Project Finance: Practical Case Studies

Risk analysis

In principle the project risks were allocated as follows:

• the commercial banks assumed construction and commercial risk throughout the con-
  struction phase;


• US Eximbank and the IDB assumed political risk; and


• the sponsors assumed all other residual risks.

The sponsors developed a risk-allocation matrix similar to the one shown in Exhibit 7.2. For
construction risk, the first layer of defence was liquidated damages payable by the contractor,
the consortium of GE Power Systems, InterGen and ICA Fluor-Daniel. The second layer was
the equity invested, 20 per cent of the capital structure. The final layer comprised the con-
struction lenders.
Because the commercial banks bore all the construction risk, while US Eximbank and the
IDB bore all the political risk, the allocation of risks among the lenders did not coincide with
the amount of funding that each institution provided. The construction lenders took on con-
struction risk in two ways: through direct lending and through standby letters of credit, issued
by the lending banks, indemnifying the IDB during the construction phase in the event of con-
struction problems. As a multilateral agency, the IDB was comfortable with Mexican politi-
cal risk but not with construction risk.
The banks were accustomed to taking on construction risk but not completely comfortable
with Mexican political risk. They arranged a political-risk insurance policy from US Eximbank
for the amount that they lent during the construction phase. The IDB does not give guarantees.
Instead, it extended a loan and retained its political risk, but covered its construction risk with
a standby letter of credit in its favour issued by the lending banks. If some event caused US
Eximbank’s political risk guarantee to be terminated, the same event would trigger payment to
take out the IDB under the letters of credit. In effect the IDB provided the same political-risk
coverage as US Eximbank, but
the documents were completely
different. As with many aspects
of this financing, developing the
structure and the required docu-
mentation to dovetail US
Eximbank and the IDB’s politi-
cal coverage required many
hours of legal work.
Among the residual risks
that the CFE originally did not
foresee was privatisation risk. If
it was to be privatised, the CFE
would become a far different
credit risk than it was as part of
the Mexican government. This
was neither a political risk that
US Eximbank would cover nor
a commercial risk that the com-

SAMALAYUCA II, MEXICO

Exhibit 7.2

Risk-allocation matrix

Commercial

banks

Project US Eximbank

CFE sponsors and IDB

Construction phase

Construction risk X

Political risk X

Residual risks X

Lease phase

CFE credit risk X

Political risk X

Residual risks X

Source: Offering Memorandum.