Federation of GCC Chambers Conference on Frameworks for funding industrial projects 12 October 2010.

Federation of GCC Chambers Conference on

Frameworks for funding industrial projects

12 October 2010

Banks

Sukuk

ECA

Public

Bo

nd

Banks

Sukuk

ECA

Public

Bo

nd

2

Agenda

Lay of the Land

What is Project Finance?

Structuring Considerations

Sources of Liquidity

Financial Process & Scheduling

3

The Economic Backdrop - Global

What has happened is known; what will happen is now the subject of much debate .....

Source: HSBC Research

New questions over EuropeGlobal - Real GDP growth

-6.00%

-4.00%

-2.00%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Developed Emerging

4

Despite significant regional government liquidity, the Middle East has not been immune to the effects of external liquidity constraints

Source: Dealogic, 12 May 2009

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

0

5

10

15

20

25

30

35

40

45

50

Volume (US$m) No. of loans

Volume (US$m) No. of loans

2005 2006 2007 2008 2009

Key Player – The Middle East

5


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Form of lending which can be be applied to a wide range of industries and involves the financing of a single major capital investment

For which repayment (either largely or exclusively) of the lenders relies on the cash flow and assets of the project, with such debt facilities being “limited” or “non-recourse” to the owners of the asset

Project finance facilities are typically provided to a SPV (a project company) established by the project sponsors solely to own and operate the project

A form of asset based finance

driven by cashflow analysis

Significant advantages to

lenders as well as owners

Shareholders

Project

LendersRelative Repayment Risk

Low High

Shareholders

Lenders

Commercial and Financial Completion support

Project

= Lender credit risk

7

Why is Project Finance used?

Allows for high levels of leverage and is therefore investment enhancing

Enables cash constrained - or risk averse - project sponsors to raise significant amounts of debt - and share risks - whilst still retaining the benefit of equity upside

Enables sponsors to leverage off general banking relationships to (1) potentially circumvent constraints on corporate debt, and / or (2) access longer term funding

Facilitates multiple joint venture partners raising finance to undertake major projects, especially if the partners have different credit standing

Depending on the country / industry,

project finance may offer

significant advantages for

Project hosts or sponsors...

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Project Finance vs Corporate Lending

Corporate Lending

Full recourse

Lenders rely on established balance sheet and cash flow

Credit analysis and rating

Usually unsecured

Limited covenants (financial, cross default and negative pledge)

Relatively low fees and margins

Short to medium tem tenor

Refinancing risk

Project Finance

Limited or non recourse

Security over project assets including physical and accounts

Detailed economic and financial analysis carried out by lenders with support of independent consultants

Comprehensive covenant package (affirmative, negative)

Usually relatively high fees and margins, although current trends favourable to borrowers

Long term tenor

Key differences between

corporate lending and project

finance

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Structuring Considerations

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Lenders closely scrutinize the Project’s rationale and its ability to withstand difficult market conditions. The following aspects in relation to project economics are analyzed:

Demand / supply analysis and likely competition

Evidence ability to generate sufficient cash against credible product pricing forecasts

Project’s competitive advantage, including:

– Feedstock volume and pricing

– Terms and conditions of the offtake arrangement

Project Economics and Rational

In structuring the financing, it is important

to ensure complementary

contracting and product marketing solutions

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Project Finance – identifying the risks

The risks associated with the repayment of the project debt can be categorised into three broad areas:

Completion Risk

Operational Risk

Revenue Risk

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Completion Risk & EPC Contracting Strategy

Completion risk is at the core of any project

finance structuring given that this

determines the availability of future

cash flow

If a full guarantee is to be avoided then completion risk

mitigation and allocation become the

critical elements of the financing

Completion risk for projects is basically a function of construction strategy:

– Which parties are responsible for completion?

Lenders’ “default” position will be a full completion guarantee (full repayment)

There are other forms of completion support

Residual Risks

(non-insurable FM, EPC performance)

Completion Risk

Vendor Performance

Engineering

Process technology

Insurable Force Majeure

EPC Contractor(s)

Process Licensor(s)

Insurers

SponsorsLenders

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Revenue Risks

It is usually necessary that an independent market advisor to lenders indicate that the Project will be competitive based on

– Relatively low feedstock costs

– Economies of scale

– Detailed marketing and logistics planning

Lenders will require independent product price forecasts

Lenders will expect term sheet risk mitigation items for short term variations

– Debt Service Reserve Account

– Dividend lock-up tests

– Variable repayment schedules

– Occasionally contingent equity is required

Lenders will usually take some revenue risks

when they are comfortable with the

Project

Utility projects are often financed without such

risks, however

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Revenue Risks

Lenders will usually take some revenue risks

when they are comfortable with the

Project

In other sectors the long-term offtake obligations come from one or a small number customers (for example in the LNG or power and water sectors)

