Prof. Michal Mejstřík Charles University in Prague & …...Russia 4 6 Finland exports imports...

Corporate finance, banks and project finance

Prof. Michal Mejstřík Charles University in Prague & Chairman of EEIP, a.s. Chairman of International Chamber of Commerce CR

The College of Economics and Management

Prague, Czech Republic July 10, 2012

Agenda

Introduction1.

Two legs of competitiveness2.

Corporate finance3.

Banks and bank financing 4.

2Corporate finance, banks and project finance10 July 2012

Project finance5.

What a cycle downswing ?

• The same features of crises - cycles of abundant liquidity expanded by „smoothing monetary policy“ , rapid credit/indebtedness growth, and a low-inflation environment followed by an asset-price bubble (and share-price buble)

• The US imbalanced macroeconomic position in the LTerm

• Clinton/Bush gmts (HUD) support of ownership housing / sub-primes – politicians forced bankers to make bad loans

• Description of key investment banking and risk management practices going global

3

• Description of key investment banking and risk management practices going global

• Mounting defaults in the US sub-prime mortgage market -> market instability -> world economic upheaval

• The failure of capital market regulation due to unregulated CDS , to what extent Greek voluntary haircut does trigger CDS ?

• Eurozone response to its “periphery” problems escalation etc.

• What are the long-term (LT) structural problems ? Are they solved within a crisis by the proper creative destruction ?

1. Intro

Two legs for country survival – macro and micro

�Two speed EU ? Different impacts of the crisis on peripherial EU member states/PIGS vs. core&Cz&Sl

� Long vs. short-term responses to the development

�What are key interrelated legs based upon rules?

�First leg – macroviability - fiscal structural

�Second leg - competitiveness �Second leg - competitiveness

�Unique features of Czech & Slovak economies(export oriented, low loan/deposit ratio, low share of FX loans, low inflation and interest rates etc.) -better than PIGS

�Future strategy of the CR & SLK – “PIGS” countryor “Finnish-type”/”German-type” country?

4

GDP per capita in PPS 2009 map

5

Source: Eurostat

Global (?) economic crises accelerated

creative destruction of processesEconomic crises weakened

economic position of matured economies and expectations are poor.

In contrast, emerging and developing countries have not been affected by the

crisis so deeply yet and in spite of their slowing down they contribute the most to

GDP growth diversified

(IMF 1/2012)

Probable slowing down of Eurozone GDP in

relative terms (IMF 1/2012)

Zdroj: EEIP, OECD, IMF, ICC, IFO

they contribute the most to the revitalization of the world

economy, their share has increased.

The crucial risk seen in the future eurozone member countries development .

Economic growth of emerging economies

increases global competition among exporters, that is multiplied by export slow

down.

Bad world business climate ICC-IFO Poor expectation of foreign trade

(IMF 1/2012)

| Strana

6

…BUT…IFO business development indices for Germany

continued

to look well after previous improvement (April 2012)

Source: IFO (2012): IFO Business Survey, April 2012

7

Germany is still relatively highly industrialized country with 24

% of industry contribution to GDP in 2010 (no.14) as well as the

Czech republic with 29.5% (No.6) http://w3.unece.org/pxweb/quickstatistics/readtable.asp?qs_id=11

GDP growth: Czech Republic

-2,0

0,0

2,0

4,0

6,0

8,0P

erc

en

tage

ch

an

ge c

om

pa

red

to

corr

esp

on

din

g p

eri

od

of

the

pre

vio

us

yea

r

* Seasonally adjusted and adjusted data by working days

Source: Eurostat8

-12,0

-10,0

-8,0

-6,0

-4,0

Pe

rce

nta

ge c

ha

nge

co

mp

are

d t

o

corr

esp

on

din

g p

eri

od

of

the

pre

vio

us

yea

r

Czech Republic Finland

Industry production:

-4,0

-2,0

0,0

2,0

4,0

6,0

Pe

rce

nta

ge c

ha

nge

on

pre

vio

us

pe

rio

d

* Seasonally adjusted data

Source: Eurostat (Mining and quarrying; manufacturing; electricity, gas,

steam and air conditioning supply) 9

-12,0

-10,0

-8,0

-6,0

Pe

rce

nta

ge c

ha

nge

on

pre

vio

us

pe

rio

d

Czech Republic Finland

The global context of eurozone problem

Sovereign risk of EMU countries now reflected in interest rates!

14

16Virtual Euro

(Jan 2009)FX rates fixed

to Euro

(May 1998)Greece´s entry to Eurozone

Lehman Bros´fall

Greek debts´revision

(Oct 2009)

t b

on

d y

ield

s (%

)

Sovereign risk =

FX risk + credit riskNo FX risk -> PIGS as

“safe heaven”

Underpricing risk!

