Blending of project and corporate finance
A lack of risk tolerance and market liquidity sometimes prevents projects from being financed
off the corporate balance sheet on a pure non-recourse basis. Projects today are financed
along a spectrum ranging from pure project finance to pure corporate finance. A company
such as Calpine, which is essentially a power plant portfolio, is one example of the blurring
of the line between corporate finance and project finance.Insurance
The role of insurance in project finance has increased steadily in recent years. Historically,
the insurance industry has provided property and casualty coverage, and political risk cover-
age. Recently, insurers have become more active in covering completion risk, operating risk,
off-take risk and residual value risk.
Residual value insurance, for example, can help sponsors and lenders to refinance risk
when projects require loan pay-outs with longer terms than are available in the bank market.
If a balloon payment (the repayment of most or all of the principal at maturity) is not made,
or a project cannot be refinanced and the loan goes into default, the lender can seize the asset.
If liquidation proceeds are less than the amount of residual value coverage, a claim for the
difference can be made against the policy.^2
Highly rated insurance companies with dynamic risk management capabilities can close
the gaps in capital structures of projects exposed to market risks. For example, in 1999 Centre
Group guaranteed the subordinated debt tranche for the Termocandelaria merchant power
project in Colombia. If the project’s cash flow was insufficient to make a debt payment, the
insurance company agreed to step in and make that payment. An insurer can provide a take-
out guarantee for project lenders when a PPA matures before a loan. Insurers can guarantee
that a project receives a minimum floor price, regardless of what happens to the market price
of its output. Insurers can provide standby equity and subordinated debt commitments and
residual-value guarantees for leases.^3
The events of 11 September 2001 exacerbated an already difficult insurance market and
created a new problem for the insurance industry: how should exposure to terrorism be man-
aged? The combination of reduced capacity, underwriter defections and shock losses from 11
September has, at the time of writing, created one of the most difficult insurance markets in
history. Among the implications for project sponsors are increases in deductibles, which
require projects to assume additional risk; the reduced availability of coverage for terrorism,
new or unproven technologies, and catastrophic perils, such as earthquakes and floods; and
substantial premium increases.^4
Over recent years the credit ratings of many infrastructure bond deals have been raised
to the ‘AAA’ level by guarantees or ‘wraps’ AAA-rated monoline insurance companies.
However, as the monoline insurers themselves have diversified from their US municipal bond
base their own risks have increased, leading to higher spreads on monoline-wrapped paper.
An emerging trend in project and concession financing is the use of targeted risk cover-
age, a structured financial mechanism that shifts specifically identified project risks to a third
party, such as a multiline insurance or reinsurance company, a designated creditor, or, con-
ceptually, any party that is willing to assume those risks, including project sponsors. The fol-
lowing have been among recent applications of targeted risk coverage:POWER AND WATERIntroduction.qxp 6/4/07 7:04 PM Page 8