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.
Two legs of competitiveness2.
2b. Competitiveness supported by the innovation and
2a. First leg - sustainable macroeconomic development
Corporate finance3.
Banks and bank financing 4.
12Corporate finance, banks and project finance10 July 2012
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.
Two legs of competitiveness2.
2b. Competitiveness supported by the innovation and
2a. First leg - sustainable macroeconomic development
Corporate finance3.
Banks and bank financing 4.
29Corporate finance, banks and project finance10 July 2012
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
Two legs of competitiveness2.
Corporate finance3.
Banks and bank financing 4.
33Corporate finance, banks and project finance10 July 2012
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?)
3. Corporate finance3. Corporate finance
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
3. Corporate finance3. Corporate finance
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)
3. 3. CorporateCorporate financefinance
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.
3. 3. CorporateCorporate financefinance
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)
3. 3. CorporateCorporate financefinance
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)
3. 3. CorporateCorporate financefinance
Recapitulation of finRecapitulation of financialancial sstatementstatements
Debt/
banks &
nonbanks
43
Source: Teplý (2010)
Capital
markets
3. 3. CorporateCorporate financefinance
KKeyey differences between equity and debtdifferences between equity and debt
44
Source: Dědek (2012)
3. 3. CorporateCorporate financefinance
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
Source: Dědek (2012)
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
3. 3. CorporateCorporate financefinance
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
Source: Dědek (2012)
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
Two legs of competitiveness2.
Corporate finance3.
Banks and bank financing 4.
47Corporate finance, banks and project finance10 July 2012
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
4. Banks and bank financing 4. Banks and bank financing
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
4. Banks and bank financing 4. Banks and bank financing
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?
4. Banks and bank financing 4. Banks and bank financing
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
4. Banks and bank financing 4. Banks and bank financing
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
4. Banks and bank financing 4. Banks and bank financing
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
4. Banks and bank financing 4. Banks and bank financing
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
4. Banks and bank financing 4. Banks and bank financing
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
4. Banks and bank financing 4. Banks and bank financing
LBO LBO financingfinancing –– exampleexample
56Source: http://www.csob.cz/en/Business/Corporate-institution/Services-and-Products/Stranky/default.aspx
Agenda
Introduction 1.
Corporate finance
Two legs of competitiveness2.
Corporate finance3.
Banks and bank financing 4.
57Corporate finance, banks and project finance10 July 2012
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)
5. Project finance5. Project finance
NPV on a NPV on a figurefigure
59
Source: BBVA (2006), Comer and Bodnar (1996)
1) payback period
5. Project finance5. Project finance
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)
5. Project finance5. Project finance
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)
5. Project finance5. Project finance
Project finance Project finance structurestructure ((ExampleExample 1)1)
62
Source: Comer and Bodnar
(1996)
5. Project finance5. Project finance
Corporate Corporate ffinanceinance--pprojectroject ffinanceinance
ccontinuumontinuum (1/2)(1/2)
63
Source: Comer and Bodnar
5. Project finance5. Project finance
Corporate Corporate ffinanceinance--pprojectroject ffinanceinance
ccontinuumontinuum (2/2)(2/2)
64
Source: Comer and Bodnar
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
5. Project finance5. Project finance
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
5. Project finance5. Project finance
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
Source: Harvey et al. (2000)
Resource Risk Keeping adequate cushion in assessment.
Operating Risk Making provisions, insurance.
Environmental Risk Insurance
Technology Risk Expert evaluation and retention accounts.
5. Project finance5. Project finance
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
Source: Harvey et al. (2000)
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
5. Project finance5. Project finance
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
5. Project finance5. Project finance
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
Source: Chartered West LB (1995)
Applicability to Uzbekistan?!
5. Project finance5. Project finance
PrincipalPrincipal participantsparticipants
71Source: BBVA (2006)
5. Project finance5. Project finance
Sources of debt financeSources of debt finance
� Domestic loan finance
� Domestic capital markets
� Export credits
� Medium-term syndicated loan
72
Source: Chartered West LB (1995)
� Medium-term syndicated loan
� International development finance
institutions
� Alternative forms/international capital
markets
5. Project finance5. Project finance
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
Source: Chartered West LB (1995)
Applicability to Uzbekistan?!
� Advisory
� Tender preparation
� Advisory to the Sponsors
� Feasibility study of the project
� Risk analysis
� Optimum economic, legal and tax
structure
5. Project finance5. Project finance
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
5. Project finance5. Project finance
AdvisorsAdvisors & & insuranceinsurance programprogram
75
Source: BBVA (2006)
5. Project finance5. Project finance
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
5. Project finance5. Project finance
Project finance Project finance structurestructure ((ExampleExample 2)2)
77Source: http://www.csob.cz/en/Business/Corporate-institution/Services-and-Products/Stranky/default.aspx
5. Project finance5. Project finance
Basic features of five key PPP modelsBasic features of five key PPP models
78Source: UN (2011)
5. Project finance5. Project finance
Classification of five key PPP modelsClassification of five key PPP models
79Source: UN (2011)
5. Project finance5. Project finance
Structure of a PPP projectStructure of a PPP project
80Source: UN (2011)
5. Project finance5. Project finance
Banks’ view on main project phasesBanks’ view on main project phases
81Source: UN (2011)
5. Project finance5. Project finance
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.
5. Project finance5. Project finance
Forfaiting (2/3)Forfaiting (2/3)
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
5. Project finance5. Project finance
Forfaiting (3/3)Forfaiting (3/3)
� 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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