IPF Guidelines- In Practice | Pakistan's PF Case Studies |

Note Please note that the following slides contain information on certain project finance transactions that have taken place in the Pakistan financial markets over the last 8 years. The information presented herein is aimed at sharing key risks that manifested themselves during construction period or over the initial operating life of the project(s) and how the Project Financiers dealt with them (or should have dealt with them) given the Project Finance framework as enshrined in the IPF Guidelines issued by the SBP and/or internal policies governing PF transactions, issued by banks and FIs for internal stakeholders’ consumption. The details and specifics of transactions mentioned are from an academic and learning standpoint only and should not be construed as being reflective of the respective projects or any of their stakeholders in any manner. |Project & Structured Finance|UNITED BANK LIMITED|

Case Studies • Excess Leverage Limited • The Runaway Contractor Limited • The Uninsurable Limited • Faulty Machines Limited • Bitten by Competition Limited • Hasty Financial Close Limited • The Travel Advisory Limited • No Gas Limited

1. Capital Structure Concerns • Description: Excess Leverage Ltd – Limited recourse financing for dual fuel (gas & HSD) cogeneration (power and water desalination) plant, having net Contract Capacity of 80.3MW and water desalination capacity of 3.0 million gallons per day. The estimated total project cost was US$ 114 million. • Issue(s) at Hand:The project was financed at a debt to equity ratio of 75:25. Three months post its commercial operations, the project had breached its initially approved debt to equity ratio; though it was still within the limit defined under Prudential Regulations. The approved tariff only catered to debt servicing for initially approved debt. Is this an acceptable situation? Does the Company need to do anything?

1. Mitigation Measures • Existing Lenders: Prior to providing their NOCs for additional funding, the existing banks should have checked if additional cash flows would be available to the company to service the new debt. An IPP has pre-determined and identified cash flows for the life of the project. • New Lenders: Prior to providing additional funding, sufficiency of available cash flows needed to be determined. So long as ROE component of the tariff could cater to additional debt being provided, new funding could be considered.

2. Completion Risk & Security • Description: Runaway Contractor Ltd – Limited recourse project-financing of a gas-fired IPP with a net generation capacity of 212MW at a capital cost of US$ 196 million. • Issue(s) at Hand:The project’s EPC contractor went bankrupt 4 months prior to COD. This not only left the project without an EPC contractor and very limited alternatives, but also put the project completion in jeopardy, both vis-à-vis financial and technical completion. Is this an acceptable situation? Does the Company need to do anything?

2. Mitigation Measures • Lenders took stock of the security available to them, in this case EPC contractor’s performance bonds. These were called by the lenders after seeking advice from lenders’ legal counsel on appropriateness of timing for the same. This provided funding to help complete the rest of the project. • Next, the company got in touch with all the sub-contractors for the project and entered into independent contracts with each of the sub-contractors and appointed a reputable engineering firm as project coordinator.

3. Insurances • Description: Uninsurable Ltd – Limited recourse financing for the construction of a 1,200 km Dense Wave Length Division Multiplexing (‘DWDM’) 20 Gigabit/second undersea fibre optic cable system starting from Karachi, Pakistan and landing at Fujairah, United Arab Emirates, at an estimated cost of US$ 36 million. • Issue(s) at Hand:The undersea cable could not be insured after COD due to the cable’s location in international waters. This meant that the project was susceptible to revenue losses as a result of cable cuts. How can the company mitigate this risk?

3. Mitigation Measures • A sinking fund was established by lenders, wherein some revenues from the cash waterfall were set aside to cater to such contingencies. • Also, the redundancies available via satellite also partially took care of the risk.

4. Completion Risk & Security • Description: Faulty Machines Ltd – Limited recourse project-financing of RFO-fired IPP with a net generation capacity of 195.2MW at a capital cost of US$ 235 million. • Issue(s) at Hand:The project’s generators were malfunctioning and breaking down due to a manufacturing default of the supplier, who was also the EPC contractor. Despite several attempts, the technical flaw could not be corrected in good time to achieve timely COD. In the meanwhile project’s financial costs kept piling up due to this delay leaving the Project with inadequate funds to achieve COD. How can the company mitigate this risk?

4. Mitigation Measures • Liquidated damages (delay and performance) committed by EPC contractor, which took care of the funding gap till such time the project achieved commissioning. • Negotiated unprecedented warranty coverage to ensure that the EPC contractor remains on the hook for faulty alternators.