Investors distinguish risk Investors do not distinguish Investors distinguish risk again!

In credit risk

Source: EEIP based on Kohutikova (2011)

2

4

6

8

10

12

4.9

0

4.9

1

4.9

2

4.9

3

4.9

4

4.9

5

4.9

6

4.9

7

4.9

8

4.9

9

4.0

0

4.0

1

4.0

2

4.0

3

4.0

4

4.0

5

4.0

6

4.0

7

4.0

8

4.0

9

4.1

0

4.1

1

Germany Spain Portugal Ireland

Greece Italy Belgium France

Greece´s entry to Eurozone

(Jan 2011)

Lehman Bros´fall

(Sep 2008)

10Y

Goy´t

bon

d y

ield

s (%

)

Interest rates

convergence

10

Increase of Risk reflected by the financial market…

Source: www.ft.com11

Agenda

Introduction 1.


2b. Competitiveness supported by the innovation and

2a. First leg - sustainable macroeconomic development

Corporate finance3.



Project finance5.

2b. Competitiveness supported by the innovation and institutions

Consequences High expectations from state interventions

(over 60% in both China and the US!!!)

Temporary (!) nationalization of

banks, government stimulus

packages according to

economic openness (US vs.

Source: The Economist 8/2009

economic openness (US vs.

Germany vs. CR)

…creative destruction of the

current architecture

…should not stop but fuel

structural changes resulting in

higher competitiveness

13

Contagion of EU Public Sector

• The efforts of national governments to mitigate the negative impacts of the

global financial sector led to a rapid growth of public debts ►currently, the

contagion of the private financial sector spilled over to the public sector

• This situation unveils the long-lasting problems of both old and new EU

Member States with appropriate and prudent management of budget

deficits as well as “EU divide” in competitiveness (as suggest the case of deficits as well as “EU divide” in competitiveness (as suggest the case of

PIIGS countries, but also of Belgium, etc.)

• Still no light at the end of the tunnel - huge governmental debt instruments

to be issued in 2012-15 again to cover structural budget deficits and lack of

banking capital to cover regulatory risks ►fierce competition among

countries (e.g.states in Eurozone vs non-eurozone countries – making risky

public debts much more expensive) and private and public bonds.

14

Macroeconomic impacts of the crisis on peripheral EU

member states versus CR & Sl & Finland

60,0

80,0

100,0

120,0

140,0

160,0

180,0

( % GDP) Gross Government Debt 2008 and 2011

2008 Change 2008-2011

Source: Eurostat

� High debt/HDP ratio of PIIGS while debt of CR & Sl relatively low

15

0,0

20,0

40,0

60,0

Gross national saving (as a percentage of GDP)

16Source: Statistical Annex of European Economy – Autumn 2010, Tables 43, 44 a 45,

http://ec.europa.eu/economy_finance/publications/european_economy/2010/pdf/ee-2010-7_en.pdft

Net Lending (+) or net borrowing(-) nation(as a percentage of GDP)

What was the quality of GDP growth ?

17Source: Statistical Annex of European Economy – Autumn 2010, Tables 43, 44 a 45,

http://ec.europa.eu/economy_finance/publications/european_economy/2010/pdf/ee-2010-7_en.pdft

Now relatively low credit risk of CZE and SLK vs. PIGS!

� 10Y Bond yields� Sovereign Credit Default Swap –CDS- spreads (basis points)

Sourcce: www.ft.com18

(Net lending or) Net borrowing should be

limited due to current gmt efforts

0

2

4

6

8

of

GD

P

Source: Eurostat (Net lending (+)/Net borrowing (-) under the EDP

(Excessive Deficit Procedure))19

-8

-6

-4

-2

0

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

Pe

rce

nta

ge

of

European Union (27 countries) Czech Republic Finland

Government consolidated gross debt still

relatively low but threatened by structural deficits

50

60

70

80

90

Pe

rce

nta

geo

fG

DP

Source: Eurostat (General government gross debt) 20

0

10

20

30

40

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

Pe

rce

nta

ge

European Union (27 countries) Czech Republic Finland

Background of the crisisLT Current account balances and political regimes

1: Transfer of wealth

2: Emerging economies

favor „free trade“(?)

over protectionism for

the first time…

“ Emerging east“

21Source: Roeller, Vernon (2008), www.bruegel.org

3: Developed economies

private & public deficits

financed by borrowings

from underdeveloped

countries

4: G20 new strategic set

up

MULTILATERAL

WORLD

“ West“

…and different levels of

productivity!