Due to the nature of the petrochemical business and the large number of customers, long-term volume offtake commitments from shareholders are often considered, provided they are “natural” petrochemical players; third parties may be considered if shareholder group not sufficiently experienced

Product sale contracts can vary between long-term marketing arrangements and long-term volume offtake commitments

Production ramp-ups are usually built into the contracts

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Technical & Operating Risks

Technical risks relate to the risk of the plant being capable of operating reliably on the basis that it has been designed to – one of the two components determining the plant’s cash flow (the other being refining margins)

– Technical problems can be either process or mechanically based

– Mechanical problems will usually be covered under the terms of the EPC contract

– Although the process technology deployed in refining tends to be viewed as less of an issue than in typical petrochemical plants, the multiple processes involved can give rise to concerns over inter-licensor disputes in the event of non-performance

In addition to concerns over technical operating issues, lenders will also require comfort that the operator of the plant is sufficiently experienced

Different models can be used, usually either an external O&M contractor (which could be sponsor) or operating staff hired directly by the project SPV

Lenders will require a detailed due diligence report by an engineering firm to review these risks and it is important that this process is controlled

Operational reliability post-construction is a

critical area for lenders and external

advice will be sought to analyse the risks

involved

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Key Due Diligence Areas

Thorough audit of the Financial Model by a recognised Accountancy firm/ Model Auditing specialist

Production of Model Audit Report on behalf of the LendersModel Audit

Review of proposed Insurance Programme (incl. levels of cover, principal exclusions, deductibles etc)

Production of Independent Consultant’s report on behalf of the Lenders

Insurance

Detailed review by Lenders’ Legal Counsel of all Project contracts

Detailed review of local law issues that may affect the Project

Detailed review of Lenders’ security arrangements

Production of Legal Counsel’s report on behalf of the Lenders

Assist lenders in negotiation and drafting of Finance and Security Documents

Legal

Conduct analysis of the target export markets

Produce and agree price forecasts to be used in the Lenders’ Base Case Financial Model

Evaluate the competitiveness of the Project compared to competing plants elsewhere in the world


Market

Conduct Environmental & Social Impact Assessment

Categorise Project under EP and evaluate EP compliance

Develop Environmental and Social Action Plans

Production of Independent Consultant’s report on behalf of Lenders confirming EP compliance

Environment

Independent review of technology, and key operating assumptions etc

Independent review of capex budgets, construction timetable etc


Technical

Key ActivitiesDue Diligence Area

Thorough audit of the Financial Model by a recognised Accountancy firm/ Model Auditing specialist

Production of Model Audit Report on behalf of the LendersModel Audit

Review of proposed Insurance Programme (incl. levels of cover, principal exclusions, deductibles etc)


Insurance

Detailed review by Lenders’ Legal Counsel of all Project contracts

Detailed review of local law issues that may affect the Project

Detailed review of Lenders’ security arrangements

Production of Legal Counsel’s report on behalf of the Lenders

Assist lenders in negotiation and drafting of Finance and Security Documents

Legal

Conduct analysis of the target export markets

Produce and agree price forecasts to be used in the Lenders’ Base Case Financial Model

Evaluate the competitiveness of the Project compared to competing plants elsewhere in the world


Market

Conduct Environmental & Social Impact Assessment

Categorise Project under EP and evaluate EP compliance

Develop Environmental and Social Action Plans

Production of Independent Consultant’s report on behalf of Lenders confirming EP compliance

Environment

Independent review of technology, and key operating assumptions etc

Independent review of capex budgets, construction timetable etc


Technical

Key ActivitiesDue Diligence Area

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Sources of Debt

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Despite difficult market conditions, the Saudi-based institutions have actively provided balance sheet capacity for top-tier Saudi projects and relationship clients.

