Project Finance Loans Research Articles

Who funds whose infrastructure? Country dyadic analysis of global project finance loans

Global project finance investments have become one of the primary funding mechanisms for large infrastructure projects worldwide over the past few decades. This paper examines the country-level dynamics of global project finance loans from 1981 to 2018, using data from all project finance deals reported in the DealScan database. Our analysis reveals that most international project finance loans originate from banks and financial institutions in advanced democracies, while the recipient countries vary widely in terms of regime type and economic development. Through systematic visualization and statistical analysis, we find that transnational capital flows for infrastructure projects are more likely to occur between countries with similar political systems or between those with starkly different regimes. This finding indicates significant lending and borrowing between full democracies and closed autocracies, suggesting that investments raised in liberal democracies enable some of the most closed dictatorships to finance their infrastructure development. The study suggests that closed and repressive regimes might substantially benefit from the globalized project financing system, warranting increased attention from scholars in International Political Economy on political implications of the globalized project finance market.

Greenfield project finance loan maturity and the role of multilateral development banks in developing countries

This paper is intended to provide empirical evidence for the financial additionality of multilateral development banks (MDBs) in private sector infrastructure projects. To validate MDBs’ financial additionality, this study uses IJGlobal’s project finance database to examine whether the loan tenor of MDBs’ project finance loans is significantly longer than the average loan tenor extended by commercial banks, using ordinary least squares (OLS) and Poisson Pseudo Maximum Likelihood (PPML) estimations. The result of the empirical analysis shows that project finance loans involving MDBs have significantly longer loan maturity than average loans in lower-middle-income and upper-middle-income countries, while projects in low-income countries and Sub-Saharan Africa do not have such a tendency. Furthermore, in host countries where government effectiveness is underdeveloped, the coefficient of project finance loans provided by MDBs is negative with statistical significance. As a policy implication, these findings indicate that for MDBs to ascertain financial additionality in countries where government effectiveness is weak, additional measures such as capacity building of the host government and additional financial intervention are needed.

Political Institutions and Global Project Finance Loans

Abstract This paper explores the link between political institutions and the size of global bank loans received to fund project finance (PF) transactions, a commonly used funding method for domestic infrastructure construction. We theorize that lenders’ political risk assessments lead to a prioritization of political predictability over other institutional features of host countries. This indicates that, all else being equal, full democracies and politically closed regimes have advantages in attracting global PF capital, while hybrid regimes are least likely to receive global funds for similar projects. Using the global PF deals reported by the DealScan database and data on political institutions and economic indicators, we show that the relationship between host country regime type and global bank loans is indeed U-shaped. Our additional analysis demonstrates that a greater PF investment is associated with a lower hazard rate of regime failure in host autocracies, particularly in the form of an irregular exit by a dictator. Overall, our findings suggest that global bank loans, mostly originating from economically advanced democracies, contribute to infrastructure funding in dictatorships that might not otherwise be available through domestic or sovereign borrowing channels.

Risk transfer in project finance loans for toll road using credit default swaps

PurposeThe purpose of this paper is to demonstrate the applicability of the Credit Default Swaps (CDS), as a financial instrument, for transferring of risk in project finance loans. Also, an equation has been derived for pricing of CDS spreads.Design/methodology/approachThe debt service cover ratio (DSCR) is modeled as a Brownian Motion (BM) with a power-law model fitted to the mean and half-variance of the existing data set of DSCRs. The survival probability of DSCR is calculated during the operational phase of the project finance deal, using a closed-form analytical method, and the results are verified by Monte Carlo simulation (MCS).FindingsIt is found that using the power-law model yields higher CDS premiums. This in turn confirms the necessity of conducting rigorous statistical analysis in fitting the best performing model as uninformed reliance on constant time-invariant drift and diffusion model can erroneously result in smaller CDS spreads. A sensitivity analysis also shows that the results are very sensitive to the recovery rate and cost of debt values.Originality/valueInsufficiency of free cash flow is a major risk in the toll road project finance and hence there is a need to develop innovative financial instruments for risk management. In this paper, a novel valuation method of CDS is proposed assuming that DSCR follows the BM stochastic process.

Information Asymmetry, Financial Intermediation, and Wealth Effects of Project Finance Loans

Abstract Using a unique hand-collected sample, we study market reactions to mining developers announcing project finance loans. We document a significant three-day abnormal return of 2.6% and a 3.4% reduction in abnormal bid-ask spread around loan approvals, consistent with information transfer from private lenders to equity holders and reduction in asymmetric information. Cross-sectional analysis reveals a negative association between announcement return and hedging requirements specified in loan contracts, which becomes insignificant after controlling for treatment effects of hedging. Specialist banks do not charge lower rates but are more likely to impose hedging requirements, consistent with rent extraction due to bargaining power. (JEL G30, G32)

Capital market reactions to project finance loans

Theory predicts that bank loan announcements could increase share prices of loan recipients through a certification effect. We provide complementary evidence using the novel market setting of project finance loans. Since the loans are off-balance-sheet, there should be no certification effect. Applying an event study methodology and the Carhart 4-factor model to a large international dataset, we find that project sponsors do not experience positive abnormal returns after announcements, but lenders do. We also find that sponsors and lenders tend to experience greater equity return volatility after announcements.

