Structure Finance
To finance capital investment projects, real estate and M&A transactions, they use project and structured financing (leveraged finance), where credit institutions play the main role. In such cases, leveraged financing is provided based on the cashflow model. It means that the source of repayment will be the project enterprise cashflow (i.e. the project's cashflow) depending on the project's economic efficiency.
The credit institution by means of Financial Covenants "prescribes" to the borrower - the project enterprise (or a special purpose vehicle) - how to operate the enterprise to meet the financial terms as agreed in the credit agreement.
Because such instructions are established in the form of concrete indicators they surely should be built in cashflow or financial models of the projects seeking such financing. Construction of those models disregarding Financial Covenants can lead to errors ranging from tens of thousands to millions euros, which could negatively influence the decisions by credit institutions. This may result in additional costs for sponsors and developers of projects.
Financial Covenants came from Anglo-American space. Financial Covenants may be used as an early warning tool to avoid risks. Analysis of changes in the said indicators, as a rule, provides possibility to receive an exact picture of economic development of the borrower. After the Basel II, credit institutions will apply Financial Covenants more and more often, and the revealed classification of project risks will influence credit terms and conditions through Financial Covenants.
Related practices
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30.07.2010
