Structuring infrastructure project finance models: a comprehensive guide
By Diana Capetillo, Associate Director.
Navigating the intricacies of infrastructure project finance modeling is never easy. With countless variables, stages, and financing structures to consider, building an accurate and reliable model is crucial for project success.
This blog post aims to demystify the process by outlining the essential elements and providing a structured approach to developing general infrastructure project finance models.
Whether you’re a seasoned professional or just starting on your project finance journey, understanding these key components is vital for creating robust, adaptable, and insightful financial models – especially when dealing with large-scale projects or complex industrial projects.
General infrastructure is often financed under a project finance scheme, rather than traditional corporate finance structures. This involves the de-risking of the special purpose vehicle (SPV), while allowing for a high gearing ratio based on project cash flow rather than the sponsor’s balance sheet. Some additional mechanisms to Project Finance are the ones provided by export credit agencies/export-import banks, such as complementary financing, credit enhancements, foreign exchange crystallisation and insurance policies. These can help improve the credit rating of the project.
Risks
Depending on the type of infrastructure project, various inherent risks can significantly influence financial conditions. For instance, a hybrid project, which blends the stability of an off-taking agreement with the volatility of merchant risk, might necessitate a split financing structure.
This could involve two tranches: a lower-risk tranche aligned with the off-taking agreement, featuring a standard Debt Service Coverage Ratio (DSCR) and terms, and a higher-risk tranche corresponding to the merchant portion, requiring a higher DSCR and more conservative terms. Additionally, other market, operational, or regulatory risks can lead to potential economic underperformance under specific circumstances, particularly when the cash flow generated is volatile or impacted by external factors.
Also, there are risks specific to each stage of the project: development, construction, operation and decommissioning.
The construction stage is considered to be the riskiest one, because it is the one in which a large deployment of capital (equity/debt) is required.
No two projects are equal; they all have their own particularities. Hence, the structuring of a Project finance loan or bond is tailored to each specific project’s needs and expected revenue stream generated by the project.
Therefore, even though the general lay-out of a project finance model might follow the same structure, and there might be similarities between projects of the same nature, each financial model is unique.
This uniqueness implies that thorough attention to detail must be paid. It also means that templates are useful at early stages, but they must be adapted to each individual project in order to provide more accurate outcomes.
How to structure a project finance model
General infrastructure project finance models should be robust enough to include the financing structure and preliminary or agreed terms and conditions and complete enough to comprise sensitivities and scenarios.
To begin, define the model’s overall structure. Subsequently, design the input sheets.
Input sheets should categorise data into fixed constants and time-varying inputs. Common time-based inputs in project finance include inflation projections, pricing forecasts, and forward rates.
Afterwards, it is important to set the timelines that establish the timeframes to be used in the model. Different timeframes might be required for the different stages of the project. For instance, development and construction, with their monthly progress tracking and financial transactions, often require a monthly timeline. Conversely, other phases of the model can utilize different durations, ultimately aggregating into annual figures for key metrics and outputs.
The construction sheet
The construction sheet is essential in a project finance model as it calculates and balances the uses and sources of capital deployments.
This sheet will draft the need of resources on a monthly basis and the source (debt or equity) of each inflow for the completion of the project.
Lenders introduce further complexity by permitting the financing of upfront fees, commitment fees, and interest during construction (IDC), resulting in a circular financial arrangement. Additionally, in certain regions, construction projects incur VAT that is eligible for reimbursement. The inclusion of VAT facilities or tax-equity structures adds another layer of financial strength to the project.
The operating sheet
The operating sheet should clearly follow the underlying power purchase agreement or equivalent offtaking contracts. It should start from the production/generation/demand and follow the calculations established in such agreement in order to properly arrive at the stream(s) of revenues. If the project is at a very early stage, the model should offer the ability to switch between market-setter (estimate tariff as per a target IRR) and market-follower (fix tariff and obtain the corresponding IRR).
This module should also calculate the Opex as per the operations and maintenance (O&M)agreement. Escalatories such as inflation should be included as in the corresponding agreements.
For long term projects, especially concessions, this sheet should include all the calculations established in the outputs and payment mechanism clauses.
The financing structure sheet
The financing structure sheets must align with agreements or preliminary assessments from financial institutions and funding banks.
For a soft mini-perm structure, its formulation should include the corresponding balloon payment, underlying amortization schedule, and cash sweep mechanism.
When a typical permanent financing structure is chosen, it might be advantageous to include an option to test refinancing once a satisfactory track record is established. The amortisation schedule should align with bank preferences, such as mortgage-style (annuity or linear) or sculpting.
The debt module should incorporate tranches that account for Export Credit Agency (ECA financing), risk differentiation, and multiple currencies.
Furthermore, this section should provide calculations and warnings regarding compliance with covenants, including Debt Service Coverage Ratio (DSCR), restricted payment accounts, cash sweeps, Debt Service Reserve Account (DSRA), and Major Maintenance Reserve Account (MMRA).
The equity sheet
The equity sheet is one of the most relevant sheets for the developers and investors.
This section should include products where equity is contributed, returns are generated, and redemption occurs. These products are Equity Bridge Loan (EBL), Shareholder loan (SHL), free-carry, carried interest, preferred equity, and ordinary equity. The resulting returns and outputs from this section will be used in the metrics sheet.
Financial statements sheet
The financial statements sheets are essential when a three-statement model approach is followed.
In project finance, regular checks should ensure a balance between assets and liabilities/equity. It’s crucial to avoid any artificial inflation or deflation of cash. Typically, depreciation should reduce net fixed assets to zero. When a model incorporates multiple timelines, an annual financial statement is essential. This sheet is particularly useful for future planning, especially in the budgeting process.
Sensitivity and scenarios analyses
Project finance models benefit from the convenience of incorporating sensitivities and scenario analyses.
Their convenience is evident if a project economically underperforms due to un-transferred risks such as non-hedged FX volatility, price volatility/demand in merchant/hybrid projects, or deficient supply/price volatility when feedstock is not secured, penalties, etc.
Also, scenarios should reflect cases for analysis, such as base, high and low cases, simulating different behaviours of the revenue stream over the project’s life. This will allow evaluation of how the project would behave financially under extreme or regular circumstances, testing the resilience of its financial structure.
Outputs and summary sheets
The outputs and summary sheets should include all relevant metrics including the sources and uses summary, the returns metrics (debt, project and equity IRR, payback, etc.).
Main outcomes outline the necessary resources for project completion and the expected return on investment/debt. They also specify the duration existing investors need to remain in the project to achieve their anticipated returns.
In summary
We can conclude that a general infrastructure project finance model must follow a very structured approach that is simple and clearly defined, yet robust enough to closely reflect actual conditions.
A project finance model should also allow for the possibility of stressing certain factors (sensitivity analysis) and present scenarios while balancing completeness with easy-to-follow formulae.
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