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Roma, 6 June 2007

The role and value of collaterals in structured finance transactions. Roma, 6 June 2007. Ivan Giacoppo. 3. Why do we need to structure a transaction ?. 4. Construction period, operating period, recoveries. 7. Some cases: Profertil, Yansab, Russia & Galvex. 5. When collaterals work.

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Roma, 6 June 2007

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  1. The role and value of collaterals in structured finance transactions Roma, 6 June 2007 Ivan Giacoppo

  2. 3. Why do we need to structure a transaction ? 4. Construction period, operating period, recoveries 7. Some cases: Profertil, Yansab, Russia & Galvex 5. When collaterals work 6. …and when they don’t 1. Rationale of PF (Advantages and Disadvantages) 2. Involvment of ECAs

  3. Why Project Finance ? Rationale for Project Finance: - Leverage - Allocation of risks …and top reasons Sponsors seek to avoid Project Finance • Unnecessary • Expensive • Transaction time and cost • Interference with commercial discretion • Burden of compliance (a.e. puts enviromental and social issues “into play”)

  4. Why and Where do ECAs have an added value? In a new competitive enviroment for Project lenders, ECAs may provide: • Diversification of funding sources and multiplying effect- syndication on sweet/sour basis; • Expertise on country risk and government influence. Especially helpful if there are political/economic problems in emerging markets; • Longer maturities and reduced all-in cost; • Environmental impactassessments by ECAs increase level of confidence that these issues are properly identified and addressed

  5. SACE and Project Finace • Portfolio: Euro 5 billion (including structured finance assets). • Sectors: • Oil & Gas • Petrochemicals • Metals • Power • Geographical areas: • Russia • Middle East • Latin America

  6. Why do we need to structure a transaction ? Construction Operations [Recoveries] Ramp-up • Risks: • Technical (performance risks) • Economic (cost overrun, delays) • Financial (funding gap, contractors/sponsors defaults) • Permits/licenses • Other political • Force Majeure • Risks: • Technical (especially during ramp-up) • Economic/managerial (competitiveness, etc) • Market (prices/quantities) • Financial (cash shortages, i.e. lack of WC) • Country risk (expropriation, forex convertibility and transferability; moratorium, permits/licenses) • Counterparties risk (sponsor/operator/offtaker default) • Legal environment • Risks: • Legal environment (enforceability) • Intercreditor issues • Market (loss after sale)

  7. Why do we need to structure a transaction ?(cont’d) ( ) Loss Given Default (LGD) Probability Default (LGD) Expected Loss (EL) Recovery Rate (R) % 1- = * * Recoveries after default Construction/ Ramp up/ Operations Collaterals Collaterals

  8. Construction period: role of collaterals Sharing the risk with those who can better control it Risk Mitigant • Securities over construction obligations: • Performance Bond; • Retention Bond; • Liquidated Damages (Delay LD, Performance LD) Non-performance • Contingencies agreements: • Sponsors Completion Guarantee; • Stand-by equity, Sub-Loans, Loans Cost overrun / delays Cost overrun / delays Prefunded Reserve Account

  9. Operating period - country risk Traditional and new country risks: role of collaterals Risk Mitigant • Can be mitigated/externalized: • Off-shore accounts; • Direct agreement for direct payments from off-shore offtakers • Blockage or delay in forex convertibility and transferability; • Moratorium of payments • Confiscation, expropriation, nationalization; • Revoke of licenses/ permits; • Legal environment • War, revolution, riot and natural disaster; • New country risks: geopolitical, sanctions Insurability / ECAs own risk

  10. Operating period - country risk (cont’d) Evolving country risk profile Declining forex risk (convertibility, transferability risks)

  11. Operating period – market, technical and other risks Risk Mitigant fixed price, tolling fee, cost-plus mechanism (i.e. power plants, utilities. infrastructures), assignment of rights under hedging agreements Market risk: price effect • assignment of rights under off-take agreements (take-or pay clause); Market risk: quantity effect • reserve accounts, Sponsors Stand-by Sub-Loans, other contingencies Market risk: price and quantity (cycle) • assignment of O&M/ feedstock/ utilities agreement • assignment of insurances Technical risk and force majeure Diversion of the project cash flows (price transferring, dividend distributions, etc) • project accounts, • offtake agreements and direct agreements for direct payments from off-takers • dividend lock-ups

  12. Recoveries – role of collaterals • A significant cause for defaults are legal or structural deficiencies which include, for example, project structures that legally could not completely protect project from sponsor bankruptcies, or projects with poorly defined property and contractual rights (i.e. disputes over increases in toll road tariffs in PF in China which resulted in financial problems that ultimately caused project defaults). • Country risk mainly refer to non-traditional sovereign risks: disputes on licenses, taxes, regulamentary constraints or breach of public off-takers (a.e. Power PF in Indonesia in the late 90s)

  13. Recoveries – role of collaterals (cont’d)

  14. When collaterals work Operating period Collateral as monitoring / controlling instrument to prevent defaults • Take an interest in ownership: interest security in shares/ownership is a good offensive tool; • Leverage Sponsors’ participation: Sponsors stand-by equity has a good leverage; • Protect cash waterfall: tools to avoid diversion of the project cash-flows (project accounts, offtake agreements) and to block dividends Recoveries • The project had a good rationale and remains a viable ongoing concern

  15. …and when they don’t Operating period • Security in assets is usually purely defensive tool; • The project company is part of a larger group (price transfer risk) • Recoveries • Mortgage on assets, share pledge and step-in rights • Legal environment • Intercreditor constraints, different securities (especially with local banks), no pari passu. Strong security never rescues a weak underlying credit

  16. Value of collaterals: some final thoughts • Declining country risk (forex control), but increasing geo-political risks; • Increasing weight of commercial risks; • The ECAs/banks take on risks & limitations of security that they were not accustomed to accepting – all at a very reduced level of pricing; • Key mitigating factors: the strength of the sponsor; the strategic importance of the project; the strength of the project economics; • Project Sponsors likely to seek increasing ‘concessions’ from ECAs (and banks) on future PF transactions: will this trend be sustainable?

