THE COMMERCIAL LENDER'S PERSPECTIVE

In a nonrecourse project financing, lenders base credit appraisals on the projected revenues from the operation of the facility, rather than the general assets or the credit of the project sponsors, and rely on the assets of the project, including the revenue-producing contracts and cash flow, as collateral for the debt. It is thus predicated on the economic and technical merits of a project rather than the credit of the project sponsor. Because the debt is nonrecourse, the project sponsor has no direct legal obligation to repay the project debt or make interest payments if the cash flows prove inadequate to service debt.

Contracts that represent the obligation to make a payment to the project company on the delivery of some product or service are of particular importance because these contracts govern cash flow. Each of the contracts necessary to construct and operate a project, such as the off-take agreement, site lease, and construction contract, must not interfere unduly with the expectation for debt repayment from project revenues. If risks are allocated in an unacceptable way from the lender's perspective, credit enhancement from a creditworthy third party is needed, such as letters of credit, capital contribution commitments, guarantees, and insurance. The project finance contracts must be enforceable and have value to the lender as collateral security.

A project financing is also based on predictable regulatory and political environments and stable markets, which combine to produce dependable cash flow. To the extent this predictability is unavailable or the risks of dependability are allocated unacceptably, credit enhancement is necessary to protect the lender from external uncertainties, such as fuel supply, product market instability, and changes in law.