PROCESS OF PROJECT FINANCING

Feasibility Study As one of the first steps in a project financing is hiring of a technical consultant and he will prepare a feasibility study showing the financial viability of the project. Frequently, a prospective lender will hire its own independent consultants to prepare an independent feasibility study before the lender will commit to lend funds for the project. Contents The feasibility study should analyze every technical, financial and other aspect of the project, including the time-frame for completion of the various phases of the project development, and should clearly set forth all of the financial and other assumptions upon which the conclusions of the study are based, Among the more important items contained in a feasibility study are: 1. Description of project 2. Description of sponsor(s). 3. Sponsors' Agreements. 4. Project site. 5. Governmental arrangements. 6. Source of funds. 7. Feedstock Agreements. 8. Off take Agreements. 9. Construction Contract. 10. Management of project. 11. Capital costs. 12. Working capital. 13. Equity sourcing. 14. Debt sourcing. 15. Financial projections. 16. Market study. 17. Assumptions.

THE PROJECT COMPANY Legal Form Sponsors of projects adopt many different legal forms for the ownership of the project. The specific form adopted for any particular project will depend upon many factors, including: The amount of equity required for the project The concern with management of the project The availability of tax benefits associated with the project The need to allocate tax benefits in a specific manner among the project company investors. The three basic forms for ownership of a project are: 1. CorporationsThis is the simplest form for ownership of a project. A special purpose corporation may be formed under the laws of the jurisdiction in which the project is located, or it may be formed in some other jurisdiction and be qualified to do business in the jurisdiction of the project. 2. General PartnershipsThe sponsors may form a general partnership. In most jurisdictions, a partnership is recognized as a separate legal entity and can own, operate and enter into financing arrangements for a project in its own name. A partnership is not a separate taxable entity, and although a partnership is required to file tax returns for reporting purposes, items of income, gain, losses, deductions and credits are allocated among the partners, which include their allocated share in computing their own individual taxes. Consequently, a partnership frequently will be used when the tax benefits associated with the project are significant. Because the general partners of a partnership are severally liable for all of the debts and liabilities of the partnership, a sponsor

frequently will form a wholly owned, single-purpose subsidiary to act as its general partner in a partnership. 3. Limited PartnershipsA limited partnership has similar characteristics to a general partnership except that the limited partners have limited control over the business of the partnership and are liable only for the debts and liabilities of the partnership to the extent of their capital contributions in the partnership. A limited partnership may be useful for a project financing when the sponsors do not have substantial capital and the project requires large amounts of outside equity. Limited Liability CompaniesThey are a cross between a corporation and a limited partnership. Project Company Agreements Depending on the form of Project Company chosen for a particular project financing, the sponsors and other equity investors will enter into a stockholder agreement, general or limited partnership agreement or other agreement that sets forth the terms under which they will develop, own and operate the project. At a minimum, such an agreement should cover the following matters: Ownership interests. Capitalization and capital calls. Allocation of profits and losses. Distributions. Accounting. Governing body and voting. Day-to-day management. Budgets. Transfer of ownership interests.

 Admission of new participants. Default. Termination and dissolution. Principal Agreements in a Project Financing1. Construction ContractSome of the more important terms of the construction contracts are Project Description- The construction contract should set forth a detailed description of all the Work necessary to complete the project Price:- Most project financing construction contracts are fixed-price contracts although some projects may be built on a cost-plus basis. If the contract is not fixed-price, additional debt or equity contributions may be necessary to complete the project, and the project agreements should clearly indicate the party or parties responsible for such contributions. Payment- Payments typically are made on a "milestone" or "completed work" basis, with a retain age. This payment procedure provides an incentive for the contractor to keep on schedule and useful monitoring points for the owner and the lender. Completion Date- The construction completion date, together with any time extensions resulting from an event of force majeure, must be consistent with the parties' obligations under the other project documents. If construction is not finished by the completion date, the contractor typically is required to pay liquidated damages to cover debt service for each day until the project is completed. If construction is completed early, the contractor frequently is entitled to an early completion bonus. Performance Guarantees- The contractor typically will guarantee that the project will be able to meet certain performance standards when completed. Such standards must be set at levels to assure that the project will generate sufficient revenues for debt service, operating costs and a