LT tendencies in CA and disbalances rooted in competitiveness….

Zdroj: www.ft.com22

2. Global net foreign debt context – permanent ? Why ? Who ?

23

Czech republic as a small player with huge potential, niches ?

Source: HSBC 24

Both CR and Germany in the situation : “The trade figures were "in contrast" to the downward

trend in the economy, and the economy had been "flirting with a technical recession“ recently.” (Carsten Brzeski on Germany)

CR openness – export quota -

ratio of export/GDP – nearly

67%, Finland 29%

Over 83% share of intra

EU27 exports from CR,.

31.9% share of CR exports to

or via Germany – No.1

partner with 37 bn. EUR,

then Slovakia 10, Poland,

France, UK, Italy etc.

Net Exports contribution to CR GDP growth, in 2011 positive again

Czech republic

Zdroj: Czech Statistical Office

Czech republic

exports imports

total 2011 MEUR 117 109

Germany 37 28

Slovakia 10 6

China 1 14

Russia 4 6

Finland

exports imports

total 2011 MEUR 57 60

Sweden 7 6

Germany 6 7

Russia 5 11

Netherlands 4 3

China 3 4

UK 3 2

USA 3 2

France 2 2

CR key exports to or via Germany (Euro 33 billion in 2011)

CR openness – export quota -

ratio of export/GDP – nearly

70%.

Over 83% share of intra

EU27 exports from CR,.

31.9% share of CR exports to

or via Germany – No.1

partner with 33 bn. EUR,

then Slovakia 20, Poland,

France, UK, Italy etc.

Germany was unseated as the world's biggest exporter by China in 2009 and was overtaken Germany was unseated as the world's biggest exporter by China in 2009 and was overtaken Germany was unseated as the world's biggest exporter by China in 2009 and was overtaken Germany was unseated as the world's biggest exporter by China in 2009 and was overtaken by the US in 2010, according to by the US in 2010, according to by the US in 2010, according to by the US in 2010, according to ifoifoifoifo....

China remained export champions in 2011 - accounting for 11

percent of worldwide exports – to be followed by the US with 8.4

percent and Germany with 8.3 percent.

However, Germany was in for a "strong comeback in 2012“. Countries outside the European Union

drove the rising German figures, with the volume of non-EU exports rising by 13.4 percent in recent

Zdroj: NERV, EUROSTAT (2012)

German openness export

quota – 41.3% .

Still 60% share of intra EU27

exports from Germany, and

71% within Europe.

Since 2009 German extra

Europe exports have grown

significantly both in absolute

and relative terms but

reached only 16% for Asia,

and 10% for America, while

Africa with 2% and

Australian/Oceania 1%.

Imports are similar – 69%

Europe, 19% Asia and 9%

America. Top 3 Dutch,

China, France

drove the rising German figures, with the volume of non-EU exports rising by 13.4 percent in recent

few months. EU exports have grown as well.

In 2011 another German export surplus of 158 bil. EUR and the

highest total volume

of exports (1060 bn.EUR up from 950 bn.) with

No. 1 France (101 bn = 9.6%), No.2 US (74 bn. = 7%), No.3 Netherlands (69 bn. = 6.5% but 13

bn. Trade deficit), No.4 UK (65 bn. = 6.2%), No.5 China (65 bn. = 6.1% but deficit 14 bn.), No.6

Italy (62 bn. = 5.9%), No.7 Austria (58 bn. = 5.5%), No.8 Switzerland (48 bn. = 4.5%), No.9

Belgium (47 bn. = 4.4%), No.10 Poland (43 bn. = 4.1%), No.11 Spain (35 bn. = 3.3%), No.12

Russia (34 bn. = 3.3% but 6 deficit), No.13 Czech Republic (2.9% with 30.6 bn exports), No.14

Sweden (22 bn. = 2.1%),… No.19 Slovakia (10 bn. = 1%)

In addition - S&P sovereign downgrades 2012 after Negative Creditwatch warning

RATINGS LIST

To From

Austria (Republic of) AA+/Negative/A-1+ AAA/Watch Neg/A-1+

Belgium (Kingdom of) (Unsolicited Ratings) AA/Negative/A-1+ AA/Watch Neg/A-1+

Cyprus (Republic of) BB+/Negative/B BBB/Watch Neg/A-3

Estonia (Republic of) AA-/Negative/A-1+ AA-/Watch Neg/A-1+

Finland (Republic of) AAA/Negative/A-1+ AAA/Watch Neg/A-1+

France (Republic of) (Unsolicited Ratings) AA+/Negative/A-1+ AAA/Watch Neg/A-1+

Germany (Federal Republic of) (Unsolicited Ratings) AAA/Stable/A-1+ AAA/Watch Neg/A-1+