  17. Value of collaterals: dual project risk • Risk profiles are inextricably linked, but rights and remedies limited to financed project • If concurrent financings, lenders to one can be adversely affected by actions of lenders to other Examples: • Oil & Gas • Upstream/midstream • Multi-segment pipeline • LNG • Upstream/liquefaction • Liquefaction/grid or power plant • Greenfield coal mine/mine-mouth power plant

  18. Collaterals and country risk: the Profertil case When collaterals work: The Profertil Case PROFERTIL, an Argentine company equally owned by Agrium Inc. and YPF S.A., started urea and ammonia production at the beginning of 2001, after completing the construction of the plant, in charge of the contractor Snamprogetti-Techint, according to a lump sum turnkey contract made in January 1998. Bahia Blanca • Nov 2000: SACE approval; • Dec 2001: Argentina crisis & peso depreciation - off-shore escrow accounts and natural hedging (USD-denominated revenues & peso-denominated costs)  no payment interruptions; • Nov 2006: pre-payment

  19. Collaterals and recoveries: the Galvex case When collaterals work: The Galvex Case • Good security package: full control over the project cash flows and pledge under English law over the shares of each company of the Galvex Group • Good market prospectives (but only in an integrated group) • Result: zero loss after recovery Bahia Blanca

  20. Collaterals and recoveries. The Russian case Russian law pledge: • A pledge does not give the pledgee the right to take control and operate the pledged asset (i.e. step-in); the security in the pledged property can be realised only by way of sale at public auction. Enforcement may require a court decision and the court may, on the request of the pledgor, defer the sale at public auction for a period of up to one year. • Unless a relevant court decision is obtained, the proceeds of the public auction are likely to be in roubles. • There is no system for the registration of negative pledges in Russia. As a result there is no way to confirm whether participatory interest have previously been encumbered • Negative pledge over shares does not: - protect against seizure/attachment by third parties - protect against pledges being granted to third parties without those third parties being aware of the negative pledge; or - provide any benefit in insolvency

  21. Collaterals and commercial risk: the Yansab case • Grass roots integrated Petrochemical Complex at a new site in Yanbu Industrial City, Yanbu, Kingdom of Saudi Arabia Yanbu Refinery

  22. Yansab: from asset-based to cash-flow based • Asset • Origins in asset-based limited recourse finance model • In resources, focus on reserve tail • Prime remedy is execution against project • Cash Flow • Influenced by securitization of financial receivables • Priority for operating costs falls away post enforcement • Net Cash Flow • Priority for operating costs guaranteed unless bankrupcy

  23. Yansab: rationale & objectives • Rationale: • To exploit KSA’s competitive advantage on ethane and propane feedstock costs: price significantly below international levels • Reliability of feedstock supply from state-owned oil and gas producer, Saudi Aramco • Saudi Arabian government’s policy promoting development of ‘primary’ and ‘secondary’ domestic petrochemical industry (and related ‘tertiary’ industries) • Objective: • To increase SABIC’s share of the lucrative Asian and European Polyethylene, Polypropylene, Butene and Ethylene Glycol markets.

  24. Yansab: rationale & objectives (cont’d) • Cost Competitiveness: YANSAB is expected to be among the most competitive global producers of HDPE, LLDPE, MEG, and PP: • competitively priced feedstock cost position • economies of scale from one of the largest polyolefin complexes. • Strong and experienced Sponsor: SABIC (“Saudi Basic Industries Co.”) • Largest non-oil company in the Middle East; “A” credit rating; majority–owned by the KSA state; of strategic importance to KSA economy • Major player in the Polyethylene, Polypropylene and Ethylene Glycol markets, will market all of the YANSAB production; • Track record of timely completing world-scale projects within budget (8 crackers since 1982, with capacity of up to 1.3m t/yr in KSA);

  25. Yansab compared to ECA project finance norms ECA normsYansab • Feedstock • Long-Term supply contract SAUDI ARAMCO allocation • Offtakes • Take or Pay – Known contractors SABIC will purchase and on-sell 100% of products • Long Term Contracts to a range of purchasers on spot basis • Security • Share pledge Not available • EPC step-in rights Not available • Security over physical assets Share in PIF security on enforcement • Security over assets of shareholders Not available

  26. Contacts Thank you for your attention Ivan Giacoppo Project Manager, Structured & Project Finance Tel. 06.6736 330 E-mail i.giacoppo@sace.it Tel.: +39 06.6736264 - 267 business.school@sace.it

  27. Disclaimer • This presentation has been prepared solely for information purposes and should not be used or considered as an offer to sell or a solicitation of an offer to buy any insurance/financial instrument mentioned in it. • The information contained herein has been obtained from sources believed to be reliable or has been prepared on the basis of a number of assumptions which may prove to be incorrect and, accordingly, SACE does not represent or warrant that the information is accurate and complete.

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