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Is the project finance industry digging deep enough?

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June 20, 2017 by David Bowcott

Every project needs money to move forward. Those funds are made up of equity and debt. The equity is contributed by the owner (or the concessionaire of the project) as a first layer of defense against project failure. The remainder of the project’s capital costs is made up of debt. Both equity and debt have methodologies to determine whether they feel they want to participate in the project. Generally speaking, the equity has a heartier risk appetite in comparison to the debt, as it sits first in line if the project fails. 

For the purposes of this article, I’m interested in the debt and its underwriting methodology, which determines whether it wishes to move forward with the project, and how it determines the price (or interest) it will charge given the project’s various risks.

Before we get into the criteria or methodology used by the debt to determine the terms it will put forward, let’s identify the most common sources of project debt (there are others).


The banks use their depositor’s funds to lend money to projects on a regular basis. Often the banks have very short-term windows for such lending. Generally, banks will lend for durations no greater than 5 to 10 years. In some jurisdictions around the world banks have been known to lend for much longer durations, likely because the options for a solid return on its depositors funds are very limited (think negative interest rates).

Private Placements Debt

The sale of debt directly to a private investor. In the world of project finance, significant private placement debt capacity can be found from life insurance companies and some pension funds. Generally these sources of debt have longer-term liabilities and feel comfortable offering terms for long-term obligations (30 to 40 years).

Rated Bonds

Bonds that are rated by third-party rating agencies like S&P, Moodys and DBRS. Generally these debt instruments are longer term in duration and are bought up by sources of capital that have longer-term liabilities on their balance sheet, like pension funds and life insurance companies. As such, these instruments have a much longer duration (30 to 40 years).

Each of the above has its methodology for underwriting. A common underwriting theme, until recently, that is shared by the above sources is that they were all risk averse when it comes to construction. As a result they have (or had) underwriting criteria that tended to focus less on the risk of construction being successfully completed and much more on the security being provided by those responsible for construction. Basically, traditional project debt underwriting wanted to know if they could be paid back in the event the construction phase was unsuccessful. Such underwriting is known as recoverability underwriting. This isn’t to say the underwriting process was devoid of any criteria to qualify those constructing the asset, but there was a heavy focus on the financial strength of those responsible for construction and the associated security they put up to equity and debt to guarantee construction.

In recent years, there has been a shift to underwriting methodologies that delve deeper into the qualifications and ability of those responsible for construction to actually complete the project. This trend has been aided by post financial crisis regulatory pressure on the capital community to better, and more deeply, underwrite the projects to which they are providing financing. It appears the debt underwriting community, though still focused on recoverability in the event of credit default, is moving more towards a model that assesses the probability of the construction stakeholders to complete the projects they undertake. This underwriting community has a growing interest in business and safety risks associated with the construction community, and the various risk controls or best practices that can be taken to prevent or mitigate those risks from taking place. Further the debt community is focusing more energy on insurance solutions that offer liquidity for the key risks, which could lead to schedule and cost overruns.They have a growing interest in insurance structures that incentivize the construction stakeholders to implement these best practices that prevent and/or mitigate risks from transpiring.

As contractors play a more pivotal role in securing project financing for owners and concessionaires, it’s vital they pay attention to these trends and the tools being used to obtain optimal project finance terms. Not only do some of these solutions provide better project finance terms, they also create less constraint on the construction contractor’s capital base. Regardless of your size or geographical area of operations, you should ensure your company is well versed on sources of project finance capacity, project finance underwriting methodologies, and the various risk controls and risk finance solutions being used to efficiently obtain capital for the projects you are building.    

David Bowcott is Global Director – Growth, Innovation & Insight, Global Construction and Infrastructure Group at Aon Risk Solutions. Please send comments to editor@on-sitemag.com.

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