PROJECT OR NOT PROJECT?
It is quite peculiar that project finance ranks as standalone specialty differentiating itself from corporate finance. It somehow implies a frontier between infrastructure, real estate, mining, energy, utilities projects on the one side and plain vanilla corporate finance on the other side.
There is, at first glance, a kind of contradiction. Corporate entities refurbishing their existing plant, equipment and machinery facilites or building new ones are clearly committed to perform what looks like projects. And yet they deserve corporate funding in the form of banking loans, banking facilities or market bonds, whereas big projects are entitled to that structure finance stuff, in the form of project finance, asset finance, trade finance, including project bonds.
The reason is that a project is expected to support its funding on a standalone basis. Contrary to the corporate entities where a financial debt instrument is only part of a pool of liabilities, projects are supported by single purpose vehicles whose financing comes from a restricted set of loans or facilities, the amount of which is calibrated on the future project cash flows. Insofar as the cash flows are fully predictable, for instance mining or oil proceeds with an off take contract signed with a first class off taker, the level of debt on these SPVs can be very high and the maturity of it, very long.
Hence the project finance industry, that, thanks to these predictable forthcoming cash flows, feels comfortable with levels of “interest coverage ratio” (numerator, interest expenses), “debt service coverage ratio” (numerator, principal and interest repayments) “loan life coverage ratio” (numerator, net present value of cash flows) that would be unsustainable in the view of a corporate finance analyst.
Hence the tendency of corporate entities to mimic project finance entities and leverage on their assets by breaking them out into various micro projects, one for the inventory, another for the facilities, a third one for the equipment… By so doing they take advantage of the addition of their assets that happens to exceed the sum of the parts… a quite dangerous approach that bears some “securitisation flavor”.
State entities are also eager to leverage on their utilities through project financing technology. PPPs or public private partnerships are a good example of it.
No path is without pitfalls. In this case, the risk is addition of debt to such a point that we could find ourselves with disproportionate macro indebtedness level, i.e when compared with GDP.
Dominique F. Pasquier