return on equity. Such guarantees are measured by performance tests conducted by the contractor at the end of construction. If the project does not meet the guaranteed levels of performance, the contractor typically is required to make liquidated damages payments to the sponsor. If project performance exceeds the guaranteed minimum levels, the contractor may be entitled to bonus payments. 2. Feedstock Supply Agreements. The project company will enter into one or more feedstock supply agreements for the supply of raw materials, energy or other resources over the life of the project. Frequently, feedstock supply agreements are structured on a "put-or-pay" basis, which means that the supplier must either supply the feedstock or pay the project company the difference in costs incurred in obtaining the feedstock from another source. The price provisions of feedstock supply agreements must assure that the cost of the feedstock is fixed within an acceptable range and consistent with the financial projections of the project. 3. Product off take Agreements. In a project financing, the product off take agreements represent the source of revenue for the project .Such agreements must be structured in a manner to provide the project company with sufficient revenue to pay its project debt

obligations and all other costs of operating, maintaining and owning the project .Frequently,offtake agreements are structured on a "take-or-pay" basis, which means that the offtaker is obligated to pay for product on a regular basis whether or not

the offtaker actually takes the product unless the product is unavailable due to a default by the project company. Like feedstock supply arrangements, offtake agreements frequently are on a fixed or scheduled price basis during the term of the project debt financing. 4. Operations and Maintenance Agreement -

The project company typically will enter into a long-term agreement for the day-to-day operation and maintenance of the project facilities with a company having the technical and financial expertise to operate the project in accordance with the cost and production specifications for the project. The operator may be an

independent company, or it may be one of the sponsors . The operator typically will be paid a fixed compensation and may be entitled to bonus payments for

extraordinary project performance and be required to pay liquidated damages for project performance below specified levels.

5. Loan and Security Agreement. The borrower in a project financing typically is the project company formed by the sponsor(s) to own the project. The loan agreement will set forth the basic terms of the loan and will contain general provisions relating to maturity, interest rate and fees. The typical project financing loan agreement also will contain yhr provisions such as1. Disbursement Controls. These frequently take the form of conditions precedent to each drawdown, requiring the borrower to present invoices, builders certificates or other evidence as to the need for and use of the funds. 2. Progress Reports.:- The lender may require periodic reports certified by an independent consultant on the status of construction progress. 3. Covenants Not to Amend:- The borrower will covenant not to amend or waive any of its rights under the construction, feedstock, off take, operations and

maintenance, or other principal agreements without the consent of the lender. 4. Completion Covenants:-These require the borrower to complete the project in accordance with project plans and specifications and prohibit the borrower from materially altering the project plans without the consent of the lender. 5. Dividend Restrictions. These covenants place restrictions on the payment of dividends or other distributions by the borrower until debt service obligations are satisfied.

6. Debt and Guarantee Restrictions. The borrower may be prohibited from incurring additional debt or from guaranteeing other obligations 7. Financial Covenants. Such covenants require the maintenance of working capital and liquidity ratios, debt service coverage ratios, debt service reserves and other financial ratios to protect the credit of the borrower. 8. Subordination. Lenders typically require other participants in the project to enter into a subordination agreement under which certain payments to such participants from the borrower under project agreements are restricted (either absolutely or partially) and made subordinate to the payment of debt service. 9. Security. The project loan typically will be secured by multiple forms of collateral, including:--- Mortgage on the project facilities and real property. Assignment of operating revenues. Pledge of bank deposits Assignment of any letters of credit or performance or completion bonds relating to the project. project under which borrower is the beneficiary. Liens on the borrower's personal property Assignment of insurance proceeds. Assignment of all project agreements Pledge of stock in project company or assignment of partnership interests. Assignment of any patents, trademarks or other intellectual property owned by the borrower. 6 Site Lease Agreement. The project company typically enters into long- term lease for the life of the project relating to the real property on which the project is to be located. Rental payments may be set in advance at a fixed rate or may be tied to project performance. 7.Insurance. The general categories of insurance available in connection

with project financings are: 1. Standard Insurance- The following types of insurance typically are obtained for all project financings and cover the most common types of losses that a project may suffer. Property Damage, including transportation, fire and extended casualty. Boiler and Machinery. Comprehensive General Liability. Worker's Compensation. Automobile Liability and Physical Damage. Excess Liability. 2. Optional Insurance. The following types of insurance often are obtained in connection with a project financing. Coverages such as these are more expensive than standard insurance and require more tailoring to meet the specific needs of the project Business Interruption. Performance Bonds. Cost Overrun/Delayed Opening. Design Errors and Omissions System Performance (Efficiency). Pollution Liability.