12 primary domestic Saudi banks, out of which 7 are considered to be active in project finance transactions in Saudi Arabia

Inma Bank, Rajhi Bank and to a certain extent National Commercial Bank finance only Sharia compliant debt facilities. Other active banks in the PF market will have the capability to fund on Islamic or conventional basis

Saudi banks have fared better compared to other international and regional banks. None of the Saudi banks have had to request any government support or to raise additional equity to shore up balance sheet

Due to severe shortage of liquidity and risk averseness in the international market, Saudi banks have significantly reduced their lending in US Dollars

Saudi Commercial Banks

Aided by a stable depositor base, strong

capital adequacy ratios and continued growth in

the local economy, Saudi banks continue to

represent an important source of funding for

projects in KSA

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Regional and international banks have been severely impacted by the financial crisis, with most of the banks having to resort to government funding due to significant investment writedowns

It will take these banks some time before they are able to restore their financial strength and play a major lending role in projects in the region and Saudi Arabia

Currently, the pool of liquidity available to projects from international and regional banks is much smaller than that seen during times before the financial crisis. The international and regional banks have the following characteristics:

Selective participation in projects within the region with focus on enhancing existing relationships

Understand the risks of project finance lending activity in Saudi Arabia but focussed on reducing their Risk Weighted Assets

Concern over tenors and pricing are a dominant theme

Likely to increase involvement in ECA covered facilities

Appetite from this liquidity pool is

mostly dependant on availability of

ECA cover

Regional and International Banks

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The SIDF usually has a longer approvals process as it involves detailed review of technical and market issues by SIDF’s own experts.

SIDF has a normal lending limit per project of US$160m for an LLC. However if there the Project comprises multiple plants then multiple loans can be granted of up to 50% of project cost or US$530m whichever is lower

In order to manage the timing issue, SIDF as soon as possible upon completion of the feasibility study and completion of application formalities such as application form, copies of industrial licences, commercial registration of project companies applying for the loan, copies of commercial agreements, quotes from EPC contractors, etc.

Given the time required for first drawdown, SIDF loan will however still need to be bridged by Saudi commercial banks.

Saudi Industrial Development Fund

SIDF remains an important participant in

project financings in KSA

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PIF is a main source of concessionary financing available in the Kingdom

One of the main conditions for PIF participation is direct or indirect government ownership of at least 5% of the project. In any case, PIF's board of directors has the discretion to set PIF's investment strategy, as well as the parameters that must be met before PIF makes an investment

PIF currently has increased its limit to lower of 40% of total project cost or US$1.3 billion (US$ 800 million where the project company is not majority owned by the government)

The terms and conditions generally match those of the commercial tranches which make it an attractive source of concessionary financing

From our experience, if both SIDF and PIF are considering participation in a project, PIF approvals will almost always follow SIDF approvals.

If PIF financing is not available at financial close, additional commitments can obtained from the local commercial banks to bridge the financing gap on temporary basis

The PIF is a main source of concessionary

financing available in the Kingdom

Public Investment Fund

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Export Credit Agencies (ECAs) - I

ECAs are government sponsored agencies which exist to promote the export of goods and services from within their countries

They function by providing direct loans, guarantees or insurance policies to commercial banks

In most cases the level of ECA support is directly ‘tied’ to procurement of eligible goods and services although ‘untied’ facilities are also possible

The financing terms ECA can provide are governed by the OECD Consensus Guidelines. This covers areas such as:

– Specific ‘content’ requirements

– Minimum contract down payment of 15%

– Support capped at 85% of contract value

– Maximum repayment term of 14 years (with average life of 7.25 years)

By providing credit enhancement to lenders

ECAs can facilitate greater appetite, longer

tenors and cheaper pricing than purely

commercial sources of funding

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Increasing proportion of hard currently liquidity …but critical to pair with a considered procurement strategy.

Commercial banks provide a loan to the Borrower. This loan benefits from a guarantee or insurance policy from the ECA The proceeds of this loan is used to pay for specific goods and services from the exporting country The ECA is paid a premium/guarantee fee

Project Company

Exporter ECAs

Lenders

Drawings

Loan Agreement

Principal & Interest

Political or comprehensive

insurance and/ or direct loan

Premium

Commercial Contract

Application Documentation

Goods & Services

Export Credit Agencies - II

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Since 2002, ECAs became an increasingly important source of financing in the region. Pre-financial crisis the ECA lending to project increased due to:

Upgrade in OECD country risk classification for Saudi Arabia from category 3 to category 2 in Nov 2005

ECA financing became much more competitive compared to cost of borrowing from commercial banks

Scale and number of opportunities combined with historically low exposure to Saudi Arabia resulted in substantial ECA appetite

Strong track record of ECA support was established for both limited and full recourse financings in Saudi Arabia, for example SEPC, Hadeed, Yansab, Petro-Rabigh, and Shuaibah

Interest of ECAs was not limited to tied facilities linked to specific exports of goods and services but also started extending to untied facilities where there was a wider national interest.

For well-structured projects in Saudi

Arabia, we anticipate that

ECAs would be keen to continue

providing support with expected

participation dependant on the EPC procurement

strategy.

