Financing for PPPs follow a project finance structure, wherein the project company becomes the borrower of the senior debt. The financing structure and terms are contractually agreed at the financial close based on the then-market conditions.
During the life of the contract, the project company may wish to refinance. This could change the composition of financial instruments (bank loan, bonds, etc) and, possibly the financiers.
Debt refinancing can come serve various purposes:
- Reducing interest costs
- Increasing debt
- Extending the debt repayment terms
- Otherwise improving loan terms
- Reducing or releasing the reserve accounts
- Releasing contingent junior capital.
Why do project companies refinance?
There are several reasons why a project company would want to refinance the debt originally used to finance the project, including the following:
- Debt maturity: If the PPP project company obtained senior debt with shorter maturities (e.g., mini-perm structure) in the original financial structure, then it poses a refinancing risk. Various factors can determine the reasons for lack of longer maturity at the original financial structure (e.g., liquidity, project risks, etc). To manage the refinancing risk, the project company would seek to refinance this with a longer term maturity debt at/before end of the term.
- Opportunity for more favorable terms: Generally the project company will consider refinancing after the project's construction phase when risk is significantly reduced. With a better risk profile, the project company will seek to refinance at a lower cost and on better terms. If the market terms are relatively better than the original close, the project company may also seek to refinance with or without change in the underlying project risk profile. In addition to financial benefits, refinancing may give the project company more flexibility as some of the more restrictive provisions of the original loan agreement could have been negotiated away.
- Financial difficulty: In the event that the project company experiences financial difficulty and needs more funding, the company might take on more debt to save the project. This is considered rescue refinancing, and is not expected to produce financing gains for the project company or government authority.
Is the government authority involved in refinancing?
Debt refinancing requires consent and/or cooperation from the government authority. This is because the authority could have a general right to approve increases in project debt, or the PPP contract may effectively give the government this authority. An increase in debt may destabilize the project company, jeopardizing the service provided under the PPP contract. In addition, the new debt providers may also require different rights from the project, which may change the authority's flexibility. This loss of flexibility along with the notion of accelerated dividends benefitting only the project company sponsors may justify the need for the authority's approval rights.
Share gains from refinancing
Refinancing can lower overall costs for users of the asset and the government, improve returns to investors, or both. To accommodate this incentive, most PPP contracts define or make reference to some standard methodology for refinancing and how its gains will be treated.
Sharing refinancing gains between the government authority and the project company is justified from an economic standpoint to compensate the authority for project's potentially lower flexibility after a refinancing.
A government authority can ensure that this happens by:
- Including a clause in the PPP contract or the country's PPP regulation that stipulates that gains must be shared by the project company and the government authority. Different countries prescribe different methodologies for sharing the refinancing gains between the authority and the project company sponsors.
- Building rights into the PPP contract for the government authority to require or request refinancing of debt should more favorable terms become available. To exercise this right, the authority should have the capacity and ability to identify the potential benefits of refinancing.