Ireland (Republic of) BBB+/Negative/A-2 BBB+/Watch Neg/A-2

Current rating of

the Czech Republic:

A A -

Source: Standard & Poor 2012 January 13

Ireland (Republic of) BBB+/Negative/A-2 BBB+/Watch Neg/A-2

Italy (Republic of) (Unsolicited Ratings) BBB+/Negative/A-2 A/Watch Neg/A-1

Luxembourg (Grand Duchy of) AAA/Negative/A-1+ AAA/Watch Neg/A-1+

Malta (Republic of) A-/Negative/A-2 A/Watch Neg/A-1

Netherlands (The) (State of) (Unsolicited Ratings) AAA/Negative/A-1+ AAA/Watch Neg/A-1+

Portugal (Republic of) BB/Negative/B BBB-/Watch Neg/A-3

Slovak Republic A/Stable/A-1 A+/Watch Neg/A-1

Slovenia (Republic of) A+/Negative/A-1 AA-/Watch Neg/A-1+

Spain (Kingdom of) A/Negative/A-1 AA-/Watch Neg/A-1+

N.B.--This does not include all ratings affected.

27

IMF: Spillovers and higher spreads…

Slide 28Source: IMF (2011). Global Economic Prospects and Policy Challenges, October 2011

Agenda

Introduction 1.


2b. Competitiveness supported by the innovation and

2a. First leg - sustainable macroeconomic development

Corporate finance3.



Project finance5.

2b. Competitiveness supported by the innovation and institutions

2. Inevitable Consequences - S&P downgrade 2012 after Creditwatch warning

“While we see a lack of fiscal prudence as having been a major

contributing factor to high public debt levels in some countries,

such as Greece, we believe that the key underlying issue for the

eurozone as a whole is one of

a growing divergence in competitiveness between the core and

Source: Standard & Poor 2012 January 13

a growing divergence in competitiveness between the core and

the so-called "periphery." Exacerbated by the rapid

expansion of European banks' balance sheets, this has led to

large and growing external imbalances, evident in the size of

financial sector claims of net capital-exporting banking systems

on net importing countries”.

30

3. competitiveness

Factor pyramide includes infrastructure and institutions

Project finance

should help!

source: Mejstřík et al (2011)

http://www.vlada.cz/cz/media-centrum/aktualne/nerv-ramec-strategie-konkurenceschopnosti-82538/ 31

4. Problem 3I

Global Competitiveness Index: problem 3i

ČR is close to the average levels, but

there is visible difference ininovation,

Zdroj: EEIP

inovation, infrastructure, and

mainly in institutions

(problem 3I).

Source: WEF (2011)

32

Agenda

Introduction 1.

Corporate finance


Corporate finance3.



Project finance5.

1. Allow a fund transfer from surplus to deficit entities

2. Capital allocation and the reallocation of capital according to its

efficiency (e.g. project selection);

3. Securing the liquidity of financial assets and through the allocation

efficiency of financial markets create prices continuously

4. Enforcement of contracts, debtors must repay their debts;

3. Corporate finance3. Corporate finance

Key functions of financial marketsKey functions of financial markets

34

5. Cost efficiency – financial markets lower costs of the payment system

and financial transactions in general, (so called operational

efficiency),

6. Support for ownership rights performance in the PRINCIPAL-AGENT

model, sometimes also called the financial model.

7. Risk sharing – FMs enable the allocation, transfer and share of risk

with other investors and companies; (?Subprime crisis/CDOs…)

8. Risk diversification – with respect to expected cash flows from

different projects (? But what about reality?)


DirectDirect vs. vs. indirectindirect financefinance

35

3. 3. CorporateCorporate financefinance

Classifications Classifications bby Financial Instrumentsy Financial Instruments II

1. Debt Markets

o Short-term (maturity < 1 year)

o Mid-term (maturity 1-10 year)

o Long-term (maturity > 10 year)

2. Equity Markets

36

2. Equity Markets

o Common stocks

o Securities are assets for holders, but liabilities for

issuers.

o Risky = high profit/loss potential

Rate of return

RiskLiquidity


Global financial stock has surpassed preGlobal financial stock has surpassed pre--crisis crisis

heights,heights, (USD (USD 212 trillion in 2010212 trillion in 2010))

37

Source: McKinsey (2011)


Financial depth is lower in emerging Financial depth is lower in emerging

markets (the absence of corporate markets (the absence of corporate

bond and securitization markets)bond and securitization markets)

38

Source: McKinsey (2009)

3. 3. CorporateCorporate financefinanceClassifications Classifications bby y ttradabilityradability of the issue of an of the issue of an

instrumentinstrument IIII

1. Primary Market

o New security issues sold to initial buyers

o Initial public offering (IPO)

2. Secondary Market

Securities previously issued are bought and sold

39

o Securities previously issued are bought and sold

o Investment Banks

o Brokers (agents of investors who match buyers with

sellers of securities/other name) vs. Dealers (link

buyers and sellers by buying and selling securities at

stated prices/own name).

o Liquidity and Valuation Provided by the Secondary

Market.


