So Professor in finance we have standard methods to amortize loans. Constant principal and constant installments. Are they suitable also for project finance? It is a good question. You mentioned the two typical methods that in normal finance we use to amortize a loan. Take for example, your case. If you want to buy a house you go to a bank, a bank will ask you to repay the loan, in typically two different kinds of methods. The first one is the so called constant principle. So, the amount of capital that will be repaid every year. Will be constant. For example, if you have a loan of 500, and the bank requires you to repay in five years. You will repay 100, for every five, for each of the five years. You can understand, Gim, that if this is the case. Scene set interest is calculated as long as time goes on, on the remaining amount of the debt. If your debt falls from 500 to 400 to 300, 200, 100 in five years time, and the interest rate is fixed. The level of interest rate that you will pay every year, will fall down considerably. So, every year, the sum of the principle repaid, and interest, will fall down. You can use this kind of schedule for project finance for sure, but, there is a pitfall. In most project finance, the performance of the project is not particularly I would say, optimal at the very beginning of the life. So paradoxically, if you use a constant principle for a project finance, the risk for you is that, the most heavy, the heaviest payments will be concentrated at the beginning, and then payments will fall down linearly, as long as the time goes on. So paradoxically, you ask the project to repay most of the funds at the beginning, and least of the funds at the end, when the project will be particularly performing. In terms of financial policy this is not exactly the most suitable kind of amortizing schedule okay? So from your point of view can we use it? Absolutely so but, keep it in mind it is not exactly suitable for project finance. Second alternative you mentioned, constant installment. This is also known as the French method to repay loans in a medium to long term. So, in this case, in five years time, you will repay every year, a constant sum, and this constant sum, is, in turn, the sum of a portion of principal and a portion of interest, and a sum of the two remains constant. Can you use it in project finance? Absolutely so, but, again, the problem is, if you're project has not a stable unlevered free cash flow. That we saw in the previous session, is the amount of available cash that you can use in order to repay the loan. The point is that, if you have some form of unpredictability, of your unlevered free cash flows and your debt service is constant. There could be years, when you have more cash than the cash that is needed, and there will be some years, when you have less cash available for the cash that you need to repay to creditors, and this is not acceptable because we have seen the concept of cover ratios, in the previous sessions, and we have seen that banks require to have a minimum debt service cover ratio. So, from this point of view also the French method, is not the most suitable way to amortize a loan in project finance. Going back to your question, everything can be used. Also the more traditional forms of repayment. However, let me say. They do not match exactly, the performance of the unlevered free cash flow and so sometimes they could create some stress. To the project, not because the project is not the good project, but simply because you are using a wrong way to amortize the loan for a specific pattern of cash flows. >> This is very interesting professor, and so are you telling us that the typical repayment schedule are a bit flexible? >> Yes, I'm saying exactly so. Instructured deals, project finance included, there is always some kind of flexibility in adapting the amortization of the loan during the operational phase to the performance of the cashflow of the project. So in a sense, you try to adapt to make more compatible. The flows that you will repay to creditors, to the flows that are generated by a designated initiative. And basically you have two alternatives to do this. The first one is, basically the so-called tailor-made method. Tailor-made is a very intuitive concept. Before the project starts, banks look at the performance, the expected performance of the unlevered free cash flows. So, let's assume that we have a cyclical kind of behavior in the unlevered free cash flows. So, banks will say, in a certain year, when I have more cash available, I will ask the SPV, to repay a higher portion of the debt. While instead in periods where the performance in terms of cash is not so brilliant I will reduce a little bit, the amount of repaid capital that I'm asking to the SPV itself, so that, the cash flow increases, the repayments to banks increase, the cash flow falls, the repayments to banks falls, too, okay? Of course, during a certain period of time the percentage repaid should always amount to 100%. So basically I'm saying that in a tailor-made kind of amortizing, you could have a year when you repay 30%, a second year when you repay 25. In the third year you repay another 25, and in the final period you repay 20%, so that in four years time you have repaid 100% of the loan. The second way, Jim, with which you can insert some elements of flexibility in repaying the loan. Is the so called, dedicated percentage method. Dedicated percentage, is another very intuitive kind of concept. Again, banks, before the project starts, look at the performance of the unlevered free cash flow of the project. And, they agree with the sponsors that a certain percentage, of that unlevered free cash flow, will be dedicated in that specific year to the repayment of principle and interest. Let me make an example. Let's assume that in a certain year, you have an unlevered free cash flow of 200. Suppose that creditors have agreed with shareholders. That every year, 80% of this unlevered free cash flow, will be dedicated to the repayment of principal and interest. So, if in that specific year you have an amount of unlevered free cash flow of 200. By doing, a tailor-made approach based on the dedicated percentage. In that specific year you'll repay a sum, that includes principal and the interest, those amount will be 80% times 200 and so 160. In turn, this 160 is composed by a portion of interest that you pay, because you are using the capital of banks. And the remaining portion that is represented by the repayment of the principle, that as long as time goes on, you are returning to your creditors. So Gim, basically, going back to your question, everything can be used in project finance, but keep in mind that the important thing is, since I rely on the only casual generated by one single initiative. I must, do every thing possible in order to make compatible the cash flows that will be paid to creditors to the unlevered free cash flows generated by the project. Tailor-made solutions, and a dedicated percentage are the two most used forms of repayment used in project finance.