A Study on the Scope of the Recognized Equity Capital of Developer in Real Estate Project Finance Loan Screening

A Study on the Scope of the Recognized Equity Capital of Developer in Real Estate Project Finance Loan Screening

Critical risk factors of the project finance loan spread in the infrastructure sector: Experience from the ASEAN countries

This paper finds that in ASEAN-4, the micro loan characteristics: loan amount and LIBOR whilst the macro characteristics: inflation, net export and GDP growth influence the loan spread in the project finance. However, simultaneously at the country level, the determinants of the loan spread are distinctive to each country’s infrastructure industry characteristic. The paper’s main contribution relates to the determinants of the project finance loan spread at the country level and regional level, ASEAN-4. The purpose of this paper is to fathom the critical risk factors behind the project finance loan pricing differential across the ASEAN-4 countries. Hence, the policy makers, project developers and lenders can have a better understanding of the drivers behind the project finance loan spread pricing. The study adopted an ordinary least square (OLS) regression methodology and collected data from ASEAN-4 countries consisting of Indonesia, Malaysia, Philippines, and Thailand.

Competition in the Project Finance Loan Industry in Europe

Competition in the Project Finance Loan Industry in Europe

INTERNATIONAL EXPERIENCE IN PROVIDING FINANCIAL SUPPORT FOR LOCAL INVESTMENT PROJECTS

The article underlines the prospect of studying international experience in the context of decentralization processes in Ukraine. Local authorities and self-governments solve problems of development of industrial and social infrastructure, expansion and modernization of means of production in the conditions of severe scarcity of financial resources. The purpose of the article is to summarize the European experience of financial support for local investment projects, in particular, energy efficiency of housing and communal services. The experience of European countries on the financial support of local investment projects is explored. In the Western literature on financial planning, the importance of cash flow analysis is essential. The development of a cash flow model is performed using the following tools of discounted cash flow analysis, net present value (NPV), internal rate of return (IRR). Financial modelling is a key part of all projects. Drawing attention to strategically important calculations is one of the main tasks in the implementation process. The basic approaches to risk management during the implementation of infrastructure projects are analyzed. Depending on the amount of information available, the risk can be assessed qualitatively or quantitatively. Quantitative risk analysis is performed to calculate risks in terms of cost and impact of time. Qualitative analysis is carried out on risks that have been prioritized for quality risk analysis and have a significant impact on the project. Public-private partnership agreements often do not fully take into account the interests of the financial sector. This limits the ability to attract funds from private investors, including international financial institutions, to local projects. The types of budget financing of local programs are separately identified in the form of project subsidies, government guarantees and targeted investment tax benefits. The main forms of project finance loan can be an investment bank loan, targeted bond loans, equipment leasing and commercial project loan. The experience of the Eastern European countries on the financial support of energy efficiency projects for housing and communal services is considered. The centres of energy efficiency centres or networks should become institutes for financial modelling of projects in Ukraine, according to the experience of Eastern European countries. Universities may be the starting points for such centres. Developing alternative models of energy-saving technologies or tariffs can be an information product and an example of creating a competitive environment in the housing and utilities system. Limited possibilities of the state budget in the context of rising external debt, deterioration of the level and quality of life of citizens, increasing the complexity of business activities require the need for further theoretical alternatives using the experience of other countries, taking into account their own experience and achieving social consensus. Keywords: decentralization, investment projects, financial modelling, financial risks, energy efficiency.

Financing infrastructure in Asia through bonds and capital markets

The project finance scenario has changed significantly around the world after the 2008 financial crisis and following the subsequent Basel III recommendations. Project finance loans from commercial banks and financial institutions have largely dried up, leaving it mostly to the export credit agencies and the bilateral and multilateral development banks to provide the institutional credit. Unfortunately, those sources are not enough, given the huge needs for construction of new infrastructure and renovation of the old ones across Asia, Africa and Latin America. The need for capital markets, through market listed financial products across asset class, unlocking a large part of domestic and corporate savings, has never been felt as strongly before. This article seeks to analyze the development story of various Asian capital markets and examine financial products, which have succeeded in their short history in receiving investor interest. The article also delves into the challenges to market development, policy imperatives and the issues relating to market liquidity and credit rating, which are the most significant influencers for public market float and investor interest.