Classifications Classifications bby By Organization of Secondary Markety By Organization of Secondary Market IIVV

1. Exchanges

o Trades conducted in central locations (NYSE, LSE)

o Exchange = single price (buy price = sell price)

o E.g. Prague Stock Exchange (PSE) www.pse.cz

40

2. Over-the-Counter (OTC) Markets

o Securities dealers at different locations buy and sell

o OTC = usually two prices (buy price and sell price)

o Derivatives (notinal value vs gross market value).

o Regulation of OTC markets/Central Counter Party (CCP)


DifferentDifferent debtsdebts´́ structurestructure in in countriescountries

41Source: McKinsey (2010)

3. 3. CorporateCorporate financefinanceIncreasingIncreasing totaltotal indebtednessindebtedness ofof developeddeveloped

economieseconomies, , deleveragingdeleveraging//creditcredit crunchcrunch just just begunbegun……

42Source: McKinsey (2012)


Recapitulation of finRecapitulation of financialancial sstatementstatements

Debt/

banks &

nonbanks

43

Source: Teplý (2010)

Capital

markets


KKeyey differences between equity and debtdifferences between equity and debt

44

Source: Dědek (2012)


Main features of corporate debtMain features of corporate debt (1/2)(1/2)

1. Classification by ownerships

o public debt

o private debt (term vs. syndicated loan, revolving credit)

o private placement

2. Classification by security

45


2. Classification by security

o unsecured debt (debenture vs. notes)

o secured debt (mortgage bonds, asset-backed bonds)

3. Classification by seniority

o senior debt

o junior debt

o subordinated debt


Main features of corporate debtMain features of corporate debt (2/2)(2/2)

4. Classification by residency of bondholders

o domestic bond

o foreign bond

o Eurobond = an international bond that is not

denominated in the local currency of the country in

46


denominated in the local currency of the country in

which it is issued (vs. “Eurobonds“ guaranteed by the

Eurozone members!)

5. Classification by rating

o investment-grade bonds = with Standard & Poor’s rating

AAA, AA, A, BBB

o speculative bonds (junk bonds, high-yield bonds) = with

Standard & Poor’s rating BB, B, CCC, CC, C, D

Agenda

Introduction 1.

Corporate finance


Corporate finance3.



Project finance5.

4. Banks and bank financing 4. Banks and bank financing

WhatWhat´́s s thethe aimaim ofof bankbank´́s management?s management?

� To manage a bank with the goal of maximising its

value for shareholders under risk conditions

� Dealing with

information

48

� Corporate governance/principal-agent problem

information

asymmetry

� Appropriate risk

management

needed


BanksBanks´́ ffinancialinancial statements and ratiosstatements and ratios� two main bank financial statements

1. balance sheet (sources and use of funds)

2. profit and loss statement (P&L)

1) Balance sheet: A = L+ NW

A = total assets, L = total liabilities,

Assets Total Liabilities

Liabilities

49

A = total assets, L = total liabilities,

NW =A-L = net worth = equity = capital

Liabilities

Equity

Assets

� Balance sheet (a statement of condition or statement of

resources) is a “snapshot” on a given day – very often

December 31 – which indicates the composition of all

asset and liabilities of the bank, including shareholders´

equity


BanksBanks´́ ffinancialinancial statements and ratiosstatements and ratios2) Profit and loss statement: P= R-C-T

P = after-tax profits, R = total revenues, C

= total costs, T = taxes

� Profit and loss statement (“P&L” or income statement)

can be viewed as an explanation as to how bank’s net

earnings before dividend distributions were achieved,

50

earnings before dividend distributions were achieved,

and why capital increased and decreased

� Profits are the lifeblood of any commercial firm

� Book value of equity (BVE) = value of equity

� Market value of equity (MVE) = share market price x

number of shares

� Market-to-book ratio (MVE/BVE) – ratio greater >1?