Project Risks
Project finance is finance for a particular project, such as a mine, toll road, railway, pipeline, power station, ship, hospital or prison, which is repaid from the cash-flow of that project. Project finance is different from traditional forms of finance because the financier principally looks to the assets and revenue of the project in order to secure and service the loan. In contrast to an ordinary borrowing situation, in a project financing the financier usually has little or no recourse to the non-project assets of the borrower or the sponsors of the project. In this situation, the credit risk associated with the borrower is not as important as in an ordinary loan transaction; what is most important is the identification, analysis, allocation and management of every risk associated with the project. The following details shows the manner in which risks are approached by financiers in a project finance transaction. Such risk minimization lies at the heart of project finance. In a no recourse or limited recourse project financing, the risks for a financier are great. Since the loan can only be repaid when the project is operational, if a major part of the project fails, the financiers are likely to lose a substantial amount of money. The assets that remain are usually highly specialized and possibly in a remote location. If saleable, they may have little value outside the project. Therefore, it is not surprising that financiers, and their advisers, go to substantial efforts to ensure that the risks associated with the project are reduced or eliminated as far as possible. It is also not surprising that because of the risks involved, the cost of such finance is generally higher and it is more time consuming for such finance to be provided.

Risk minimization process Financiers are concerned with minimizing the dangers of any events which could have a negative impact on the financial performance of the project, in particular, events which could result in:

1) The project not being completed on time, on budget, or at all; 2) The project not operating at its full capacity; 3) The project failing to generate sufficient revenue to service the debt; or 4) The project prematurely coming to an end. The minimization of such risks involves a three step process. 1) The first step requires the identification and analysis of all the risks that may bear upon the project. 2) The second step is the allocation of those risks among the parties. 3) The last step involves the creation of mechanisms to manage the risks. If a risk to the financiers cannot be minimized, the financiers will need to build it into the interest rate margin for the loan. Step 1- Risk identification and analysisThe project sponsors will usually prepare a feasibility study, e.g. as to the construction and operation of a mine or pipeline. The financiers will carefully review the study and may engage independent expert consultants to supplement it. The matters of particular focus will be whether the costs of the project have been properly assessed and whether the cash-flow streams from the project are properly calculated. Some risks are analysed using financial models to determine the project's cash-flow and hence the ability of the project to meet repayment schedules. Different scenarios will be examined by adjusting economic variables such as inflation, interest rates, exchange rates and prices for the inputs and output of the project. Various classes of risk that may be identified in a project financing will be discussed below. Step2- Risk allocationOnce the risks are identified and analyzed, they are allocated by the parties through negotiation of the contractual framework. Ideally a risk should be allocated to the party who is the most appropriate to bear it (i.e. who is in the best position to manage, control and insure against it) and who has the financial capacity to bear it. It has been observed that financiers attempt to allocate

uncontrollable risks widely and to ensure that each party has an interest in fixing such risks. Generally, commercial risks are sought to be allocated to the private sector and political risks to the state sector. Step3- Risk managementRisks must be also managed in order to minimise the possibility of the risk event occurring and to minimise its consequences if it does occur. Financiers need to ensure that the greater the risks that they bear, the more informed they are and the greater their control over the project. Since they take security over the entire project and must be prepared to step in and take it over if the borrower defaults. This requires the financiers to be involved in and monitor the project closely. Such risk management is facilitated by imposing reporting obligations on the borrower and controls over project accounts. Such measures may lead to tension between the flexibility desired by borrower and risk management mechanisms required by the financier.