5. Regulatory Risk • Description: Bitten by Competition Ltd – Limited recourse project-financing of Pakistan’s first liquid petroleum gas (‘LPG’) container terminal for import of LPG and allied marketing and distribution services across Pakistan, at a total capital cost of US$ 32.6 million. • Issue(s) at Hand:Shortly after ‘Bitten by Competition’ achieved COD, the project’s major competitor, Aggressive Limited, flooded the market with locally manufactured LPG, thus driving down the price of the product. Further, ‘Bitten by Competition’ also suffered a second blow on account of mismatch of regulations vis-à-vis product cost versus price. While Bitten was importing LPG on Saudi Aramco plus freight charges basis, the product’s local market prices were far lower on account of specific regulation governing product prices domestically. This virtually drove Bitten out of business. What can the company do?

5. Mitigation Measures • Bitten lobbied, albeit belatedly, with the government authorities and regulators to change the pricing regime. Eventually, OGRA introduced new LPG policy in 2011 through which the domestic prices of LPG were pegged to Saudi Aramco, the international pricing standard and made it mandatory for local manufacturers to import part of LPG they were marketing to rationalize their cost mix.

6. Completion Risk • Description: Hasty Financial Close Ltd – Limited recourse project-financing of fully integrated fertilizer project capable of producing two intermediate products, i.e., Ammonia and Nitric Acid and three final products Urea, Calcium Nitrate (CAN) and Nitro Phosphate (NP) with a total initial capital cost of US$ 587 million. • Issue(s) at Hand:In order to avoid missing gas allocation to the project, ‘Hasty Financial Close’ rushed into a financial close in the absence of finalized supply and engineering contracts and detailed design and drawings. The financiers had committed their facilities based on personal and corporate guarantees of the project sponsors. Few months into the construction period, the project’s engineers began revising supply and procurement requirements after receiving the facilities’ detailed design and drawings. This exercise was conducted without gauging the financial implications of revised procurement. As a result, at the conclusion of this exercise, the project cost estimates had almost doubled to US$ 983 million. Is this an acceptable situation? What could the Company have done to avoid this?

6. Mitigation Measures • The lenders to the project capped their exposure to Hasty Financial Close, extended loan to a healthier group company with stable cash flows, which was on-lent to the Project Co., and further, called in sponsor support to plug the large void in the project cost. As a result, the project debt to equity ratio plunged from initially envisaged 65:35 to 56:44. • The company could have helped reduce such ballooning costs, by taking an integrated approach through involving the finance team to gauge the financial implications of revising procurement and design strategy instead of letting the engineering team lead the show solo.

7. Political Force Majeure • Description: Travel Advisory Ltd – Limited recourse project-financing of 220MW RFO-fired IPP having a total capital cost of US$ 297 million. • Issue(s) at Hand:Close to COD, the commissioning engineers for the Steam Turbine that were scheduled to come in physically to plant site could not do so due to volatile security situation in the country. This put the company in tremendous pressure vis-à-vis Project commissioning and added delay-related costs to the project. What should the Lenders do? What could the Company do?

7. Mitigation Measures • The lenders did not fund any non-pass through delay costs. Hence their exposure was limited to pass-through project costs only. • Travel Advisory’s sponsors commissioned the project’s steam turbine by taking the off-shore TA on video conference and other distance-based project management tools. Further, the delay related project costs were funded through sponsor equity.

8. Political Risk • Description: No Gas Ltd – A fertilizer company, undertook to double its capacity to become Pakistan’s largest single train Urea plant. The Project debt of US$ 750 million was funded by a myriad of foreign and local currency loans. • Issue(s) at Hand:Upon achieving COD, No Gas was not allocated its rightful share of gas, which it had secured through an international competitive bidding process. Due to governance issues, limited additional gas was produced and no progress was made on LNG imports thus resulting in multiple stakeholders fighting for a limited supply of gas. The government, driven by populist measures rather than economic rationale, awarded gas connections to domestic users and CNG consumers. As a result, the plant remained non-operational for 19 out of 21 months. With no new cash flows in sight and debt repayment obligations looming, the company’s bottom line eventually came into red and it was forced to seek relief from lenders. What should the Lenders do? What could the Company do?

8. Mitigation Measures • The Company pursued legal remedies with vigor and approached the courts for breach of contract, though the gas supplier continued to dis-honor even the court judgments. • While the Company’s legal battle continued, it proactively diverted gas from its old plant to the new plant, thus resulting in greater efficiencies and immediate upside of 15% in the cashflows. • The Company took lenders into confidence and given the situation, together they arrived at a repayment schedule suited to the new adjusted cash flows, resulting in a two year tenor extension. • Finally, the lobbying and negative effects of this breach led to government intervention and eventual restoration of gas supplies (through other sources)-though a year late.

IPF Guidelines- In Practice | Pakistan's PF Case Studies |