The functions of the banking systemThe functions of the banking system

1) Clear and settle payments

2) Aggregate and disaggregate wealth and

flows of funds

Transfer funds

51

3) Transfer funds

4) Process information

5) Manage uncertainty and control risk

6) Provide ways for dealing with agency

problems that arise in financial

contracting


The key functions of a bankThe key functions of a bank

1) Effective transformation of capital

2) Non-cash money supply

3) Providing non-cash payment services

52

Maturity mismatching

long-term assets vs. short-term liabilities

Assets Total Liabilities

Liabilities

Equity

Assets


StructureStructure ofof worldworld financialfinancial institutionsinstitutions

SWF

2.6%

Private equty

1.6%

Hedge funds

1.1%ETF

0.8%

Global assets managed by financial institutions as of the end of 2010

(total = $ 159 trillion)

53

Bank deposits

44.0%

Pension funds

18.8%

Mutual funds

15.5%

Insurance funds

15.5%

Source: Petr Teplý based on TCUK


Services and Services and pproductsroducts to to corporatescorporates

1) Payments and cash management

2) Deposits and other investment products

3) Risk management

4) Financing

54

4) Financing

1) Acquisition Finance

2) Real Estate Finance

3) Project Finance

4) Export Finance

5) Syndicated Loans,

6) Programme for Co-

financing Projects

Supported from EU Funds,

7) Primary Issues Services.

Source: http://www.csob.cz/en/Business/Corporate-institution/Services-and-Products/Stranky/default.aspx


BasicsBasics ofof acquisition financingacquisition financing (AF)(AF)

� AF = external debt financing of the buyout of a

company by another company.

� Two types of acquisition financing:

1) The Special Purpose Vehicle (SPV) structure, known as

Leveraged Buyout (LBO),

55

Leveraged Buyout (LBO),

2) Direct acquisition of a company by another company,

known as Mergers and Acquisitions (M&A).

Source: http://www.csob.cz/en/Business/Corporate-institution/Services-and-Products/Stranky/default.aspx

� LBO financing = the financing of an acquisition

transaction with a substantial portion of borrowed

funds (leverage).

� LBO usually uses a SPV structure – see next slide


LBO LBO financingfinancing –– exampleexample

56Source: http://www.csob.cz/en/Business/Corporate-institution/Services-and-Products/Stranky/default.aspx

Agenda

Introduction 1.

Corporate finance


Corporate finance3.



Project finance5.

� A form of financing projects, primarily based on

claims against the financed asset or project rather

than on the sponsor of the project.

� However, there are varying degrees of recourse

possible. Repayment is based on the future cash

flows of the project.

5. Project finance5. Project finance

BasicsBasics ofof projectproject financefinance

58

� No collateral (just the project)!!! As a result, other

measure are important:

� Cash-flow of the project

� Debt service coverage ratio (DSCR)

� Net present value (NPV)

� Internal rate of return (IRR)

� Payback period etc.

Source: BBVA (2006), Comer and Bodnar (1996)


NPV on a NPV on a figurefigure

59

Source: BBVA (2006), Comer and Bodnar (1996)

1) payback period


NPV NPV andand itsits competitorscompetitors

� Importance of the NPV measure (see Capital

budgeting)

� Other criteria for investment decision making

(NPV´s competitors)

60

1) payback period

2) discounted payback period

3) accounting/booking rate of return

4) internal rate of return

5) profitability index

Source: Teplý (2005b)

� 3 main models

1) Engineering, Procurement and Construction

Contract - (EPC Contract)

� Delivery of „whole“ project

2) Operation and Maintenance Agreement - (O&M

Agreement)


KeyKey featuresfeatures ofof projectproject financefinance

61

Agreement)

� Partial delivery (operations and maintenance etc.)

3) Public Private Partnership (PPP) model

� „Joint venture“ of public and private sector

Source: Authors based on Hoffman (2007)


Project finance Project finance structurestructure ((ExampleExample 1)1)

62

Source: Comer and Bodnar

(1996)


Corporate Corporate ffinanceinance--pprojectroject ffinanceinance

ccontinuumontinuum (1/2)(1/2)

63



Corporate Corporate ffinanceinance--pprojectroject ffinanceinance

ccontinuumontinuum (2/2)(2/2)

64


5. Project finance5. Project financeComparison Comparison ofof PF PF with with ootherther fformsorms of of

ffinancinginancing

Financing vehicle

Similarity Dis-similarity

Secured debt Collaterized with a specific asset

Recourse to corporate assets

Subsidiary debt Possible recourse to corporate balance sheet

65

Source: Harvey et al. (2000)

sheet

Asset backed securities Collaterized and non-recourse

Hold financial, not single purpose industrial asset

LBO / MBO High debt levels No corporate sponsor

Venture backed companies

Concentrated equity ownership

Lower debt levels; managers are equity holders

� Corporate Finance

� Company invests in many

projects and possesses many

growth opportunities.