Assessment and mitigation of credit risks in project financing

Lending to long-term investment projects in fragile countries requires additional financial instruments to control the sustainability of project cash flows and to increase the borrower’s financial discipline in debt servicing. This paper analyzes the special aspects of using financial covenants as credit risk mitigation instruments in project financing in Ukraine. It also argues that regulatory requirements to maintain financial strength indicators at the appropriate level have an indirect impact on the change in project finance loan rates. The study primarily aims at developing approaches to defining a credit rate corridor for an investment project, depending on changes in the values of financial sustainability indicators. The implementation of the proposed approach allows increasing the validity of credit risk components for investors and optimizing capital value for borrowers.As required by international practice, violation of covenant terms is the trigger for satisfying the creditors’ claims. According to the authors’ conclusions, the use of financial covenants as a tool for protecting the creditors’ interests should not be an instrument of unreasonable financial pressure on borrowers. The study reveals benefits and drawbacks of using financial covenants to mitigate credit risk and reduce the probability of a borrower default in the field of project financing in Ukraine.

Risk-adjusted pricing of project loans

PurposeThe purpose of this paper is to assess whether project finance loans were properly priced based on their risk before the crisis of 2008-2009 and what lessons can be learned under different market circumstances.Design/methodology/approachA literature review presents the structure of project financing, how banks are inspired to apply risk-adjusted price calculations for loans to create value for shareholders and how risk measurement differs by project loans. The authors adapt a general model for risk-adjusted pricing to project loans. Based on empirical parameters, assuming different margins and leverages, the authors estimate the implied maximum probability of default of projects, where project loans could produce value added to lenders. The authors compare these maximum probabilities of default with reference points.FindingsThe authors conclude that by the years of 2006-2007 several projects were very unlikely to produce any value added for shareholders and did not reach the minimum margin. Market and regulatory circumstances of 2016-2017 have significantly increased required margin levels and must shift lenders to a more conservative pricing and leverage policy.Research limitations/implicationsThough the presented model is general, the simulation focusses on the European banking market.Practical implicationsIn high market competition, banks tend to underestimate risk, underprice loans and loosen risk parameters. The crisis pushed banks back to a more conservative approach, however, the danger to return to a loosen project loan policy is real. The simulation shows how required prices are influenced by different market circumstances.Originality/valueThe paper adapts the risk-adjusted pricing methodology of standard loans to a new segment of project financing and gives an insight into the risk-pricing characteristics of project loans. The authors can draw down several valuable conclusions what how the market environment or project phases affect risk-adjusted pricing and the ability to produce value added to shareholders.

Collateralized Debt Obligations

We find that credit rating is the most important variable in determining tranche spread at issue on Collateralized Debt Obligations (CDOs) issues backed by project finance (PF) loans. Factors that are important for pricing in the case of corporate bonds, such as market liquidity and weighted average maturity, are also relevant for determining spreads on these securities. Furthermore, the nature of the underlying assets has a substantial impact on CDO pricing: primary market spread is significantly higher when the underlying PF loans bear a higher level of market risk and when the proportion of projects still under construction in the securitized portfolio is larger.

Loan tenor in project finance

PurposeThe purpose of this paper is to develop a better understanding of the debt structuring of project finance (PF) loans and the main drivers affecting the maturity of bank loans in infrastructure deals. When banks grant loans to a project, they have two decision variables: the interest margin or the spread and the maturity of the loan. Although several studies analyze the drivers of the spread, few studies in the literature look at the maturity of bank loans. As infrastructure projects are typically highly leveraged, the structuring of bank lending is an important parameter in the financial viability of the project.Design/methodology/approachThe paper develops a regression analysis of the loan’s maturity on four categories: characteristics of the project, political risk of the country where the project is executed, the macro-economic setting and the regulatory framework. By using a new data set of InfraDeals containing data on bank loans of more than 1,800 infrastructure projects worldwide from 1997 to 2016, this paper reveals new insights on the debt structuring of banks for PF loans.FindingsThe results indicate that the maturity of bank loans granted to infrastructure deals is predominantly driven by political risk and regulation, rather than the structuring of the project. This implicates that the region where the deal is closed weighs more heavily than the specificities of the project itself.Originality/valueThe results have important policy implications. The paper allows to develop a better understanding on how political risk and new regulation, like Basel III, might affect the PF market. The paper is the first one finding empirical evidence of the impact of Basel III regulation on PF lending. By delving deeper into the political risk variable, the authors formulate several recommendations to mitigate political risk.

