An Empirical Analysis of Limited Recourse Project Finance

Abstract

This paper provides the first full-length empirical analysis of project finance, which is defined as limited or non-recourse financing of a newly to be developed project through the establishment of a vehicle company. We compare the characteristics of a sample of 4,956 project finance loans (worth $634 billion) to comparable samples of non-project finance loans, all of which are drawn from a comprehensive sample of 90,784 syndicated loans (worth $13.2 trillion) booked on international capital markets since 1980. We find that project finance (PF) loans differ significantly from non-project finance loans in that PF loans have a longer average maturity, are more likely to have third-party guarantees, and are far more likely to be extended to non-US borrowers and to borrowers in riskier countries. PF credits also involve more participating banks, have fewer loan covenants, are more likely to use fixed-rate rather than floating-rate loan pricing, and are more likely to be extended to borrowers in tangible-asset-rich industries such as real estate, and electric utilities. Despite being non-recourse finance, floating-rate PF loans have lower credit spreads (over LIBOR) than do most comparable non-PF loans. Contrary to expectations, we find that PF loans are not larger than non-PF loans, but are in fact significantly smaller than corporate control or capital structure loans (two of the four non-PF loan samples examined). Loan pricing regression analysis reveals that PF and non-PF loans are funded in segmented capital markets, with spreads on PF loans being influenced both by different factors and to different degrees by common factors. PF loan spreads are directly related to borrower country risk, the use of covenants in the loan contract, and project leverage. Spreads are also higher when a borrower is in a tangible-asset-rich industry, and loan spreads and fees are shown to be complements rather than supplements. The presence of a third-party guarantee significantly reduces PF loan spreads, while loan size and maturity generally do not influence PF loan pricing. Though direct comparisons of the leverage ratios of project finance vehicle companies and the operating companies that arrange most syndicated loans are not possible, we do find that projects funded with PF loans are indeed heavily leveraged-with an average loan to project value ratio of 67 percent. Finally, when we apply an organizational choice model to a large sample of loans extended to borrowers in industries, which frequently use project finance, we are able to achieve out-of-sample predictive accuracy of almost 80 percent.