� Cash flow separation is

difficult to accomplish in

corporate finance. Project


Agency Agency cconflictsonflicts between between oownershipwnership and and ccontrolontrol

� Project Finance

� Project company is dissolved

once the project gets

completed. No future growth

opportunities.

� Cash flows of the project are

separated from cash flows of

sponsors. The single discrete

66

corporate finance. Project

cash flows are co-mingled

with the cash flows from

other assets making

monitoring of cash flows

difficult.

� The verifiability of cash flows

is difficult.

Source: Hillon (2006)

sponsors. The single discrete

project enable lenders to

easily monitor project cash

flows.

� The verifiability of CFs is

enhanced by the waterfall

contract that specifies how

project CFs are used


Risk Risk mmitigationitigation (1/2)(1/2)

Risk Solution

Completion Risk Contractual guarantees from

manufacturer, selecting vendors of repute.

Price Risk hedging

Resource Risk Keeping adequate cushion in assessment.

67


Resource Risk Keeping adequate cushion in assessment.

Operating Risk Making provisions, insurance.

Environmental Risk Insurance

Technology Risk Expert evaluation and retention accounts.


Risk Risk mmitigationitigation (2/2)(2/2)

Political and

Sovereign Risk

• Externalizing the project company by forming it

abroad or using external law or jurisdiction

• External accounts for proceeds

• Political risk insurance (Expensive)

• Export Credit Guarantees

• Contractual sharing of political risk between

lenders and external project sponsors

68


lenders and external project sponsors

• Government or regulatory undertaking to cover

policies on taxes, royalties, prices, monopolies, etc

• External guarantees or quasi guarantees

Interest Rate Risk Swaps and Hedging

Insolvency Risk Credit Strength of Sponsor, Competence of

management, good corporate governance

Currency Risk Hedging


Key project issues in Central EuropeKey project issues in Central Europe

� Revenue risks (e.g. macroeconomic change, future

status of purchaser of product)

� Raw material risks – reliability of suppliers

� General economic risk:

� Cost inflation

69

� Cost inflation

� Exchange rate depreciation

� FX convertibility

� Interest rate

Source: Chartered West LB (1995)

� General

� Change in government support/legislation

� Changes in fiscal regime


Treatment of economic/political risksTreatment of economic/political risks

� Protection in relation to government’s

contractual obligations (e.g. concession

agreement)

� Protection in relation to currency

convertibility

70

convertibility

� Protection in relation to devaluation risk

� Role of international development agencies

� Investment guarantees


Applicability to Uzbekistan?!


PrincipalPrincipal participantsparticipants

71Source: BBVA (2006)


Sources of debt financeSources of debt finance

� Domestic loan finance

� Domestic capital markets

� Export credits

� Medium-term syndicated loan

72


� Medium-term syndicated loan

� International development finance

institutions

� Alternative forms/international capital

markets


Domestics private investors: constraints!Domestics private investors: constraints!

� Shortage of commercial, industrial and

institutional investors

� Lack of depth in equity markets

� Shortage of managerial and financial

73

� Shortage of managerial and financial

skills

� Length of pay-back period in a

changing economy


Applicability to Uzbekistan?!

� Advisory

� Tender preparation

� Advisory to the Sponsors

� Feasibility study of the project

� Risk analysis

� Optimum economic, legal and tax

structure


AdvisoryAdvisory & arrangement& arrangement� Arrangement/Financing

� Financial Underwriting

� Funding in the Capital

Markets

� Other financial facilities:

bridge etc.

� Possibility of equity

74

structure

� Other sponsor research

� Legal structure

� Coordination between different

participants

� Project presentation in the Capital

Markets

� Negotiation with the financial

institutions

Source: BBVA (2006)

� Possibility of equity

investments


AdvisorsAdvisors & & insuranceinsurance programprogram

75

Source: BBVA (2006)


FinancingFinancing toolstools todaytoday

� Bank financing� Main financial source

� Debt with SPV.

� Operative relationship with the sponsors, no financial relationship

� High leverage ratios

� Long repayment terms (taking into account cash flows)

76

Source: BBVA (2006)

� Long repayment terms (taking into account cash flows)

� It is out of the balance financing for the sponsors, no effect in rating

� Pricing: Interest rate + margin

� Reference rate: LIBOR, PRIBOR etc.

