Financing Infrastructure Projects

An Analysis of Issues and Cases…

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Presentation Structure

Project Finance TransactionsIssues in Infrastructure FinanceCase Studies

IDFC : A Summary

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Who We Are…

Established by the GoI in 1997

Lead private capital to commercially viable infrastructure projects; promote public-private partnerships

Bring innovation to private financing in Indian infrastructure

Provide policy advice to encourage private financing in infrastructure

We are a specialty financial institution focused only on infrastructure fundingWe are a specialty financial institution focused only on infrastructure funding

With a balance sheet size in excess of Rs. 17,000 Crore, and NIL NPAs, IDFC ranks amongst the largest financial institutions focused on financing Indian infrastructure

With a balance sheet size in excess of Rs. 17,000 Crore, and NIL NPAs, IDFC ranks amongst the largest financial institutions focused on financing Indian infrastructure

Project Finance Transactions

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‘Financing a Project’

Project Finance doesn’t mean ‘financing a project’!

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‘Financing a Project’ …2

How does Joe Blo Inc. finance a chemical factory?

Joe Blo Inc.

Lenders

ChemFac

Equity

Equity Returns

Debt

Debt Repayment

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‘Financing a Project’ …3

Such financing is also called:– Balance Sheet Financing, or– Recourse Financing

Here the project ‘Lenders’ have a low level of due-diligence on the project itself, but a high level of due diligence on Joe Blo Inc.!

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‘Project Finance’

How does Joe Blo Inc. finance an airport?

Joe Blo Inc.

Lenders

Airport

Equity

Equity Returns

Debt

Debt Repayment

Other Equity Investors

Other Lenders/ Bondholders

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Project Finance Defined

“Raising of funds to finance an economically separable capital investment project in which the providers of

funds look primarily to cash flow from the project to service their debt and

provide returns on their equity”

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Emergence of Project Financing:

Appropriate techniques for projects with high capital requirements and a complex risk profile

Payouts are based only on the projects’ own assets and cash flows stream

Creditors rely on the ability of the project for repayment of related debt obligations, non-recourse debt

Multi-source financing: syndicated commercial banks, bonds, ECAs, multilaterals

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Why Project Finance?

Isolate ‘Risk’Project ‘Transparency’Greater ‘Leverage’Control/ Ownership issues

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Characteristics of Project Finance

Complex contractual arrangements

Limited or non-recourse financing

Risk management strategies and techniques

Changing perceptions, new innovations

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Demand Supply Gap

Annual investment needs in Urban Infrastructure alone are about Rs.

400 billion* as against an availability of Rs. 50 billion,

(excluding new mass transit and township development projects)

*give or take a few hundred billion!

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Equity

Sponsor/ CorporateEquity FundsFinancial InstitutionsMulti-lateral Institutions

World Bank, IFC

Public

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Debt

BanksFIsDebt FundsMultilateral Institutions

World Bank, ADB, IADB

Export Credit Agencies (ECA)Public

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Principles of Risk Management

Allocate project-specific risks to parties best able to bear them

Control performance risks through incentive contracts

Use market-hedging instruments (derivatives) for covering market-wide risks (interest and exchange rate fluctuations)

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Risk Management

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Risk Management

Base Value

2

2

0

5.184802

13.600926

0.15

Goods Traffic Growth Scenario

Tariff Growth Scenario

Project Cost Sensitivity Factor

Variable Operating Expenses as per KRC norms (per MT)

Fixed Operating Expenses as per KRC norms

Percentage of Traffic Startup

Min DSCR, with DSRA0.0 0.3 0.6 0.9 1.2 1.5 1.8 2.1 2.4 2.7 3.0

Base Value: 1.1

1 3

1 3

0.1 –0.1

4.89606 4.89606

13.600926 12.981576

0 0.3

Project IRR

Cumulative

Probability

0

.1

.2

.3

.4

.5

.6

.7

.8

.9

1.0

–0.1000 0.0000 0.1000 0.2000 0.3000 0.4000

EV=0.1028

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Oh What A Web!Concession Agreement

