Project Finance

Dr Anisur Rahman

Project Finance

??

Project

needs finance or
funding

Significant projects have some features that relate to

financing.

project is very large - exceeds capacity of single organization

cross national boundaries
technically complex
capital intensive

Financial

Vs Technical
Financing projects

loans, bonds, etc.

What is Project Finance?

Project finance is the raising of fund on a
Limited Recourse basis, for the purposes of
developing a large capital- intensive
infrastructure project, where the repayment of
the financing by the borrower will be
dependent on the internally generated
cashflows of the project

Project Finance

Project

can be financed

Privately
Publicly or
Hybrid

 In

any construction project rate of

expenditure changes dramatically throughout
the project lifecycle

Project Finance strategies

Characteristics

of a financing strategy

Enough finance
Commitment
The total cost of finance may be substantial

When

should we start financial planning?

Funding Sources
AVAILABILITY
TERMS
EVALUATION
STRUCTURING
ACCEPTANCE
to raise $ when needed and
to minimize risk and costs

Workable
FINANCIAL
PACKAGE

Three Types of Finances

Equity

Debt

Aids

Equity
Funds

subscribed by shareholders from their own resources.

Called Risk capital - High risk with no guarantee of return.
Equity investors have the last claim if the project goes into
liquidation.

Equity sources from

Corporate Cashflow
Individual Investors
Joint ventures
Government
Multi-lateral Investors

Debt
An

obligation on the borrower to repay principal

and interest to pre-arranged schedule.

Commercial Banks (against security)

Multilateral lenders (World Bank)
Suppliers

The

lender has a priority claim if the project goes

into liquidation.

Aid
To meet social and community objectives:
Government to another Government

tied (some obligations)

Agencies like World Bank

Non-Traditional Sources

Subordinated Debt
In the case of default, creditors with subordinated
debt wouldn't get paid out until after the senior debt
holders were paid in full.

Counter-trade
The seller accepts goods in lieu of cash payments

Build, own, and transfer (BOT)

The supplier finance, build & operate the facility to
recover the costs and profits over an agreed period of
time.

Non-Traditional Sources
Standby

loan

Contingent-capital mechanism under which a lender gives written

commitment to advance a specified amount of money at
specified terms on demand or on a specified future date.

The loan facility will not be used unless circumstances warrant,

Borrower can cancel it at anytime.

Used typically

to ensure availability of critical funds following a catastrophe, or

to obtain construction financing at a lower interest rate on the assurance

that permanent financing will be available when a project is complete and
is generating income.

Term Loan

Finance large infrastructure project where very high

funding required
Normally a group of financer provide the fund instead of
single financer.
Cost of raising fund includes

Management fee
Commitment fee
Agency fee
Underwriting fee
Success fee
Guarantee fee

Example: Channel tunnel project (UK, France) - The

project cost 4.65 billion

Financial structure involved 210 lending organisations lead

financer were Japanese banks (30%), NatWest bank etc

Other Loans

Export credits
Pure form of loan provided by the exporter of the
product/equipment, Bank, or Government agencies of the
exporting country to promote export
Euro-currency loans
Loans provided by the banks from the unregulated and informal
market for bank deposits and bank loans denominated in a
currency other than that of the country where the bank is located
Debentures
Similar to term loan but the loan is divided into securities and
sold through stock exchange (stock market)
Usually in the form of bonds,

Financing Problems

Debt Service
cash flow problems

Fees payable to banks (providers)

stand-by fees

Insufficient funds
miscalculation, under-estimating

Currency
Inflation and exchange rate

Political and economic risks

Financial Risks
Construction

finance risks must be identified

earlier
Risks in a construction finance can be either

within control of at least one party

not within any partys control but can be insurable
not within any partys control and can not be
insurable

Financial Risk Analysis

A

typical financial risk analysis should include

Financial market analysis
Cost analysis
Market analysis
Financial analysis

Inflation and Contracting

Fixed

most of the financial risks of the construction process

is assumed by the contractor.
Clients favour this contract over others.

Cost

price contract

- Plus contract

based on negotiation and the owner bears most of the

financial risk. (overheads/profit as %age)

Impacts on Project Management

No

project without finance.

Long lead time (government bureaucracies).
Lenders dictate conditions that are often tied to
production schedules.
Status of borrower, location, debt/equity ratio.
Therefore, understand lenders concerns

debts will be repaid on time.

adequate security and recourse.
for shareholders, dividends will be paid.

Decision Makers Preferences

Attitude

toward Risk

Risk averse (avoid risk)

Risk neutral
Risk prone (seeking)

What

sort of company is yours?