Types of Risks
Basically different types of projects are posed to different risks. Similarly the risks mentioned below are related to this particular project. 1) Completion RiskCompletion risk allocation is a vital part of the risk allocation of any project. This phase carries the greatest risk for the financier. Construction carries the danger that the project will not be completed on time, on budget or at all because of technical, labour, and other construction difficulties. Such delays or cost increases may delay loan repayments and cause interest and debt

to accumulate. They may also jeopardize contracts for the sale of the project's output and supply contacts for raw materials. Commonly employed mechanisms for minimizing completion risk before lending takes place include: (a) Obtaining completion guarantees requiring the sponsors to pay all debts and liquidated damages if completion does not occur by the required date; (b) Ensuring that sponsors have a significant financial interest in the success of the project so that they remain committed to it by insisting that sponsors inject equity into the project; (c) Requiring the project to be developed under fixed-price, fixed-time turnkey contracts by reputable and financially sound contractors whose performance is secured by performance bonds or guaranteed by third parties; and (d) Obtaining independent experts' reports on the design and construction of the project. Completion risk is managed during the loan period by methods such as making pre-completion phase draw downs of further funds conditional on certificates being issued by independent experts to confirm that the construction is progressing as planned. 2) Operating RiskThese are general risks that may affect the cash-flow of the project by increasing the operating costs or affecting the project's capacity to continue to generate the quantity and quality of the planned output over the life of the project. Operating risks include, for example, the level of experience and resources of the operator, inefficiencies in operations or shortages in the supply of skilled labour. The usual way for minimising operating risks before lending takes place is to require the project to be operated by a reputable and financially sound operator whose performance is secured by performance bonds. Operating risks are managed during the loan period by requiring the provision of detailed reports on the operations of the project and by controlling cash-flows by requiring the proceeds of the sale of product to be paid into a tightly regulated proceeds account to ensure that funds are used for approved operating costs only.

3) Market RiskObviously, the loan can only be repaid if the product that is generated can be turned into cash. Market risk is the risk that a buyer cannot be found for the product at a price sufficient to provide adequate cash-flow to service the debt. The best mechanism for minimising market risk before lending takes place is an acceptable forward sales contact entered into with a financially sound purchaser. 4) Credit RiskThese are the risks associated with the sponsors or the borrowers themselves. The question is whether they have sufficient resources to manage the construction and operation of the project and to efficiently resolve any problems which may arise. Of course, credit risk is also important for the sponsors' completion guarantees. To minimise these risks, the financiers need to satisfy themselves that the participants in the project have the necessary human resources, experience in past projects of this nature and are financially strong (e.g. so that they can inject funds into an ailing project to save it). 5) Technical RiskThis is the risk of technical difficulties in the construction and operation of the project's plant and equipment, including latent defects. Financiers usually minimise this risk by preferring tried and tested technologies to new unproven technologies. Technical risk is also minimized before lending takes place by obtaining experts reports as to the proposed technology. Technical risks are managed during the loan period by requiring a maintenance retention account to be maintained to receive a proportion of cash-flows to cover future maintenance expenditure. 6) Regulatory or Approval RiskThese are risks that government licenses and approvals required to construct or operate the project will not be issued (or will only be issued subject to onerous conditions), or that the project will be subject to excessive taxation, royalty payments, or rigid requirements as to local supply or distribution. Such risks may be reduced by obtaining legal opinions confirming

compliance with applicable laws and ensuring that any necessary approvals are a condition precedent to the draw down of funds.

Appraisal Project FinancingThe SBI has formed a dedicated Project Finance Strategic Business Unit to assess credit proposals from and extend term loans for large industrial and infrastructure projects. Apart from this, project term loans for medium sized projects and smaller clients are delivered through the CAG and the NBG. In general, project finance covers Greenfield industrial projects, capacity expansion at existing manufacturing units, construction ventures or other infrastructure projects. Capital intensive business expansion and diversification as well as replacement of equipment may be financed through the project term loans. Project finance is quite often channeled through special purpose vehicles and arranged against the future cash streams to emerge from the project.The loans are approved on the basis of strong in-house appraisal of the cost and viability of the ventures as well as the credit standing of promoters.