Government & Project SPV

SHA

Equity Investors

Equity Investment Agreements

With Pvt Equity Investors

Construction/O&M Contracts

Project SPV & Contractors/ Operators

DLA/ Substitution

Project SPV, Promoters,

Lenders, Government

State Support Agreement

Government & Project SPV

Loan Agreements

Lenders & Project SPV

Inter-Creditor Agreements

Inter-se the LendersPledges & Hypothecations

Lenders & Promoters Site Lease Agreement

Project SPV & Land Owner

TRA Agreement

Trustee Bank, SPV, LendersBank Guarantees etc

Issues in Infrastructure Finance

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Service Provision Options

Infrastructure Services

Status Quo:Govt creates assets & provides services

Privatization:Private Sector

creates assets & provides services

Commercialization:Govt creates assets

& hands over to Pvt Sector to

provide services

PPP/ PFPI

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How Much Time Did They Take?

Airports:Started in 1998-99Bidder identified in 2001SHA in 2002Concession/ FC in 2005

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How Much Time…(2)

(Industrial) Water Supply: Started in 1995-96Bidder identified in 1997Concession in 2003FC in 2004

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How Much Time…(3)

Commercial Complex:Started in May 2002Bidder identified in June 2004Government approval June 2005Concession/ FC just now…

SEZ:Started in 2002Bidder identified in 2003Approvals not yet in place…

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How Much Time…(4)

Industrial RoadsStarted in 2002Bidder identified in 2005Concession/ FC just now…

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How Much Time…(5)

How many large (> Rs. 500 Cr) projects have reached financial closure, and work commenced

Last 8-10 years of PPP4 Airports1 Water supply projectNumber of Road (NHAI/ MORTH only)Number of Telecom/ Power Projects

And how many are completedIn round figures – none

Except in Roads, Telecom, Power

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Why are the projects delayed?

Possible Reasons?FinanceInadequate Project Development

Hasten to bid?

Approval structures/ processes not being in place

Plug-and-play approach?

Social/ Environmental reasons

LAND

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Then why PPP?

PPP ProjectsTake more time, more effort, and are also – prima-facie – more cost BUT

Shortage of budgetary funds

Improvement in levels of service to users

Innovation in designs, project management and implementation of projects

Long-term operations and maintenance of assets

Focus on service to users – not just asset creation

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Are Funds an Issue?

Yes and NoYES

Project Development FundsEquityDebt in Urban Infra (water, city roads, metro transport projects, sanitation, solid waste)

NOCommercial debt (sectors other than mentioned above)

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Inadequate Project Development

Hasten to set up project/ bidBidders/ lenders then start asking for data/ studies

Thin slice method to get all the DPRs done

Re(negotiation) of project and contract parameters along the way

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Approval Process/ Structures

Once the bidder is identified:Land, Environmental ClearancesCabinet approvals

Searching for consensus

Legislative/ legal amendments requiredSearching for sources of Government funds/ equity/ grantsUser unwillingness to pay

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Approval Process/ Structures… (2)

Since there are no replicable frameworksEach project is a “stand-alone” experiment

Rarely is precedent used. Bangalore and Hyderabad airports are rare instances of projects using precedent

Infra Acts/ Polices have enough flexibility to…Enable frequent by-pass of their intent!

Transparency conditions are applied regardless of whether they are regular “Contracts” or BOT Projects

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Key Lessons - Roads

Bypasses on national highways and river bridges have demonstrated reasonable success

Common sense approach to traffic forecasting along with statistical analysis Emphasis on getting base year traffic right

Small state highway projects have also done well in states such as Maharashtra, MP Developed by local promoter groups with a strong ‘ears to the

ground’ philosophy

Certain large projects such have not been able to generate the expected numbers in the early years High project cost, competing routes, service roads, higher

growth rate expectations being the primary reasons

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Key Lessons - Telecom

Limited mobility not sustainable leading to migration to full mobility.

Mass-market model for the sector (based on high penetration and low ARPUs).

Consolidation in the sector.

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Key Lessons - Power It is essential to first fix the ‘leaky bucket’

Competitiveness of tariff essential to ensure viability of a generation project.

Retail tariffs to ultimately mirror the cost of supply.