� No bank financing

� Securitization

� Bonds


Project finance Project finance structurestructure ((ExampleExample 2)2)

77Source: http://www.csob.cz/en/Business/Corporate-institution/Services-and-Products/Stranky/default.aspx


Basic features of five key PPP modelsBasic features of five key PPP models

78Source: UN (2011)


Classification of five key PPP modelsClassification of five key PPP models

79Source: UN (2011)


Structure of a PPP projectStructure of a PPP project

80Source: UN (2011)


Banks’ view on main project phasesBanks’ view on main project phases

81Source: UN (2011)


Forfaiting (1/3)Forfaiting (1/3)

� Forfaiting – assignment for

consideration/purchase of medium and long-

term “secured” receivables with debt

evidence as promissory notes (or a B/E

accepted by a bank, bank guarantee, or L/C)

82

Source: Mejstřík et al (2008)

accepted by a bank, bank guarantee, or L/C)

by a forfaiter at a fixed interest rate.

� Forfaiting is usually on a non-recourse basis.

� Forfaiting is usually for large one-time

transactions.



Exporter

Importer 3

5

941 7 6

2

Common structure of a forfaiting transaction:

1. Commitment to purchaseexport receivables

2. Commercial contract

3. Delivery of goods

83

Source: Mejstřík et al (2008)

Forfaiter

Bank

8

10

1 7 6

4. Gives guarantee

5. Hands over documents (e.g. bill of loading)

6. Delivers documents

7. Discounted payment

8. Presents documents forpayment

9. Repays at maturity

10. Payment to the forfaiter



� The forfaiting price is defined by a discount, which is the amount that

lowers the nominal value of the receivable, the amount the original

owner receives from the forfaiting company. This discount can be

redefined as an effective rate of forfaiting. This rate (or discount)

basically consist of three elements:

� Refinancing costs (raising funds costs) of the forfaiting company,

depending on the volume, maturity, currency etc.

84Source: Mejstřík et al. (2008)

� Risk premium, related to the creditworthiness of the original owner,

quality of the receivable and creditworthiness of the guarantor bank,

� Net margin that covers other costs of the forfaiting company

(administrative expenses, tax expense etc.) and should ensure a certain

level of profit.

� There are two basic methods of discount (effective rate) calculation: the

Straight discount method and the Discount to yield method.

Discussion

TThanks for your attentionhanks for your attention..

LetLet´́s discuss it now!s discuss it now!

85

� BCG (2008): Get ready for private shakeout, www.bcg.com

� ICC (2011): Financing of Investment and Trade, Paris

� IMF (2009-12) reports www.imf.org

� CR Gmt Strategy of International Competitiveness, www.vlada.cz

� McKinsey (2008): Mapping global capital markets: Fifth Annual Report, McKinsey Global Institute, October 2008

� NERV (2011) Mejstřík M.et al: Framework of Competitiveness Strategy for CR, http://www.vlada.cz/assets/ppov/ekonomicka-

UsefulUseful sourcessources forfor competitvenesscompetitveness

NERV (2011) Mejstřík M.et al: Framework of Competitiveness Strategy for CR, http://www.vlada.cz/assets/ppov/ekonomicka-rada/aktualne/Ramec_strategie_konkurenceschopnosti.pdf

� Mejstřík M., (2004): Cultivation of Financial Markets in CEE, Karolinum press, Czech Republic

� Reinhart C.M., Rogoff K. S. (2008): The Aftermath of Financial Crises, paper prepared for presentation at the American Economic Association meetings in San Francisco, January 3, 2009

� Sinn H.W., Wollmershaeuser T., (2011), TARGET loans, current account balances and capital flows:The ECB’s Rescue Facility, NBER http://www.nber.org/papers/w17626

� www.bbc.com

86

OtherOther usefuluseful sourcessources II

� BBVA (2006). Financing PPPs: Project Finance

� Brealey R.A., Myers S.C. (2000). Principles of Corporate Finance, Mc

Graw-Hill, New York, 2000

� Dědek, O. (2012). Corporate finance, lectures´ handout at Charles

University in Prague

� Hoffman, S. (2007). The Law & Business of International Project

Finance, 3rd edition, Cambridge University Press.

87

Finance, 3 edition, Cambridge University Press.

� Teplý, P. (2005a). Operating Leverage, Financial Leverage and Beta,

lecture at Charles University in Prague on 8 May 2005

� Teplý, P. (2005b). Project evaluation, lecture at Charles University in

Prague on 15 April 2005

� Teplý, P. (2007). Credit Application, lecture at Charles University in

Prague on 12 October 2007

� United Nations (2011). A guidebook on public-private partnership in

infrastructure

OtherOther usefuluseful sourcessources IIII

88

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