Risk Management in
Construction Project

Dr Anisur Rahman
G09 1.19
a.rahman@griffith.edu.au

Risk Analysis and Management

All projects are subject to change (risk and

uncertainty).
Risks can not be removed all the time but the
impact of risks can be reduced through risk
management
Risk management

How sources of risks in project are identified

How they are assessed/measured in terms of its
likelihood, impact and consequences.
How these can be dealt appropriately in a project
environment

Risk & Uncertainty Concept

Risk is when a decision is made based upon

past experience or data
Known risks (material cost)
Known Unknown risks (exist, but not sure about
possibility)- it could or will but dont know when
or what degree.
Unknown Unknown risks (unforeseen)

Risk Analysis & Management

IDENTIFY

TRANSFER

AVOID

SHARE

ACCEPT

ABSORB

Construction Risk Management Exercise (1)

a demolition construction project in a very

congested urban area (e.g. Southport), identify the
major risks and suggest how they can be
minimized.

For

Construction Risk Management Exercise (2)

A joint-venture construction corporation is tendering for a

BOT contract from a provincial government in China
Mainland for building a bridge with a 25-year concession
period. The company will charge a toll for vehicles using
the bridge in order to make income. The government
imposes a maximum construction duration of 4 years,
beyond which a damage rate will be charged per week
over-run. Discuss major risks in the contract, and propose
strategies of responding the risks.

Risk Management Steps

Identify

Assess

Analyse

Manage

Monitor

Risk Identification
The first and perhaps the most important step in attempting
to deal with exposure to risks is to identify them.
Risk identification involves detailed examination of the

project strategy, through which potential risks may be

uncovered and possible responses are framed.

Risk identification focuses the attention of project

management on the strategies for controlling and allocation

of risk, for example through the choice of a contract
strategy.

It highlights those areas where further design, development

work, or clarification is needed

Should include all risks whether or not under the control of

the PM, parent organisation or any stakeholder.

Sources of Risks

Any factor with a probability of occurrence which

can influence the project outcome is the source of
risk.
Construction risk drivers:

Financial risks
Legal risk
Political
Social
Environmental
Communication
Geographical
Geotechnical
Construction
Technological
Demand/product risks

Examples: Internal and External risks

Internal risks

External risks

Poor

Market-driven

project definition

Unreliable
Decision

task estimate

making process

Availability

of resources

Changing
Political

change

technology

upheaval

Environmental

factors

Poor

tracking capability

Economic

Lack

of reporting procedures

Global

competition

Social

changes

Communication

bottle neck

Unchecked

scope creep

Managerial

incompetence

cycles

Legislative

constraint

How Do You Identify Risks?

Review current and past projects: Requires a

close examination of all previous, existing projects
and their potential sources of risks to reduce the
impact on the project.

Project simulation: if you dont have access to a

previous project data, a project simulation will offer
some assistance. It is possible to review a project
schedule from a risk perspective using a number of
project simulations to see different what if scenarios
across the Project.
Continue

How Do You Identify Risks?

Some of the obvious scenarios are:

Can the schedule absorbs any delay? Type of risks could cause
delays?
Confident of the scope? Type of risks could change scope?
Available resources? Type of risks could impact on resources?
What if the specifications was compromised due to poor
mgt/scope changed?
What if reworking is essential?
What if budget was reduced?
What if client shortened the timeline?
What if important approval or other significant milestones failed
to realise?
Continue

How do you identify risks?

Project checklists: development of simple checklists

that are useful in recording all the potential and actual
risks.
Feasibility studies: time consuming and costly but still
effective.
Commercial database: Mostly secondary data; most of
them already collected by some other parties for some
other specific reasons. To avoid reinventing risk wheel.
Project team knowledge: the project team are the
people who are planning and implementing. Ask them for
opinions, idea and feedback by actively involve them
Interview: all the relevant stakeholders.
Deliverable descriptions or product descriptions:
which defines the product in its technical details together
with the information on the associated risks in dealing
with the product.

Risk Assessment
Asses

both the likelihood and consequences

of the identified risks;

The

objective is to separate the minor

(acceptable) risks to major risks and to help
develop a process of determining appropriate
responses.

