Project Refinancing

PROJECTS

Project Refinancing

To Be or Not To Be? Adrian Eakin examines some of the obstacles to refinancing a PPP Project.

A number of early Public/Private Partnerships in Northern Ireland are now at a stage where the existing project facilities may be refinanced - shareholders eager to do so may well find that the exercise is not as straightforward as they had initially hoped.

Topical

It seems everyone is talking about refinancing - the latest OGC Guidelines set the sponsoring Authority's share of any refinancing gain (i.e., the profit made by the project company on a project's refinancing) at 50% and the OGC's Code of Conduct on the issue encourages Authorities to seek a 30% share where no contractual sharing mechanism exists - hardly surprising following reports that the consortium running the Fazakerley Prison PPP Project made a £10m profit on the project's refinancing alone.

Forms

Refinancing can take various forms, lower rates of interest being the most common once a project has moved out of the high risk construction phase into the less risky operational phase. However, it may also be possible (to an extent) to unlock funds held in reserve accounts (for example, the sinking fund and debt service accounts) and in some cases to replace shareholder loans with either equity capital or senior (bank) debt - all of these arrangements can lead to unforeseen enhanced profits for a project company's shareholders. Should shareholders be entitled to unforeseen profits for successfully completing the construction phase or are they already well paid? What effect does the Authority's credit rating have on interest rates? There are a lot of issues at play.

Issues

Shareholders considering refinancing an existing project should initially consider the following basic issues:

• Project Agreement - this needs to be checked to determine whether refinancing is possible without the Authority's consent - doubtful. Early PPP contracts may not have included provisions entitling the Authority to a share of refinancing gains but there are likely to be a number of issues that effectively prevent refinancing without the authority's consent, for example, warranties given by the project company to the Authority in relation to the financing structure, restricted definitions of "lender", restrictions on creating security over the project agreement (or increasing amounts payable on termination) and the absence of a clause obliging the Authority to sign a new direct agreement with any new lender. Obviously the Authority could seek a share of any refinancing gain as a price for waiving the relevant provisions and it is in this context that the OGC's Code (encouraging a share of 30% in favour of the Authority) suddenly becomes relevant.
• Sub-Contracts - these ought not to restrict refinancing but they (along with any direct agreements) need to be checked for any assurances given by a project company to sub-contractors in relation to the existing financing arrangements. Where a reputable sub-contractor is asked to contract with a special purpose company with little net worth and no assets other than project revenues, assurances can sometimes be given in relation to the availability to the project company of sufficient project finance to complete the project. Such warranties (if any) should be limited to the date of the sub-contract and therefore be easily circumvented.
• Financial Viability - prepayment fees payable to the lender on a prepayment of funds are not uncommon and can range from 20-40 bps payable in the first few years of the project's operational phase. Aside from that fee (and legal and financial costs) the cost of unwinding any hedging structure could also be significant. Most long-term projects involve fixed rates of interest being paid by the project company to its lender, either by the lender offering a simple fixed rate (and hedging the risk internally) or by the project company "swapping" its floating (LIBOR) rate for a fixed rate with another counterparty (under an ISDA Agreement). Either way, there is likely to be a finance breakage cost to be factored in to the refinancing.

Going forward, the ability to make serious gains on a refinancing may now be limited - the OGC provisions appear in the standard form contract and the cost of PPP debt has fallen from an average of 150 bps over LIBOR (in 1997) to 100 bps over LIBOR now. As for projects already underway, only time will tell.

Adrian Eakin is a Partner in the firm's Corporate Department specialising in projects and financing work. He recently advised Viridian Group plc and Sx3 on the Province's biggest externally financed IT PPP Project involving 285 schools.

Adrian can be contacted at adrian.eakin@lestrangeandbrett.com

Quote: the consortium ..... made a £10m profit