What is ‘Project Financing’?

The following definition describes the concept of the expression ‘project financing’:  The financing of a major capital project in which the bank looks principally to the cash flows and earnings of the project as the source of funds for repayment and to the assets of the project as collateral for the loan. The general credit of the project entity (sponsor) is usually not a significant factor, either because the entity is a company without other assets or because the financing is without direct recourse to the owner(s) of the entity (i.e. through guarantees).
To structure a clearly defined project financing it is necessary to establish a segregation of the assets and cash flow which constitute the project. A separate legal entity facilitates this.
Where a company effectively consists of several projects, it is often possible to increase the overall debt capacity by maximizing the debt load of individual projects. To establish project-financing-loans, bankers (or other lenders) undertake a more detailed examination of each individual project. The result can be the sum of the parts is greater than the whole.
The word ‘principally’ in the above mentioned definition is important: The pure project financing loan in which lenders look exclusively to the cash flow and assets of the project is very rare. For the bankers (or other lenders) there is almost always an element of recourse to the project sponsors or interested third-parties in respect of certain identified risk areas. It is almost inconceivable that loan documentation would ever be drawn up without containing at the very least some covenants and warranties, and that if these were breached there would be no recourse against the assets of the borrower (or sponsor) generally.
Cost of project financing: Raising a project loan involves additional costs against a traditional bank loan. These include the longer time frame and more intense involvement of lenders, higher legal fees, the costs of independent consultants and incidental expenses. A proportion of these costs tend to be fixed (i.e. not variable with the amount of the loan) such that a project financing is more expensive for small amounts. Interest margins tend to be higher than for traditional borrowing.   

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