A bluffer's guide to project finance

Essentially interest-bearing securities that oblige the borrower to pay the bond-holder a level of interest, usually semi-annually and at a fixed rate, and to repay the principal amount of the loan either in instalments or at maturity. May also be used to refinance a project initially funded through bank finance.

Capital markets The markets where capital funds - debt and equity - are traded.

Coupon The interest rate on a bond that the issuer promises to pay the investor until maturity, expressed as an annual percentage of the face value of the bond.

Cover ratios A guide to the performance and 'creditworthiness' of the project company. Usually expressed as the ratio of available cash-flow to the scheduled repayments and interest the project company has to make over a given time.

Credit committee Typically a committee of senior managers within a bank with the authority to approve the granting of finance ('credit') to the project company.

Credit rating A credit rating agency's indication of an entity's long or short-term creditworthiness. A long-term rating of Aaa/AAA is the most creditworthy (eg the UK government); BBB is the minimum investment grade rating.

Debenture A charge over the project company's assets, which normally favours the lenders and will take precedence over equity.

Debit service reserve A cash reserve kept by the project company usually as a requirement of the lenders to meet future debt service costs (principal and interest) should there be a shortfall in revenue.

Due diligence A checking and verification process by the lenders, or by independent experts appointed on their behalf, usually of the project's legal, technical, insurance and healthcare aspects.

Equity Ordinary share capital invested in the project company. A wider definition of equity includes longterm loans. Typically equity has the last claim upon the project's income, hence the highest risk, and is therefore the most expensive source of finance.

Financial close The time when the credit agreement is signed by all parties concerned. First 'drawdown' of funds follows.

Financial model A computer model that projects the financial performance of the project company, including cashflow, profit and loss account and balance sheet. It also includes calculations of the cover ratios (above).

Gearing The ratio of debt to equity in the project company.

Hedging Action to mitigate a risk. Typically the risk that interest rates might increase is hedged by the project company taking out an interest rate swap or purchasing an interest rate cap (below) for all or some of the loan's duration.

Interest rate cap and collar An option purchased by the project company from a financial institution which effectively establishes upper and lower limits on the rates of interest it will pay. If the lending rate rises above this agreed level, the difference is paid by the financial institution. If it falls below, it is paid by the project company.

Interest rate swap A contract between a borrower and a financial institution, exchanging the borrower's obligation to pay a variable interest rate on a loan for an obligation to pay a fixed interest rate to the financial institution.

Investment grade A credit rating acceptable to a risk-averse investor.

Junior debt Debt subordinate in terms of interest and principal repayment to senior debt (below). No scheduled repayment is made to the providers of junior debt until all scheduled repayments and interest due to senior debt providers have been met. Tends to cost more because of higher risk of default on repayment.

LIBOR London inter-bank offered rate - the base bank lending rate in the London money market for an agreed period.

Maintenance reserve A cash reserve kept by the project company, usually at the requirement of the lenders, to meet future maintenance capital expenditure costs should there be a shortfall in revenue.

Margin The rate of interest charged above LIBOR or other base rate.

Mezzanine finance A form of junior debt. Lies between equity and senior debt.

Monoline insurers An insurance company specialising in one type of business. Can be used to credit-enhance bonds (eg insuring bond interest and principal repayments).

Also known as 'bond wrappers'.

Off balance sheet An asset or a liability that does not appear in the financial statements of the relevant entity (eg the NHS trust).

Private placement The sale of stocks, bonds or other investments directly to an institutional investor such as an insurance company.

Refinancing The prepayment of existing debt and its replacement with debt enjoying better terms.

Risk capital Equity and loan stock and junior debt.

RPI swaps Often payments under a concession agreement are indexed in line with the retail price index (RPI). If RPI falls to low levels, it affects the project company's income. Under an RPI swap, the project company may swap a variable RPI-based rate on a fixed principal amount for a given indexation period.

Senior debt Ranks above junior debt for interest and principal repayments.

Special-purpose vehicle A company set up for the specific purpose of entering into the concession agreement. Also known as project company.

Step-in rights Senior debt providers typically have the right to step into the relevant contract and perform the underlying obligations contained in that contract.

Syndication The arrangers may invite additional lenders to participate in the senior or junior debt through a syndication or a 'selldown'. Usually takes place after financial close.

Tail The period in a project financing from when the relevant debt is due to be repaid until the end of the concession agreement.

Underwriter Financial institution that guarantees to the project company to provide a specified amount of debt or equity for a project financing on pre-agreed terms.

From: Project Finance - A Pocket Guide, by RKW and SG (Societe Generale). Tel: 0207-486 0434.