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When is a ‘Bankable’ Document Bankable? – Part 1

World Cement,

A few years ago the author participated in a meeting with a major European bank in support of the owners of an eastern European rebar manufacturing mill. The objective of the meeting was to present an investment project to modernise the mill, the main feature of which was the replacement of the ancient gas-fired open hearth furnaces with a single Electric Arc Furnace. This would reduce costs and increase productivity. Some €300 million of project finance was needed to implement the project.

Against advice, the owners of the mill enthused about the environmental improvements that the project would bring about and the number of jobs the investment would secure. The bankers listened politely and then moved the discussion to what they considered to be the crux of the matter. How, they wanted to know, would the company maintain a free cash flow sufficient to service the debt when construction markets were in freefall all over Europe and rebar prices falling?

An important lesson was learned. Whereas the positive impact of the investment on the environment and jobs would look good in the bank’s Social Responsibility Report, the only thing that really matters is the risk of default. Banks focus on the cash flow of the project and therefore all factors that might impinge upon cash flow. It follows that investors should follow a risk-based approach in presenting information to banks.

The ‘Bankable Document’

A ‘Bankable Document’ is a feasibility study or a Techno-Economic Feasibility Review (TEFR) that is of bankable standard. This is a difficult concept to capture in a few words; in essence, it means that the study is thorough and of high quality, but also that it contains all the essential information to allow banks to make an informed risk assessment.

A common mistake made by investors is to present information to banks too early in the process. In the same way that job applications do not survive the first sift if they are littered with grammatical errors and spelling mistakes, banks take a dim view of project documents that do not answer their questions. This reflects on those who submitted the documentation. Anything that undermines the credibility of investors is not helpful. This is not to say that discussions with banks before a project is fully developed are to be avoided. It is worth exploring at an early stage whether the project is likely to be of interest. Even if the project looks exciting, banks may reject it because they are seeking to cap their exposure to a sector or a country.

Another mistake is to build the Bankable Document around design and technology. This is important, of course, but the focus needs to be on the financial model, as banks are principally interested in free cash flow over the tenor of the loan or loans under consideration. Owners often present financial models that generate net present value and return on equity – numbers that are actually of little interest to banks. What they need to see is the Debt Service Cover Ratio and, rather than sensitivities, they want to see how this ratio performs under stress – the so-called ‘Bank Case’. This is why it is better to anticipate some plausible downside scenarios in the analysis, such as a construction delay, a capex overspend, a slower than assumed ramp-up in production, and reduced ex-works prices. The rest of the Bankable Study needs to explain how the underlying assumptions in the financial model have been derived so that banks can evaluate their reliability. This evaluation involves an examination of three categories of risk – construction, operations, and commercial. There is a fourth category, political risk, but this is an internal consideration for the banks.

This is part one of a two-part article written by Paul Wellings, Independent Cement Consultants, for World Cement’s August issue and abridged for the website. Part two will be available on 18 August. Subscribers can read the full issue by signing in, and can also catch upon-the-go via our new app for Apple and Android. Non-subscribers can access a preview of the August 2015 issue here.

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