The

information required will include:

Likelihood of the risk;

Impact of the risk;
Person responsible for the risk

Probability of Risk Occurrences

An attempt to try to estimate the chances of something

to happen;
When working with probability it is common to use
either numerical values on an appropriate scale or use
descriptive terms such as high, medium or low.
Probability category
Explanation
Score

Rating

Rare

Unlikely

Moderate

Likely

Most probable that it could occur

Certain

100% chance that it could occur

1 in a 100 chance of occurring

Slight possibility
Reasonable to consider it could happen

Profiling the Consequence Rating

Consequence category
Explanation
Score
1

Rating
Insignificant Impact would be inconsequential

Minor

Moderate

Major

Noticeable but not serious impact

Manageable scale of impact
Large scale impact

Catastrophi Extreme scale (possibly widespread0

c
of impact

Probability and Consequence Matrix

Risk Assessment Matrix

Risk
event
Bad
weather
Poor
team skill
Scope
changes
Budget
reduction

Likelihood

Consequences

Responsibility

Likely

Catastrophic- substantial
schedule delay

Team member

Moderate

Major- poor quality and

motivation, project drift

PM

Certain

Major- variation in time,

budget and quality

All Stakeholder

Rare

Major- downgrade of
resources, quality and
completion estimates

PM

Risk Analysis and Evaluation

To

analyse the risks and evaluating its

potential impact across the project.

Each

project and/or task should have a

detailed analysis undertaken to investigate
further the risk events likely to impact on it

Risk Analysis Techniques

A wide range of techniques is available, including:

Sensitivity analysis - a quantitative technique which

allows the effect of economic changes in a project to be
explored. Non-probabilistic approach
Probability analysis using Monte Carlo simulation
Decision trees
Utility functions
Expert judgment
Stakeholder meeting

Sensitivity Diagram for Major Risks in a

Construction Project

Risk Response
Possible risk response strategies in project
management:
Risk

transfer
Risk avoidance
Risk control
Risk acceptance

Risk Response - Transfer

Risk transfer may be accomplished either
contractually by allocating risk through
contract conditions or by insurance.
Parties to whom risk has been transferred
generally responded by including an
appropriate risk allowance in the cost estimate
or charging a premium.

Abrahamsons Principles
not be

Consideration of Risk Sharing

Contractor assuming risk

The owner will be paying contingency costs that might
be more they are really worth.
If the uncertain events do not occur, windfall profit.
A contractor who accepts a risky fixed price contract is
at a disadvantage against a larger contractor.
In the long term, the gambling contractor goes
bankrupt.

Consideration of Risk Sharing

Owner assuming risk

The owner will incur additional administrative costs.
the contractor must have incentive to manage and
control the cost entailed in the risk.
the contractor may be in better position to negotiate
with subcontractor and suppliers.
The owner must be prepared to make extra payments
as the uncertain events occur.

Risk Sharing
The

owner is the initiating party of the contract

The

owner is capable of loading all construction

risk to the contractor

Risks

over which the contractor has no control

should be assumed by the owner

Risk Response

When risk cannot be transferred for whatever

reason, management action is required to either
reduce (or to retain) or avoid or accept it.

Risk Response: Risk avoidance

Where the level of risk is deemed unacceptable to

retain, the best method of dealing with the risk is to
avoid the activity with which the risk is associated.

Risk Response: Risk control

If risk cannot be fully avoided, its impact could
be reduced, for example:
- by re-assessing strategy
- by developing alternative solutions
- by re-designing the project

Risk Response: Risk Acceptance:

Risk Acceptance: While risk avoidance and risk
minimization can help to reduce the overall level of
risk, some residual risk will always remain.
The decision maker needs to determine how best to
control it.
The most common approach to controlling residual risk
is through a contingency allowance.

Risk Response Risk Acceptance

Contingency allowance may be expressed in the
form of a single figure or as a percentage of
cost, time or any other variable and added to
the base estimate.
It may also be broken up into a series of smaller
contingencies, which are added to the base
estimate at specific time intervals.

Risk Monitoring

Risk management is continuous process- Why?

Risk- is a moving target

Probability of occurrences is a moving target

Consequence responsibility is a moving target

Management strategies: changing nature of risk and risk

sources, probability, consequences and the assignment of
responsibility urge for the need to a range of monitoring and
controlling strategies encompassing various degree of
acceptance, mitigation and rejection

Risk monitoring describe how risks will continually be tracked

to ensure that effective risk management is performed
throughout the life of the project, such as use of methods and
techniques like risk checklists and watch lists.

Key Points to Remember

Risk is a constant companion since project involve on going changes.
Every effort should be made by the relevant stakeholders to identify and

manage risk since no projects comes with crystal ball.

Risk management is structured process that seeks to deliver suitable

risk management strategies for the project

The scope, magnitude and impacts are dynamic they will change

throughout the project

Risk assessment is not just done at the beginning of the project it is

performed regularly throughout the project lifecycle

The management of the risk must be assigned to the authorised

stakeholders if it is to be managed effectively

Attempt should be made to remove the subjectivity from both probability

and consequence estimate

Do not forget to update your risk management strategies

All project stakeholders should be acknowledged project risks and sign

off on the agreed control strategies at each stage of the project lifecycle

Remember risks has both negative and positive impacts