Factors to attract private sector participation in the sector:

Regulatory confidence longer term regulatory tariff regime (“No Moving Goal Post”)

Legal and Administration support freedom and support from Government to disconnect consumers

Government credit risk mitigation appropriate mechanism for delivery of subsidy to be developed

Credible business plan to meet transition period funding requirements past unfunded liabilities to be taken over by Government

Credible base line data

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Key Lessons - Urban It is essential to first fix the ‘leaky bucket’

User charge regime has to come into place - tariffs to ultimately mirror the cost of supply

Subsidy to be explicit

Large governance issues to be addressed

Factors to attract private sector participation in the sector:

Regulators to be in place

Ring-fenced ULB revenues

Legal and Administration support freedom and support from Government to disconnect consumers

Government credit risk mitigation appropriate mechanism for delivery of subsidy to be developed

Credible base line data

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Way Forward…?

Not to rush into a Project bid/ implement approach

Get frameworks/ approvals/ funds in place before doing soCapacity building and reform should go aheadNow there is enough project experience/ expertise to set up a “precedent” basis

Adequate project preparationFunding required to do soNot too many “money bags” waiting to invest into infrastructure…

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Small Number Of Profitable Projects

BOT

Larger Number Of Marginally Profitable Projects

Govt. ‘Leveraged’ Privatisation

Unprofitable, But Imperative

Projects

Budgetary Allocation

Maintenance Works

Dedicated Funds (Road

Fund)

Way Forward… (2)

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Concept of PFPI

Traditional Approach Asset creation funded through government borrowingsService provision and maintenance of assets by public sector

PFI ApproachAsset creation funded by private financeService provision and maintenance of assets by private sector Fundamental Tenets

Value for Money Risk Transfer to Private Sector

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What PFPI is not .. What it is (1)

PFPI is not privatisation or disinvestment

PFPI is not about borrowing money from the private sector

PFPI is more about creating a structurein which greater value for money is achieved for services

through private sector innovation and management skills

delivering significant improvement in service efficiency levels

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What PFPI is not .. What it is (2)

This means that Governmentno longer builds roads, it purchases miles of maintained highwayno longer builds hospitals, it buys health servicesno longer buys computers and software, but pays for managed IT services

Case Studies

Experiences in Project Finance

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An Airport Project

65 percent

35 percent

EIB loan

HERMES-securedloan

EU grant

Equity capital Subordinatedloan

AirportDevelopmentFund

approx. 50%

15%

18%

10%

6%

2%

Total Cost, 2.1 Mio Euro

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A Road Project

66%

17%17%

Debt

Sub-Debt

Equity

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Case Study - Waste to Energy…

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Case Studies - 12

Garbage to GoldEasy for any self-respecting alchemist?!

Technically superior, but also more expensive

Can the returns (financial or economic) justify the higher costs?Obviously cannot be termed as the cost-equivalent of a regular power plant

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Case Study - The SWERF Project at LucknowProject to generate about 5 MW of power from MSW

Project to offer a MSW Management solution to the cityAbout 1000 TPD; of this about 750-800 Tons lifted the same dayProjected population of 25 lac in 2001Present disposal practices are far from being sanitaryWaste composition would be heterogeneous in most respects

Project had its Award process satisfactoryLoI issued on August 1996 thro’ competitive bidding Waste Supply Agreement in Feb 1997, PPA signed on July 1998, Land Lease agreement in March 1999, GoUP Guarantee in Feb 2000

Project enjoyed the commitment of its Stakeholders the LNN, UPPCL, MNES, local community, Pollution Control Board etc.

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Case Study - Structuring The ProjectFinancial closure achieved through tie-up of

Equity (Rs 20.00 crs); Senior Debt (Rs 26.50 crs); Deferred Credit (Rs 11.50 crs);Capital Subsidy (Rs 15.00 crs)

Contractual structure completed thro’ execution of Waste Supply Agreement by LNNPower Purchase Agreement with UPPCLEquipment Supply & Know-how provision agreements with Entec/ IUT/ JanbacherEPC arrangements with Jurong/ Jeevitha/ L&TO&M arrangements with Haustle

Commercial tightness ensured thro’ provisions ofContracts - Defect Liability provisions, Financial G’tee backed performance, & LD’sOfftake agreement - LC’s and Government Guarantee

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Thank You…