Project Finance might just be the longest-running, most-requested topic that we still haven’t covered even after 5+ years of writing about different types of finance firms.
But that ends today.
There’s a ton of confusion over what you actually do in Project Finance, how it’s different from private equity / Leveraged Finance / Debt Capital Markets / Public Finance, and what the advancement opportunities look like.
So we’re going to tackle all of those one-by-one in this interview with a reader who moved into Project Finance from M&A:
Projecting Your Way Into Project Finance
Q: So, how’d you get started in Project Finance?
A: I started out in M&A, and worked there for almost 2 years before deciding to explore other areas of finance.
At that point, I was interviewing around for buy-side roles and a recruiter approached me with a Project Finance role.
I always had a curiosity around debt products, and was intrigued by what I found out during interviews about the day-to-day activities in Project Finance roles.
I made it through multiple rounds of interviews, and I’ve been here ever since.
My story is unusual because most people do NOT go from M&A to PF – it’s much more common to move in from something like Leveraged Finance.
Q: OK, great. So what do you do in Project Finance?
A: In Project Finance, you advise clients and/or lend funds for the debt used in infrastructure investments.
There are 2 main work streams: advisory and lending.
In the first case, the bank or Project Finance Group acts in an advisory capacity to the client.
So the client would engage the bank at an earlier stage of the deal, and would consult with the bank on the optimal structure to achieve their funding goals.
From the client’s perspective, the ideal situation would be maximized debt load, maximized debt tenors, a quick financial close, and low debt pricing.
Each debt funding source or structure results in a trade-off between these criteria, and it comes down to prioritizing which elements are most important for the client.
Work during this stage involves intensive modeling, running various scenarios, and developing marketing materials such as the information memorandum.
Once the deal structure is determined, you would then tap into the banking market and work with other banks to raise the required financing for the project.
This brings us to the second work stream in project finance – lending.
In this role, you serve as the lender for infrastructure investment deals. Most of the time, this starts when you receive an “information pack” from an advisory bank.
If your bank acts as the advisor to a client, more often than not, you would be “required” to participate in or even lead the lending, meaning your bank would aim to be the biggest lender in the deal. This promotes the deal and sends positive signals in the market.
And then your job as an advisor is to round up other, smaller lenders – and to send them information packs, gauge their interest, and get everyone to contribute enough funding to move forward with the deal.
The lending role is the same role that large banks play in leveraged buyouts when raising debt for the private equity firms, except we work with investments in infrastructure assets instead of normal companies.
“Clients” (any firms that invest in infrastructure) generally come to us in the later stages of a deal, ask us to look at the numbers, and then propose a debt package to fund the deal.
So an infrastructure fund might say:
“Hey, we’re going to build this power plant for $1 billion USD. Here’s what its financial profile looks like, here are its key contracts and revenue streams, and here’s the market research we’ve done. What kind of loan can you offer?”
Overall, the lending role is still more similar to buy-side roles than it is to sell-side investment banking jobs because you’re investing your own funds.
While you need to manage clients and the advisory bank on the commercial front, you also need to dedicate a good amount of time to build a business case and present the deal to your bank’s internal credit committee (just like how you would present a deal to the investment committee in a private equity fund).
The main difference is that as a lender, we focus heavily on the downside risk of deals, as the key objectives are capital preservation and covering the debt service.
Q: OK, thanks for writing a book to answer that one.
So how would you summarize the differences vs. those other fields I mentioned?
A: The main differences:
- Investment Banking: Unlike in IB, we invest our own money and we win or lose based on how the infrastructure investments perform.
- Infrastructure Investing: They focus on the equity funding of investments, and we focus on the debt funding. Infrastructure Investing:Project Finance::Private Equity:Large Bank Lenders (no, it’s not a perfect analogy, but that is the basic difference).
- Public Finance: We only work with privately funded assets, so we do not raise capital for federal/state/local governments.
- Leveraged Finance and Debt Capital Markets: We only invest in infrastructure asset deals, not in acquisitions of entire companies; we also do not supply funding for every day, ongoing corporate use (i.e. as in DCM).