Domestic lead arranger certification and the pricing of project finance loans

AbstractUsing a sample of 1,270 project finance syndicated loan tranches arranged from 1998 to 2011 and worth over $300 billion, we estimate the causal impact of certification by domestic lead arrangers on the pricing of project finance loans in emerging markets. We hypothesize that, on average, domestic arrangers are better able to structure and screen project finance deals, credibly communicate the true value of a project and its underlying network of contracts, and monitor the loan contract compared with foreign arrangers. If so, all things being equal, domestic arranger certification should result in lower loan spreads compared with foreign arranger certification. Our results support this hypothesis. After controlling for project and loan characteristics and the potential endogeneity of the lead arranger's selection, we find that certification by domestic arrangers causes a significant reduction in loan spreads across different industrial categories and geographic locations of projects. This finding demonstrates the economic value of domestic arranger certification in project finance lending. Our results suggest that, in the presence of information asymmetry between project sponsors and participant lenders in the syndicate, certification by domestic arrangers offers a superior mechanism to minimize search, information, and monitoring costs.

Determinants of bank loan spread in project finance

PurposeThe purpose of this paper is to develop a better understanding of the pricing decisions of banks for project finance (PF) loans and the main drivers affecting the cost of debt in infrastructure deals. As infrastructure projects are typically highly leveraged, the cost of bank lending is an important driver of the overall funding costs for the project.Design/methodology/approachFirst, the paper provides a general review of the drivers of the cost of funds in PF. Second, the paper develops a regression analysis of the loan’s spread on four categories: project, loan, bank characteristics and the economic environment. By using a new data set of InfraDeals containing data on bank spreads of more than 700 infrastructure projects worldwide from 2006 to 2016.FindingsThe results show that the cost of debt is predominantly affected by the market and the business cycle, rather than the structuring of the project. This implicates that the timing when the deal is closed weighs more heavily than the specificities of the project itself.Practical implicationsThe results have important policy implications. As PF deals are often paid for by taxpayers, this paper could help policymakers to use public funds for infrastructure in the most efficient way.Originality/valueOne weakness of existing studies in PF loan pricing is that they undervalue the role of the economic environment in the cost of debt. Few studies in the literature include macroeconomic control variables in their model and the others do not seem to find significant results. This paper reveals new insights on the pricing decisions of banks for PF loans.

Domestic Lead Arranger Certification and the Pricing of Project Finance Loans

Using a sample of 1,270 project finance syndicated loan tranches arranged from 1998 to 2011 and worth over $300 billion, we estimate the causal impact of certification by domestic lead arrangers on the pricing of project finance loans in emerging markets. We hypothesize that, on average, domestic arrangers are better able to structure and screen project finance deals, credibly communicate the true value of a project and its underlying network of contracts, and monitor the loan contract compared to foreign arrangers. If so, all things being equal, domestic arranger certification should result in lower loan spreads compared to foreign arranger certification. Our results support this hypothesis. After controlling for project and loan characteristics and the potential endogeneity of the lead arranger's selection, we find that certification by domestic arrangers’ causes a significant reduction in loan spreads across different industrial categories and geographic locations of projects. This finding demonstrates the economic value of domestic arranger certification in project finance lending. Our results suggest that, in the presence of information asymmetry between project sponsors and participant lenders in the syndicate, certification by domestic arrangers offers a superior mechanism to minimize search, information and monitoring costs.

Financial Advisor Reputation and the Cost of Debt: Theory and Evidence from Project Finance Loans

An important puzzle in credit markets is why some firms use the services of financial advisors (FA) rather than undertake those tasks themselves. This paper examines, using theory and empirical evidence, whether the presence and the reputation of FA can act as a credible signal of project quality. Our theoretical model shows that, because of the structure of success fees, project lenders may worry that FA will try to sell them excessively risky projects, leading to higher costs of debt. Using Projectware data on project finance (PF) loans granted to public-private partnership projects arranged between 2001 and 2015, we test empirically and find strong support for our theoretical prediction. Indeed, our empirical results show that the presence and the reputation of FA are associated with higher costs of debt. Moreover, the evidence shows that FA presence and reputation are linked to higher project debt ratios. Overall, our findings suggest that the structure of success fees offers strong incentives to FA to focus on providing high debt levels rather on reducing asymmetric information between sponsors and lenders. Therefore, the presence and reputation of FA do not seem to be credible signaling devices for quality in the market for project finance loans.

The price of project finance loans for highways

Public Private Partnerships (PPP) have been among the preferred methods for building, operating, and financing highway projects. With PPP comes a higher cost of capital, which, under the theoretical economic rationale for PPP development, is recovered through greater operational managerial efficiency - thus delivering value for money. This paper addresses the cost of financing highway projects, particularly the spreads of project finance loans. The authors attempt to identify which variables related to the project, loan, and macroeconomic context, have a greater impact on spreads, and how they impact on the final spread. To examine the relationship between spreads and variables, this research used a data set of 22 PPP projects in the highways sector in Portugal, with a total of 63 loans, awarded between 1990 and 2010.