3.4.3. The security for debt capital in project finance

Debt capital, in form of credit and bonds, is usually a large portion of the project’s financial resources⁵⁴. By nature of project financing the available securities are limited, especially until start of production and consequently even senior debt takes risk that is partly unsecured.

Therefore lenders, particularly lenders of senior debt, require the sponsors and other project participants to supply certain guarantees and further require security by means of covenants and conditions precedent.

These additional securities may include:

• Forfeiting of contract receivables
• A minimum level of equity supply by the sponsors; equity binds the sponsor and reduces the risk to the lender that the sponsor abandons the project uncompleted
• Step-in rights (into project contracts in case of a parties failure)
• Security package from the sponsors, (cash deficiency agreements or other)
• Power of veto on changes in project contracts
• Minimum debt service cover ratio

Lenders further require a minimum dept service cover ratio (DSCR) and a debt service reserve account as buffer against market volatility, which is calculated as

With CFADS = Cash Flow Available for Debt Service = operating cash flow + interest⁵⁵

The DSCR is a value to rate the debt service ability and safety margin to pay debt.

Illustration 11: Relevance of debt service cover ratio⁵⁶

The degree of guarantees the sponsors are required to make does sub-classify the method of project financing⁵⁷:

• Recourse on sponsor: sponsor unconditional guarantees to lenders (take or pay)
• Limited recourse on sponsor: cash flow related lending covered by conditioned guarantees to lenders (e.g. shareholders security package)
• Non recourse on sponsor: pure cash flow related lending, no consolidation on balance sheet of minority holder/ sponsor

⁵⁴ According to Finnerty project financing involves about 70% debt capital in average
⁵⁵ Moody’s investor’s service December 21, 2012, Rating Methodology for Power Generation Projects: Moody’s defines cash flow available for debt service as cash flow from operations in any given period less major maintenance capital expenditures. See also side note 3
⁵⁶ Böttcher, B ttner p 106
⁵⁷ Reuter p 12