Export Credit Agencies - III

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In light of reduction in appetite from international and regional banks post financial crisis, there is substantially increased demand from sponsors for ECA support. This has led to:

ECAs focussing more on supporting projects involving contractors and equipment providers from their home countries (ie less focus on untied ECA financings)

ECA premiums have increased in some cases to reflect changes in perceived risk while bank pricing for funding ECA assets has risen substantially as a result of liquidity charges

ECA supported financing continues to be very competitive for borrowers and attractive for banks given very low return on weighted assets

Where ECAs provide direct lending programmes these have also seen increased demand, given the attractive long-term fixed interest rates and the reduced liquidly of commercial banks even for covered facilities

For well-structured projects in Saudi

Arabia, we anticipate that ECAs

would be keen to continue providing

support with expected

participation dependant on the EPC procurement

strategy.

Export Credit Agencies - IV

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Multilateral Agencies

Multilateral Agencies are financial institutions jointly owned by a group of countries and designed to promote international and regional economic co-operation

Examples of Multilateral Agencies include:

– International Finance Corporation (IFC)

– European Investment Bank (EIB)

– European Bank for Reconstruction and Development (EBRD)

– Asian Development Bank (ADB)

– Islamic Development Bank

Have ‘developmental’ agendas and can be useful in certain markets

Can provide a range of funding including direct lending and equity participation

Commonly used instruments on project finance transactions are:

– EIB direct loans (with or without bank counter guarantees)

– IFC / EBRD ‘A’ – ‘B’ Loans

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The Financing Process

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The Project Finance Process: Summary Timeline

Estimated Timeframe:

3 - 6 months

PHASE 5

1. Negotiation of Project and Finance Agreements

2. Achieving Financial Close


3 months

PHASE 4

1. EPC finalisation

2. Launch to market

3. Preferred bank selection


2 - 4 months

PHASE 3

1. EPC bid review

2. Lender due diligence

3. Document drafting

4. Info Memo


2 - 4 months

PHASE 2

1. Tender for Contractors

2. Commercial Development

3. Term sheet development

PHASE 1

1. Prioritise Key Project Objectives

2. Finalise JV Discussions

3. Obtain Stakeholder Approval

Such may vary materially depending on the progress of commercial and contractual negotiations

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Managing the Project Finance Process: Delivering the Financing Plan and Strategy

Size the project and define the funding requirement;

Assess the potential debt sources for the financing for the Project, with particular attention to appetite, tenor, capacity, liquidity and pricing;

Advise the sponsors on the commercial contractual negotiations to ensure such contracts are bankable;

Identify studies typically required to successfully obtain the Financing, including technical, market and environmental reports.

Appoint and manage the lenders’ technical and environmental consultant to identify key lender issues that need to be addressed in the structuring;

Develop a financial model to analyze the economics of the Project and provide information to support the Sponsor’s investment decision; and

Recommend an appropriate financing plan and strategy taking into account current financial market conditions.

The Financial Advisors can support developers

in structuring a bankable project and securing an

optimal funding package

The Financial Advisor can act as Lead

Consultant to coordinate and manage technical,

legal, marketing, environmental and other

advisors

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Managing the Project Finance Process: Marketing Phase - Achieving Financial Close

Develop a bankable financing structure using data from the financial model and bank market practice and taking into account inputs from the Sponsor’s tax, legal, and accounting advisors;

Develop an engagement timetable for the different sources of liquidity, bearing in mind that certain pools of liquidity will require longer lead times than others;

Assist in the development of a preliminary term sheet in order to secure Sponsor approval;

Prepare a bid package for potential debt providers including an invitation letter, a confidentiality agreement, a draft arranging and underwriting mandate letter, a draft term sheet for the Financing and its security package, a preliminary information memorandum (the “PIM”), a preliminary Bank Financial Model and summaries of third party reports;

Review and summarise the financing bids and assist the Sponsor in selecting the optimal financing group;

Assist the Sponsors and Legal Counsel in the negotiation and finalization of the financing documentation until signing of the documents, satisfaction of conditions precedents and draw-down of the facilities.

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Conclusions

Economic outlook remains uncertain, however the GCC is well positioned for robust and sustainable growth

Select the right financing methodology that suits your requirements and objectives ie corporate vs project financing

Financiers are now far more selective with transactions so maximise the sources of funding – tap the Money Tree

Focus on developing well structured and viable projects that have a clear competitive advantage, are aligned with the government’s industrialisation strategy and are supported by credible financial and technical sponsors

Federation of GCC Chambers Conference on Frameworks for funding industrial projects 12 October 2010.

Documents

Transcript of Federation of GCC Chambers Conference on Frameworks for funding industrial projects 12 October 2010.