Refinancing and selling a stake in a specialist project company (SPV) are two ways for sponsors/shareholders to restructure a project while making a little, what they call, money…
Above are the financial flow charts before and after the refinancing of the project to design, build, finance and operate Fazakerley Prison, UK
We talk about these two ways in more detail at our APMG PPP International Certified PPP Specialist training program
If you would like to have a closer look at Russian practice, I recommend you to study carefully the case of refinancing public private partnership project by placing bonds in the amount of more than 5 bln rubles
(~$65 mln). Under this project, 12 social infrastructure facilities (schools, kindergartens, a library and a center of culture and contemporary art) were built in Yakutsk…
Refinancing, in general terms, is the replacement of the existing debt obligations of the private partner with new obligations on terms favorable to the private partner.
This improves the financial performance of the PPP project for the sponsors/shareholders (internal rate of return, IRR; net present value, NPV, etc.).
One can give examples, again from the practice of project financing, why refinancing is carried out:
To optimize payments (reduce interest payments, «collect in one basket» (consolidate) all previous debt, move from a fixed to a floating interest rate and vice versa, etc.)
To replace the old debt with the new one (sometimes this is agreed upon beforehand when signing initial documents on financing a public-private partnership project)
«free up» the funds blocked at the lender’s request as a contingency reserve
prolong the term of the loan, thus reducing current payments
diversify (diversify) the group of creditors, for example, by issuing bonds, etc.
Usually the borrowers, and in our case, the private partner and his sponsors/shareholders, are interested in refinancing if:
(i) the old debt or new debt is possible at a lower interest rate
(ii) the balance of your outstanding debt is high enough, and
(iii) the costs of early repayment of the previous loan (e.g., prepayment fees/fines) and servicing the new loan are no greater than the benefit of the lower interest rate.
Forms of refinancing
So, let’s imagine a public-private partnership project in which (on PFI terms, we’ve talked about this in detail in previous posts) a school or hospital, let’s say, or even a prison building has been built and is being successfully operated.
Obviously, there is no risk of construction and everything associated with it, the uncertainty is also minimized — the first payments from the state partner are received on a regular basis, the project company has a steady income and everything seems to be fine.
And the private partner, specifically — the project sponsors / shareholders of the special project company (SPV), come to the bank and the state partner and start talking about whether we should reconsider the terms on which the loans (debt) were granted …
What do the private partners insist on?
The private partner, usually the sponsors/shareholders of the project company, will most likely insist on:
— reduce the interest rate
— Increase the maturity of the loan
— Increase the size of the loan by, among other things, improving the coverage ratios (a video lesson on these ratios from MGIMO may be seen here: «interval» Debt Service Coverage Ratio, DSCR; Loan Life Coverage Ratio, LLCR; Project Life Coverage Ratio, PLCR) and
— reducing reserves (for debt service, equipment overhaul (CHP), asphalt replacement (road), etc.)
And, as we noted earlier, if the project is profitable enough, the private partner can ask to issue bonds at the end of construction
Let’s digress a little: often when discussing the financial structure of a PPP deal, we hear: can we plan for refinancing in advance?
The answer we give is: you can.
In practice, we have seen projects, and quite often built/structured in such a way that the private partner relied entirely on subsequent refinancing: instead of long-term loans, the project company (SPV) took a short-term (3-4 years) loan with the explicit intention of replacing this short financing with a long-term financing agreement (possibly by issuing the same project bonds) as soon as the construction and launch risks of the project are reduced.
But in this situation, there is another big risk that later on, in those 3-4 years, at the time of the decision to refinance, the financial situation in the country ok
Share of profits on refinancing
Typically, the public partner’s obligations upon termination of a PPP agreement are related to senior debt and junior debt outstanding at the time of payment upon termination of the PPP agreement.
Thus, refinancing leading to an increase in debt will lead to an increase in obligations at termination.
And it is logical to assume that a share in the profits from refinancing is some sort of compensation for the public sector for taking additional risks, so the public sector is likely to demand a share in the profits from refinancing resulting from refinancing…
You can get that share in a lump sum, you can stretch it out over time, or you can reduce the payment to the private partner.
By the way, a question.
What path did the Yakutsk City Administration take in refinancing?