

• Project finance involves the public funding of infrastructure and other long-term, capital-intensive projects.
• This often utilizes a non-recourse or limited recourse financial structure.
• A debtor with a non-recourse loan cannot be pursued for any additional payment beyond the seizure of the asset.
• Project  debt is typically held in a sufficient minority subsidiary not  consolidated on the balance sheet of the respective shareholders (i.e.,  it is an off-balance sheet item).

The project finance structure for a Design, Finance, Build, Own, Operate Manage and/or Transfer (DFBOOM/T) project includes multiple key elements. 

Project finance for DFBOOM/T projects generally includes a Special Purpose Vehicle (SPV). The  company’s sole activity is carrying out the project by subcontracting  most aspects through construction and operations contracts. Because  there is no revenue stream during the construction phase of new-build  projects, debt service only occurs during the operations phase. 

For this reason, parties take significant risks during the construction  phase. The sole revenue stream during this phase is generally under an offtake agreement or power purchase agreement. Because there is limited or no recourse to  the project’s sponsors, company shareholders are typically liable up to  the extent of their shareholdings. The project remains  off-balance-sheet for the sponsors and for the government. 

Not all infrastructure investments are funded with project finance.  Many companies issue traditional debt or equity in order to undertake  such projects.

Project debt is typically held in a sufficient minority subsidiary not  consolidated on the balance sheet of the respective shareholders. This  reduces the project’s impact on the cost of the shareholders’ existing  debt and debt capacity. The shareholders are free to use their debt  capacity for other investments. 

To some extent, the government may use project financing to keep project  debt and liabilities off-balance-sheet so they take up less fiscal  space. Fiscal space is the amount of money the government may spend  beyond what it is already investing in public services such as health,  welfare, and education. The theory is that strong economic growth will  bring the government more money through extra tax revenue from more  people working and paying more taxes, allowing the government to  increase spending on public services. 

When a company defaults on a loan, recourse financing gives lenders full  claim to shareholders’ assets or cash flow. In contrast, project  financing designates the project company as a limited-liability SPV. The  lenders’ recourse is thus limited primarily or entirely to the  project’s assets, including completion and performance guarantees and  bonds, in case the project company defaults. 

A key issue in non-recourse financing is whether circumstances may arise  in which the lenders have recourse to some or all of the shareholders’  assets. A deliberate breach on the part of the shareholders may give the  lender recourse to assets. 

Applicable law may restrict the extent to which shareholder liability  may be limited. For example, liability for personal injury or death is  typically not subject to elimination. Non-recourse debt is characterized  by high capital expenditures (CapEx),  long loan periods, and uncertain revenue streams. Underwriting these  loans requires financial modeling skills and sound knowledge of the  underlying technical domain. 

To preempt deficiency balances, loan-to-value (LTV) ratios are usually limited to 60% in non-recourse loans.  Lenders impose higher credit standards on borrowers to minimize the  chance of default. Non-recourse loans, on account of their greater risk,  carry higher interest rates than recourse loans. 

If two people are looking to purchase large assets, such as a home, and  one receives a recourse loan and the other a non-recourse loan, the  actions the financial institution can take against each borrower are  different. 

In both cases, the homes may be used as collateral, meaning they can be  seized should either borrower default. To recoup costs when the  borrowers default, the financial institutions can attempt to sell the  homes and use the sale price to pay down the associated debt. If the  properties sell for less than the amount owed, the financial institution  can pursue only the debtor with the recourse loan. The debtor with the  non-recourse loan cannot be pursued for any additional payment beyond  the seizure of the asset.