Also, “project financing” is usually raised by clients through special purpose vehicles with limited or no recourse to the client – which means that if a deal turns bad, we would only be able to gain title over the assets in the special purpose vehicle.
This is very different from corporate debt, which gives you rights to the operating company itself (i.e. you have first claim to the company’s assets, above the equity investors).
This is why rigorous technical / legal / financial due diligence is imperative, and why it’s so important to balance debt maximization and risk management.
Project Finance Jobs: Storage Assets, Senior Debt, and SPVs
Q: Great. So let’s continue with this theme: how do you think about deals?
What are the key factors and metrics to look at?
A: The focus in Project Finance is 100% on debt.
From a pure lending perspective, the equity IRRs are not important to us, and we care mostly about the constraints on the debt and the downside risk of the deal.
Having said that, in an advisory role, we are always mindful of the clients’ focus on project IRRs – and within the debt constraints, we aim for solutions that benefit lenders and also potentially boost clients’ IRRs.
The first question we always ask is: If this project sinks, how much could we sell it for? Could we recover any of our funds? If so, how much?
For example, let’s say it’s a $200 million asset and we’re lending $150 million to fund its purchase.
We might estimate how much we could get for assets that are sold off in future years, and then see if we could recover part or all of that $150 million initial investment.
With many of these assets, there’s price risk (spot rates might decrease) and volume risk (customers might leave).
But if it’s something like a power plant with all government contracts, both those risks are reduced and may be almost negligible depending on the contract structure.
With an asset such as a storage terminal, though, there’s market risk involved .
For example, if the clients contracted on an annual basis do not renew their contracts and the investment fund is holding the asset for 5-10 years, this could result in gap periods where storage capacity is not contracted but debt payments are due – or if capacity is re-contracted at lower rates, debt service ratios might be strained.
So we spend a lot of time digging into those details and evaluating the quality of customers, contracts, the underlying market dynamics, the average length of contracts, and more, and evaluating how much risk there is in a true downside scenario.
Since we mostly lend senior debt, we’re never going to “make a killing” on these projects – interest rates are relatively low and there’s no equity option built in, which is why most of the analytical work is designed to better assess the downside risks.
Furthermore, the downside scenarios above are rarely a matter of writing off an asset.
Often, there are contract clauses built in around termination payments to the clients or asset purchase options by the clients of your client, and you would need to go through various contracts to fully understand and model out these scenarios.
Q: Moving into more granular details, what’s a typical day in your life like?
A: The hours are definitely better than in M&A; 60 hours per week is the average here, though that fluctuates depending on deal activity.
On a typical day, I start reading emails before I arrive at work so I can figure out how my day will play out.
The main difference here (although this is a broad generalization) is that each work stream takes more time to complete.
For example, let’s say that you’re evaluating a storage asset with 100 contracts.
If you’re working in banking and your MD needs to see the analysis ASAP, you might just assume simple percentage growth rates in the model.
Here, we would actually model out the revenue from each contract separately over many years into the future, which can take a very long time.
So on a live deal, it’s pretty much impossible to do a “quick and dirty model” – they take more time to complete because of the level of detail.
In between this technical work, I’ll assist with due diligence, review debt terms and incoming deals, and also speak with other banks if we’re acting as the advisor on the deal.
I also spend time reviewing government policies and issues like tax credits for projects – sometimes governments promote infrastructure investing via tax benefits or by guaranteeing debt. So those factors are also important to understand.
If there are a fair number of ongoing deals, I’ll split my time equally between those 3 tasks (modeling, coordinating with other lenders, and doing market research).
The Project Finance… Financing Process
Q: I see. Can you walk us through what happens in a typical deal process in Project Finance?
A: Sure. I’ll walk through this under the assumption that you’re acting as the advisor:
Step 1: We get an “information pack” from the infrastructure investment fund, including the financial model, market information, and so on, and they ask us if we want to participate.
After understanding the deal, we would seek to gauge our credit committee’s appetite for the deal.
