Determinants of project finance loan terms
2018-12-03T17:20:41Z (GMT) by
Project finance has become a vital financing vehicle for undertaking capital-intensive and infrastructure investments. In 2017 alone, the value of deals signed using project finance was estimated at approximately $229 billion. Despite its increasing importance, little is known regarding the impact of project-level, and country characteristics on the loan terms. This thesis proceeds in examining these determinants along three empirical essays. The first essay (Chapter 3) focuses on how domestic lead arrangers certification (in emerging markets) impact the pricing of project finance loans. Using a sample 1270 project finance loan tranches signed between 1998 and 2011, and worth over $300 billion, the chapter posits that domestic lead arrangers certification reduce search and information cost, which in turn, reduces the financing cost. The results, after controlling for endogeneity of certification decision, indicate a reduction of 47 basis points in the spread offered on PF loans. The magnitude of this reduction differs across industries, geographic region, and income classification of the project countries. The second essay (Chapter 4) examines the relationship between PF contractual structures and loan outcomes, using a sample of 5872 project finance loan tranches signed between 1998 and 2013, and worth approximately $1.2 trillion. The chapter hypothesises that (i) non financial contracts (NFCs) (that is, contracts used to manage the various project functions), reduces overall project risk, (ii) the involvement of project sponsors as key counterparties to the non-financial contracts is an additional signal of project s potential worth, and (iii) the effects observed in (i and ii) are stronger, if sponsor counterparties have verifiable credit ratings. After matching loan tranches with NFCs to those without, the results indicate that the use of NFCs reduce both the loan spreads and leverage ratios. This impact is higher if the sponsor counterparties are credit-rated. The results are also stronger for developing countries. The third essay examines the impact of country-level institutions on project finance loan spread and leverage ratio, using a sample of 3,362 loan tranches signed between the year 1998 - 2012. The chapter investigates whether political and legal institutions are substitutes (or complements), that is, if improvement in one absorbs the weakness of the other, and vice versa. Further, the essay examines if project finance network of contracts substitutes for these institutions. The results indicate that political and legal institutions are substitutes. Specifically, improvements in political institutions lead to a reduction in both the loan spread and leverage ratio for countries with weak legal and governance institutions. The chapter also finds that where NFCs are included in PF, the impact of political institutions on loan spread reduces. On the other hand, the impact of political institutions on leverage ratio is higher when NFCs are used. The findings from the three research chapters provide interesting insights on how lenders and sponsors create value through contract design.