This is an extract from our renewable energy and infrastructure project finance modeling course.
-You understand now why DSCR sculpted repayments are the most common form of repayment structure. But there are a few others that are worth discussing.
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. Now, as you can imagine, this isn’t very common for project finance, because it just wouldn’t be workable. Project cash flows tend to be very stable over time because of all of those contracts. So 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. Even if the owners are Bill Gates and the Queen of England who could certainly afford to do so. 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 wanna take the refinancing risk. They’d much rather get their capital back every quarter or every six months, slow and steady.
An alternative repayment method to the bullet is the balloon repayment. Where 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 this is actually a common structure. Let me give you an example. Let’s say we have a 20-year project with 18 years of debt service and DSCR sculptor repayments. The principal is repaying the loan balance over time, based on the expected cards of 18 years. The challenges in many places lenders can’t lend you money for 18 years. Instead, they may actually provide you with a loan of six years. But with an assumption, you’ll be able to refinance that loan in year six, and year 12 to get a total of 18 years of debt service.
Wait, what? What kind of terms would you even assume when you’re just guessing about a loan that’s not gonna be provided for another six or 12 years into the into the future at market rates? We can’t possibly know today.
Yeah, pretty much on the same terms as the initial loan or at least on terms of the guessing now for 12 years in the future, it’s a wild guess.
I know. And even if you think you haven’t heard of this, you may have it’s called a miniperm. And okay, there is some logic to it being an 18 year loan has 18 years of cash flow to repay the loan. So, will I have a higher debt size than a six year loan? And more debt equals higher returns. The project likely also has less risk once has been operating for a few years and it’ll have a history of operations. So the cash flows may be regarded as more certain. But who knows what the market would be like then.
So you mean to say that the banks are offering me three loans now?
Well, it is really three loans and the banks are also taking the risk that the project can be refinanced with a new loan. Because if it can’t there won’t be enough money sitting in the project to pay them back. The banks will commit now to the first loan with this risk, and they will want the option to participate in the new loan, but they won’t promise to refinance it at the guessed terms. The banks 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 the cash flow of the project until either the debt is repaid or it’s been lowered to a level such that they can refinance. And it’s also risky to equity if you can’t refinance the loan either bank’s take 100% of the cash flow, Or you may even default and have the banks foreclose on you and own the project. So many perms are a common structure given lenders can always lend you money in reality for 30 years. So maybe then the option but they’re kind of scary too.