We compare the deal to previous deals completed by our group from every angle – financial robustness, familiarity with the clients, track record of the client in operating and managing such projects, location of the project and underlying market dynamics, etc.
We also spend a lot of time looking at the security structure of the deal, and specifically how special purpose vehicles (SPVs) are being used.
The purpose of the SPVs is to create separation between the parent company and the rest of the asset, and to assign different elements to different parties.
For example, the customer contracts might reside with the parent company even if the asset goes bust, so we, as the lenders, might only be able to claim the title to that asset.
While SPVs can “reduce risk” from the client’s perspective, from our perspective they’ve merely reallocated risk to us.
And so we need to thoroughly assess the impact of the proposed structures. Many SPVs are tax-related as well, so we need to factor in the tax impact on cash flows in our own models.
All this is carried out through dialogues with clients – for example, if the security structure is too weak for the appetite of most banks, we would highlight such features to the client.
Q: We’re only on Step 1.
That already sounds like quite a lot of work.
A: Oh, it gets better. So let’s say that we’ve reviewed the initial information and we decide that we want to do the deal – here’s what happens next:
Step 2: We build our own model for the same deal at this stage, and we start calling on other Project Finance teams and groups to see who else might want to participate.
The more groups there are, the more cumbersome the process because each one wants slightly different terms.
So we try to optimize for what the client wants and shortlist the initial pool of banks to something more manageable.
Step 3: Then, we figure out the appropriate amount of debt to use and the terms of the debt.
On most deals, we lend primarily senior debt with interest rates between 2% and 10%, though that varies by region, asset type, and economic conditions.
Sometimes multiple tranches of debt are used, and each one has a different purpose.
For example, let’s say that a storage facility has both international customers and domestic customers with different contract terms for each customer type.
If there are also domestic lenders and international lenders, we might create 2 different tranches of debt: international and domestic.
And then we ensure that cash flows from international customers pay for the international tranche of debt, and the same for the domestic side.
This is another reason why modeling gets more complex in Project Finance – you don’t see this same mechanic of different revenue streams supporting different debt tranches in (most) private equity deals.
Q: I’m intrigued. Keep going, please.
A: You bet.
Step 4: Once we’ve built our own model and narrowed down the list of other lenders that want to participate, we spend a lot of time negotiating the debt terms with them.
Even if there are only 5-6 other groups involved, this always takes a long time because everyone wants something different and some banks are more difficult than others.
On the other hand, the upside here is that a lot of interesting conversations take place – because banks consider project issues from different perspectives, and sometimes new issues come to light.
Step 5: Then, once we’ve finalized the debt terms, each bank or PF firm goes back to its credit committee to win approval for the deal.
This period lasts a few weeks, and the client waits around while the banks all get internal approval to fund the deal.
Step 6: Finally, once we hear back from everyone, we go back to the equity investor(s) in the deal and start the process of drafting loan documents. By this point, the client has agreed to the debt terms in advance; it’s very, very difficult to change those terms at this stage.
Technically, we’ve already found and highlighted the key terms required to protect us in the “downside cases” in Step 5…
But certain details may not have already been accounted for - and so a fair amount of negotiation still takes place between the banks and the client at this stage.
When the documentation is all complete, we go back to the credit committee to win final approval for the deal.
Q: You’ve been mentioning “debt terms” throughout, but what exactly do the terms include beyond the interest rates?
A: The main ones are the tenor (period of the loan) and the repayment term.
For example, is it a 5-year loan? A 10-year loan?
Is it 10% principal repayment per year, or 70% over 10 years and then 30% upon exit?
The contract length for existing customers often affects this – for example, if it’s a power plant with 10-year contracts, the lenders might push for a 9-year loan to give themselves a “buffer” in case something catastrophic happens in year 10 and the entire loan can’t be repaid.
These terms also differ between “greenfield” and “brownfield” projects – for greenfield projects, debt repayment has to be postponed until cash flow is generated, and the debt will be drawn down over time instead of 100% upfront (i.e. as in the acquisition of an existing asset or company).
A Project-Based Culture and Hierarchy?
Q: OK, my head hurts from all this technical talk.