Project finance strategic business unitA one-stop-shop of financial services for new projects as well as expansion, diversification and modernization of existing projects in infrastructure and non-infrastructure sector. Expertise Being India's largest bank and with the rich experience gained over generation, SBI brings considerable expertise in engineering financial packages that address complex financial requirements. Project Finance SBU is well equipped to provide a bouquet of structured financial solutions

with the support of the largest Treasury in India (i.e. SBI's), International Division of SBI and SBI Capital Markets Limited. The global presence as also the well spread domestic branch network of SBI ensures that the delivery of your project specific financial needs are totally taken care of. Lead role in many projects Allied roles such as security agent, monitoring/TRA agent etc. Synergy with SBI caps (exchange of leads, joint attempt in bidding for projects, joint syndication etc.). In a way, the two institutions are complimentary to each other. We have in house expertise (in appraising projects) in infrastructure sector as well as non-infrastructure sector. Some of the areas are as follows: Infrastructure sector: Infrastructure sector Road & urban infrastructure Power and utilities Oil & gas, other natural resources Ports and airports Telecommunications Non-Infrastructure sector-

 Manufacturing: Cement, steel, mining, engineering, auto components, textiles, Pulp & papers, chemical & pharmaceuticals Services: Tourism & hospitality, educational Institutions, health industry Expertise Rupee term loan Foreign currency term loan/convertible bonds/GDR/ADR Debt advisory service Loan syndication Loan underwriting Deferred payment guarantee Other customized products i.e. receivables securitization, etc.

Why project finance SBU?

Since its inception in 1995 the Project Finance SBU has built-up a strong reputation for it's indepth understanding of the infrastructure sector as well as non-infrastructure sector in India and we have the ability to provide tailor made financial solutions to meet the growing & diversified requirement for different levels of the project. The recent transactions undertaken by PF-SBU include a wide range of projects undertaken by the Indian corporate. EligibilityThe infrastructure wing of PF SBU deals with projects wherein:

the project cost is more than Rs 100 Crores. The proposed share of SBI in the term loan is more than Rs.50 crores. In case of projects in Road sector alone, the cut off will be project cost of Rs.50 crores and SBI Term Loan Rs. 25 crores, respectively. The commercial wing of PF SBU deals with projects wherein:

The minimum project cost is Rs. 200 crores (Rs. 100 crores in respect of Services sector). The minimum proposed term commitment is of Rs. 50 crores from SBI.

Process of sanctioning-

1) Proposal-

The bank usually asks the firm to give the following details Nature of the

proposal The purpose for which the term loan is required ( whether for expansion, modernization, diversification etc..)

2) Brief History- In case of an existing company essential particulars about its promoters,
its incorporation, subsequent corporate growth to date, major developments or changes in management. 3) Past Performance- A summary of past performance in terms of licensed/installed or operating capacities, sales, operating capacities, and sales and net profit for the three years should be analyzed. The figures relating to sales and profitability should be analyzed to ascertain the trend during the 3 years. In sum, the companys past performance has to be assessed to study if there has been a steady improvement and growth record has been satisfactory. 4) Present financial position- The Companys audited balance sheets and profit and loss account have to be analyzed. If the latest audited balance sheet has more than 6 months old, a pro-forma balance sheet as on a recent date should be obtained and analysed. 5) Project- Here the technical feasibility and the financial feasibility of the project is studied. 6) Project implementation schedule- Examine the project implementation schedule with reference to Bar Chart or PERT/CPM chart(if proposed to be used by the company for monitoring the implementation of the project) and in the light of actual implementation schedules of similar project

Pre sanction processAppraisal 1. Preliminary appraisalThe following aspects have to be examined if the proposal is to Financing a project Whether the project cost is prima facie acceptable. Debt and equity gearing proposed and whether acceptable Promoters ability to access capital market for debt/ equity support Whether critical aspects of project- demand, cost of production, profitability etc.are prima facie in order. After undertaking the preliminary examination of the proposal, the branch will arrive at a decision whether to support the request or not. If the branch finds the proposal acceptable, it will call for from the applicants, a comprehensive application in the prescribed pro-forma, along with a copy of project report, covering specific credit requirements of the company and other essential data/ information. The information among other things should include Organization setup with a list of board of directors and indicating the Qualifications, experience and competence of the key personnel in Charge of the main functional areas e.g.. Production , purchase ,Marketing and finance in other word brief on the managerial resource and whether these are compatible

with the size and the scope of the proposed activity . Demand and supply projections based on the overall market prospects ogether with a copy of market research report . The report may comment on the geographic spread of the market where the unit proposes to operate, demand and supply

gap , the competitors marketing arrangement.

