Under PPP arrangements, in contrast to more traditional procurement, the private sector finances the projects from the outset. It receives payment or pre-payment, provided the asset meets performance criteria and availability.
There may be a unitary payment upfront or payment over a period. As the sponsors are unlikely to be in a position to put up all sums to fund the project forward through equity investment, it is likely to require finance from a bank to cover a part of the upfront costs of the project.
The lender will wish to be satisfied that the project cash flows are sufficiently strong and assured to secure repayment at the appropriate rate under the appropriate risk. Traditional financing may be by way of bonds or appropriate facilities from financial institutions.
The borrowing will be limited to recourse to the revenues of the project, at least after the development stage. There may be negotiation in relation to the extent of recourse.
Bank lending to project companies is usually by way of project term loans in the nature of commercial loan agreements. In larger cases, the debt may be on a syndicated basis by a number of banks or institutions lending on the same terms and conditions through a loan agreement.
There may be a term loan with a floating rate, which is hedged to provide fixed funding to match the revenue. Standard bank warranties, representations, covenants etc. will be provided subject to negotiation.
An equity investment by the project entity may be required as a condition by the awarding authority. This will commonly be between 10 and 15% of the cost. This will act as a cushion for the lenders from risk.
The sponsors in the project will subscribe for equity. They may agree to lend debt to the project company on the basis that it is subordinated to other lending. This may be in addition or as an alternative, to equity. Other parties may contribute equity, including institutional investors, specialised funds, etc.
Bonds may be issued to finance projects. This is relatively unusual. Bondholders will not generally wish to accept risks in the construction phase, given that the authority is unlikely to have to pay anything unless the project is completed and commissioned. The risk may be reduced by bank guarantees, standby letters of credit, completion guarantees by the project sponsors or by an insurance company.
An insurer may guarantee repayment of the bonds. Its credit rating may give the bonds a higher rating than could be achieved by the project company’s covenant.
Bond documentation is likely to be more standardised. Its cost in the markets is likely to be cheaper with less extensive covenants than a loan agreement. It allows access to a broader creditor base. Bond instruments are more readily traded.
Traditionally, with bonds, an obstacle is the number of participants, including credit rating agencies, lead managers, trustees, insurers, depositories and paying agents. In contrast, there may be a single syndicated agent.
Bonds will generally have a single drawdown so that the lending must be carried during the construction period with no corresponding revenues.
Amendments to project agreements will usually require the participation of bondholders in general meetings. More onerous disclosure is required in bond issues than in the syndicated debt market. Due diligence and disclosure appropriate to a public offering is required which may raise confidentiality issues and issues of commercial sensitivity. Bond funding may be volatile.
In some limited cases, lease financing may be appropriate where major capital equipment is required by the project company in order to perform its obligations. The project company enters into a finance lease with a leasing company which finances the cost of the assets.
The cost is recovered through lease payments/ rental. There may be scope for the passing of capital allowances to the lessor company, depending on the jurisdiction.
Inter-creditor agreements may be required where the lessor owns the assets which are essential to providing the service. Other debt funders will wish to ensure that the project cannot be damaged by the finance lessor exercising rights to repossess the assets. This is particularly so if the assets have a realisable value, although less so if they are tailored and unique.
There may be direct agreements with the awarding authority. Almost invariably public-private partnerships vehicles are financed on a limited recourse basis. Recourse is had to the project assets only. A special purpose company acts as such and conducts no other business.