Let’s move onto what everyone really wants to know about: how much money you make.
Or maybe the culture of Project Finance groups.
A: Yeah, so the culture is heavily influenced by the type of bank (or other firm) you’re at.
The most active banks in Project Finance, from a lending perspective, tend to be Japanese and French, with local banks mixed in as well (depending on your region).
A lot of European banks have actually removed their Project Finance arms and gotten out of the business entirely – so less traditional firms are building out their PF teams these days.
There’s a difference between those two groups, but there’s a bigger cultural difference between investment banking and Project Finance: in general, you’ll see fewer “Type A” people and crazy workaholics than you would in a traditional IB group.
People here tend to think longer-term, and aren’t quite as focused on this year’s exact bonus numbers and/or hopping to the latest and greatest exit opportunity.
Promotions tend to happen as long as you stick around, but it can be a slower process unless you perform really well.
Stability is one of the main draws of Project Finance: you’re giving up pay, but you’re getting better hours and you’re less likely to be fired via a quick trip to the conference room.
Q: On that note, the pay. The pay. What can you say?
A: It’s definitely a discount to IB pay.
Please don’t quote me on this, but here’s a report on salaries in Asia for an example.
They report MD salaries of 3 million HKD to 6 million HKD (roughly, $400K USD to $800K USD) in Leveraged Finance, but only 2 million HKD ($260K USD) to 2.3 million HKD ($300K USD) in Project Finance.
Analyst and Associate numbers aren’t so far apart, but there’s still a 20-40% discount vs. Leveraged Finance if you look at the Analyst and Associate numbers in Singapore and Hong Kong.
You’ll still make more money than the average university or business school graduate, of course, but you should NOT go in expecting pay on par with traditional investment banking or private equity compensation.
Q: You mentioned earlier that Project Finance teams like people with strong credit backgrounds.
Where have you seen co-workers go after working in PF?
Getting into traditional investment banking industry groups, M&A groups, or private equity is less common, although I have seen a couple friends move into such roles.
Q: So, bottom-line: Project Finance is for you if…
A: If you like to work on deals, and especially the credit side of deals, but you want a better work/life balance than you get in IB/PE, and you’re willing to accept lower pay in exchange for that.
Having a strong interest in government policy and infrastructure assets also helps.
Q: Any recommended resources for readers who want to work in Project Finance?
A: I asked around, but my firm does not allow us to share our internal training resources.
NOTE FROM BRIAN: Fortunately, I used my ninja powers to secure a sample Project Finance model for you anyway – click here to check it out.
No, this is not exactly “light reading material,” but it gives you a sense of what to expect in this sector from a technical standpoint.
Q: Great, thanks.
And we sort of skipped over this in the beginning, but what was the recruiting process for Project Finance like?
A: It’s very similar to private equity / investment banking recruiting, with multiple rounds of interviews where you meet everyone, and then a modeling test at the end.
They really like people with credit experience (LevFin, DCM, and maybe even mezzanine funds), though they’re open to candidates from other backgrounds.
The questions are everything you’d expect: “Why Project Finance?” “Tell me about your deal experience.” “How do you evaluate an investment?”
The modeling test I received was fairly simple: they just asked me to build a DCF for an infrastructure asset and then estimate how much debt the project could take on.
The FCFs in my model came out to around $100 million over the life of the project, so I took a guess and said “$80 million of debt – an 80% leverage ratio seems appropriate.”
That was actually wrong and overly aggressive: the asset that I modeled typically has a leverage ratio closer to 60%, but it wasn’t a deal-breaker and I won the offer anyway since my model was mechanically correct.
For the “Why Project Finance?” question, you can cite the points we discussed and explain that you like macroeconomics, government policy, and being able to connect with more tangible output – and say that you see yourself as more of a “finance person” than a strategy / operations person.
As long as the project is repaying your debt in a healthy manner, there is almost nothing you can do to influence the exit or the asset’s performance in Project Finance, so there’s little of the “operational side” that you see in traditional PE.
Q: Awesome. Thanks for your time. I learned a lot!
A: My pleasure.