share, competitive advantage of the applicant , proposed

Current practices for the particular product or service especially relating to terms of credit sales, probability of bad debts. Estimates of sales cost of production and profitability. Projected profit and loss account and Balance Sheet for the operating years during currency r of the bank assistance. Branch should also obtain additionally Appraisal report from any other bank/financial institution in case appraisal has been done by them, NO Objection Certificate from term lenders if already financed by them and Report from Merchant bankers in case the company plans to access capital market, wherever necessary. In respect of existing concerns, in addition to the above particulars regarding the history of the concern, its past performance, present financial position, etc. Should also be called for. This data should be supplemented by supporting statements such as: Audited profit and loss account and balance sheet for the past three years Details of existing borrowing arrangements, if any, Credit information reports from the existing bankers on the applicant company Financial statements and borrowing relationship of associate firms/group companies. 2. Detailed AppraisalThe viability of a project is examined to ascertain that the company would have the ability to service its loan and interest obligations out of cash accruals from the business. While appraising a project all the data/ information furnished by the borrower is counter checked and wherever possible, inter-firm and inter-industry comparisons should be made to establish their veracity.

The appraisal of the new project could be broadly divided into the following sub headsPromoters track record; Types of fixed assets to be acquired; Technical feasibility Marketability Production process Management Time schedule Cost of project Sources of finance Commercial Profitability; Security and Margin Repayment period and debt service coverage; Funds Flows statement ;and Rates of return. If the proposal involves financing of a new project, the commercial, economic and financial viability and other aspects are to be examined as indicated below Statutory clearance from various government depts/agencies License/ clearance /permits as applicable Details of sources of energy requirements, power, fuel etc.. Pollution control clearance Cost of project and source of finance Buildup of fixed assets. Arrangements proposed for raising debt and equity Capital structure Feasibility of arrangements to access capital market Feasibility of the projections/estimates of sales cost of production and profit covering the period of repayment.

 Break-even point in terms of sales value and percentage of installed capacity under a normal production year. Cash flows and fund flows Whether profitability is adequate to meet stipulated repayments with reference to Debt Service Coverage Ratio, Return on Investment. Industry profile and prospectus Critical factors of industry and whether the assessment of these and management plans in this regard are acceptable Technical feasibility with reference to report of technical consultants, if available Management quality, competence, track record Companys structure and systems. Also examine and comment on the status of approvals from other term lenders, project implementation schedule. A pre-sanction inspection of the project site or the factory should be carried out in the case of existing units. 3. Present relationship with the Bank: The banks also take into consideration the relationship of the firm or the customer with the banks. It takes into account the following aspects Credit Facilities now granted. Conduct of the existing accounts. Utilization of limits- FB & NFB. Occurrence of irregularities, if any. Frequency of irregularity i.e.; the number of times and the total number of days the account was irregular during the last twelve months. Repayment of term commitments. Compliance with requirements regarding submission of stock statements, Financial Follow-up Reports, renewal data, etc Stock turnover, realization of book debts. Value of accounts with breakup of income earned. Pro-rata share of

 non-fund and foreign exchange business. Concessions extended and value thereof. Compliance with other terms and conditions. Action taken on comments /observations contained in RBI inspection Reports. CO inspection and audit reports. Verification Audit Reports. Concurrent audit reports. Stock Audit Reports Spot Audit Reports. Long Form Audit Report (statutory Report). 4. Credit risk RatingDraw up rating for Working Capital and Term Finance. 5. Opinion Reports- Compile opinion Reports on the company, partners/ promoters and the proposed guarantors. 6. Existing charges on assets of the unit-If the company, report on search of charges with proposed guarantors. 7. Structure of facilities and Terms of Sanction-Fix terms and conditions for exposures proposed facility wise and overall: Limit for each facility- sub limits. Security- Primary & collateral, Guarantee. Margins- for each facility as applicable. Rate of interest. Rate of commission/exchange/other fees. Concessional facilities and value thereof. Repayment terms, where applicable. Other standard covenants.

8. Review of the proposal-Review of the proposal should be done covering Strengths and weaknesses of the exposure proposed Risk factors and steps proposed to mitigate themDeviations if any, proposed from usual norms of the bank and the reasons thereof. 9. Proposal for sanction- Prepare a draft in prescribed format with required back-up details and with recommendations for sanction.