Bullet, Balloon, & Mini-Perm Repayments

This is an extract from our renewable energy and infrastructure project finance modeling course.

 

If you have taken one of Pivotal180’s project finance courses, you probably understand why Debt Service Coverage Ratio (DSCR) sculpting is the most common form of repayment structure. But there are a few others that are worth discussing, including the bullet, balloon and mini-perm financing schemes.

What is a bullet repayment structure?

Let’s start with the bullet repayment structure. This is where the borrower only pays interest throughout the term of the loan. But there are no principal repayments until maturity, when the whole amount needs to be paid off at once.

As you can imagine, this isn’t very common in project finance. It wouldn’t be workable. Project cash flows tend to be very stable over time thanks to the numerous contracts. It’s hard to imagine a situation in which a typical project could ever generate enough cash flow in that final debt repayment period to pay off a large debt facility that hadn’t been slowly amortized over time. And remember, project finance loans are non recourse. So, if the project needs more money to cover that final bullet payment, the owners don’t have any obligation to do so. That is true even if the owners are Bill Gates or the King of England, who could certainly afford it.

So, a bullet loan maturity could never be paid off with cash flow, and it would almost certainly need to be refinanced with another loan. And banks don’t want to take the refinancing risk. They’d much rather get their capital back every quarter or every six months, slow and steady.

What is a balloon repayment structure?

An alternative repayment method to the bullet is the balloon structure. Instead of just paying the interest we also pay some principal before the maturity date of the loan. This slightly improves the position of the lenders over our bullet repayment structure. But it still sounds pretty unfair for the lenders and has a similar issue to the bullet repayments.

What may surprise you is that balloon repayments are actually a common structure in project finance. Let me give you an example:

Let’s say we have a 20-year project with 18 years of debt service and DSCR sculpted repayments. The principal is repaying the loan balance over time, based on the expected Cash Available for Debt Service (CADS) of 18 years. The challenge is, in many places, lenders can’t lend you money for 18 years.

Mini-perm loans for Project Finance

Here’s where the mini-perm financing structure comes in. This is a type of short term loan which can be used to finance large-scale infrastructure and/or renewable energy projects. Instead of lending money for 18 years, lenders may actually provide you with a loan of 6 years. But with an assumption, you’ll be able to refinance that loan in year 6, and refinance it again in year 12, to get a total of 18 years of debt service.

Now, you may be asking: What kind of terms would you assume for a loan that’s going to be provided in 6 or 12 years into the future at market rates? It’s a wild guess.

Risks in mini-perm repayment structures

There is some logic to the mini-perm structure. Three different loans across an 18 year period means a higher debt size than just a single 6 year loan, and more debt typically means higher returns. Moreover, the project is likely to have less risk once it has been operating for a few years, so the cash-flows may be regarded as more certain and will probably be available to repay. But again, who knows what the market would be like then.

Mini-perm risks for banks

Banks also take risk, as the project will eventually need to be refinanced. If this doesn’t happen, there won’t be enough money to pay the initial loan back.

Knowing this, banks usually commit to the first loan and will want the option to participate in the new loan, but won’t promise to refinance it at the guessed terms. They will also put in some protection and maybe be a bit conservative. And typically if you can’t refinance the loan, there may be a provision by the lenders to take 100% of cash-flows of the project until either the debt is repaid or it’s been lowered to a level such that they can refinance.

Mini-perm risks for equity

This also means that a mini-perm repayment structure is risky to equity, because if the loan cannot be refinanced, banks take the entirety of cash-flows, or you may even default and have the banks foreclose on you and own the project.

So, mini-perms are a common structure, given lenders can’t always lend you money in reality for 30 years. They may be the only option, but can be scary too.