Characteristics of Project Financing

Project financing involves non-recourse financing of the development and construction  of a particular project in which the lender looks principally to the revenues expected to  be generated by the project for the repayment of its loan and to the assets of the project  as collateral for its loan rather than to the general credit of the project sponsor.

Project financing is commonly used as a financing method in capital-intensive industries  for projects requiring large investments of funds, such as the construction of power  plants, pipelines, transportation systems, mining facilities, industrial facilities, and heavy  manufacturing plants. The sponsors (the sponsor(s) or developer(s) of a project financing is the party that organizes all of the  other parties and typically controls, and makes an equity investment in, the company or  other entity that owns the project)  of such projects frequently are not sufficiently  creditworthy to obtain traditional financing or are unwilling to take the risks and assume  the debt obligations associated with traditional financing methods. Project financing permits the  risks associated with such projects to be allocated among a number of parties at levels  acceptable to each party.

The important characteristics of Project financing are:

1. Non-Recourse

The typical project financing involves a loan to enable the sponsor to construct a project  where the loan is completely “non-recourse” to the sponsor, i.e., the sponsor has no  obligation to make payments on the project loan if revenues generated by the project are  insufficient to cover the principal and interest payments on the loan. In order to  minimize the risks associated with a non-recourse loan, a lender typically will require  indirect credit supports in the form of guarantees, warranties and other covenants from  the sponsor, its affiliates and other third parties involved with the project.

2. Off-Balance-Sheet Treatment

Depending upon the structure of a project financing, the project sponsor may not be  required to report any of the project debt on its balance sheet because such debt is non-recourse  or of limited recourse to the sponsor. Off-balance-sheet treatment can have the  added practical benefit of helping the sponsor comply with covenants and restrictions  relating to borrowing funds contained in other indentures and credit agreements to  which the sponsor is a party.

3. Maximize Leverage

In a project financing, the sponsor typically seeks to finance the costs of development  and construction of the project on a highly leveraged basis. Frequently, such costs are  financed using 80 to 100 percent debt. High leverage in a non-recourse project financing  permits a sponsor to put less in funds at risk, permits a sponsor to finance the project  without diluting its equity investment in the project and, in certain circumstances, also  may permit reductions in the cost of capital by substituting lower-cost, tax-deductible  interest for higher-cost, taxable returns on equity.

4. Maximize Tax Benefits

Project financing should be structured to maximize tax benefits and to assure that all  available tax benefits are used by the sponsor or transferred, to the extent permissible, to  another party through a partnership, lease or other vehicle.

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