Carlo, today weâll discuss a case of the application of project finance to a typical sector like of project finance to a typical sector like power production and in particular weâll focus on the analysis of a biomass project, so production of power using scraps from agriculture, food and beverage, business, etc. In particular, I remember a case that was set up in Italy some years ago. It was originated in 2007 by a food and beverage company that was operating a distillery, and had the idea at the time to reuse and had the idea at the time to reuse the scraps from the distillery business, so the exhausted grapes, in order to produce power from renewable energy, and to use the power to fulfill the power needs of the same distillery. In this case the Bonollo distilleries, this was one of the key sponsors, had the idea to set up a ten Megawatt plant, so, not that big, for a total consideration in terms of all the budget for the construction of around 64 million and with a debt equity ratio excluding the VAT facility in the region of four times. It is ten megawatts, so it is not a huge project. 64 million is not that big. But the interesting point of this case is that it enables to us to understand why at a certain point an industrial sponsor can be interested in carrying out this kind of deal. And there were also some critical points that creditors at a certain point decided to put under the spotlight in order to understand whether or not the involvement of Bonollo was a good thing, or a bad thing, from the creditors point of view. So, it is interesting from this point of view to discuss also the topic related to you know how the money was spent, how the deal was financed, and at a certain point also to understand something more related to the point of the incentives that the different sponsors can have in order to develop such kind of projects. Fine, I see here when we look at how money was spent and how it was collected than the total investment was of about 63 million. And the, of this total investment, it was financed with the typical project finance techniques. So we see that equity was collected from industrial sponsor on a 50-50 basis on one part there's Bonollo Distilleries. And the other industrial sponsor is Alerion Clean Power. That was the green business- green utilities operator in Italy. And so, this was just for about ten million out of the 63 million. So, the greatest bulk of the financing came in the form of a syndicated loan, and with the involvement of several banks in dual stage syndication by which several banks have jointly underwritten the amount lent. And in particular what I see is that there are two facilities in which the syndicated loan came. And in particular, a base facility. Which takes on the, the largest part of the loan, which I think is related to the building of the project. And so to cover project costs. While there is instead also a VAT facility, which instead, is dedicated to the payment of the VAT- During the construction phase, right, right, Carlo, you are perfectly right. I see also a here a debt service reserve account, what is it for? Yes you were right when saying this is a typical project finance structure if you look at the uses and sources of funds. At the end of the construction phase and you must consider that the construction phase for this project was of about a couple of years. So, going from January 2009 down to December 2010 plus a six month commissioning period. So the period where, the plant is still operating. But not 100% full capacity. So, at a certain point you have the project that starts, but doesn't perform as in the one active regime, it gets the you know, the full capacity of the project. You are right when you say this is also typical from the liability side point of view. So, the contribution of equity out of the total consideration of the project which is excluding VAT in the region of four times, so it's highly leveraged. This was, possible at the time, because we were at the end of 20 let's say mid 2008, so very close to the turmoil. So we were sufficiently lucky, to set up the financing before everything fell apart. In addition to this you can also appreciate by looking at the sources and uses of funds that as you say. There is a perfect match between the VAT facility on the liability side. And the VAT anchoring during construction on the asset side. Mind that in countries where VAT is in action, you raise the credit for VAT during construction, vis-a-vis the state. And you must find a set on the liability side. By looking at financial model, the VAT is then amortized on a compensation base and looking at the financial model typically the tenure of the VAT facility was in the region of five years. The base facility was in the region of 41 million. It was a amortizing loan, so typically amortized, on specific schedule of repayments with a tenure of 15 years. So, pretty long at the time but again, market conditions enable the sponsors to carry out, this kind of thing because market conditions were still a little bit to relaxed at the time. Compared with what we already know in terms of theory of capital budgeting or project finance you see that on the asset side you have the direct investment and the direct investment is in the region of 47.5 million, plus in direct items represented by the capitalized interest in fees on the VAT doing construction. But you mentioned correctly, that there are too a couple of elements that we didn't mention in the traditional capital budgeting exercise. The first one is on the asset side, that deals debt reserve account. And on the liability side the self financing. Let me tell you why basically this happens. It doesn't happen so frequently because, typically, industrial projects are completed by the contractor, then the independent engineer, runs the acceptance test in order to verify whether or not I can accept the plant. And then, I decide either to stop the plant and make it better, or to accept it and to run it at full capacity. In this case I mentioned before, that there was a period of six months of commissioning. Commissioning is, I would say, the start up phase. So you start using the plant, in order to understand if the plant is good or not. But, if the plant is working, itâs already producing power, and since this power plant was using renewable sources, it also has the possibility to get some green certificates, that you can start selling to the national grid administrator. And so from this point of view, also during I would say the terminal phase of the construction phase, you are generating cash. From this point of view, you have two effects. On the assets side you must, as we have mentioned in our capital budgeting session, set aside the debt service reserve account. So you must set aside a portion of this cash, trapping it into the vehicle and avoiding the total distribution of this cash flows to the sponsors. Second element: As long as you run the pre-operational phase, you are able to generate positive results. And so you generate positive net income. But if you generate positive net income, this accrues on the equity of the liability side, which is the self financing kind of story. So, in a nutshell this clearly indicates you that whenever you have to deal with project finance, which is a mix of construction and operation. Or for example, refurbishing, when you have already existing facilities. And you are refurbishing them. You have this facility that already produces a revenue, but at the same time, you are running a refurbishment phase. So you are mixing up things. So don't be surprised, if you find something that is typical of the operational phase, in a typical sources and uses of funds of the construction phase. Hm? This is basically what? What basically. So this is typically to cover for periods in which there might be some unexpected just for the operations for the start up phase but also for periods in which there might be some unexpected sheets in the cash flows data. Correct. Creditors from the very beginning want to capture a portion of the cash, inside the vehicle, in order to overcome future unexpected events. And since the commissioning phase, could trigger some risks. It is preferable to retain the cash, inside the vehicle, rather than allowing sponsors to get their hands on this bulk of cash, that has been originated in the project. And this is also related in, as a compliment to the security package, and to the cover ratios. In a sense, I would say it is a reinforcing mechanism that provides, I would say more comfort to the creditors in order to, I would say, sleep safe, in case something unexpected comes out at a later stage. Well Carlo, we have commented a little bit on you know how the sources and uses of funds typically worked. I have a couple of points for, you know continuing the discussion. You mentioned that this project was organizing a typical dual state syndication. And this was obvious, given the market conditions of the time. If we look also at a some of the key cover ratios that service cover ratio, low life cover ratio, we've seen that the VAT facility was repaid in five years. The tenor of the loan was 15 years, so pretty long. But however, we were pretty confident about the future success of the project because by looking at the loan-life cover ration, that service cover ratio. On average, DSCR and LLCR would were in the region of 1.4, 1.5. And low life cover ratio of two. So, a very solid project. Probably for the reasons, that we will discuss later on in terms of, roll of the project sponsors. Let me however briefly comment with you the typical contextual structure. You mentioned that the typical financing of this project was pretty much in line with the standard of the finance project market. But also looking at the network of contracts that is nothing particularly strange. If we have a look at, you know, the typical contractual structure, a part of the financing represented by the bank syndicate with an order course loan. And the 50%, 50% equity contributions that you mentioned, by Bonollo distilleries, the key sponsor, and Alerion Clean Power, the green business utility that was listed in the Italian stock exchange. So, from this point of view are typical two sponsor kind of SPV, in this case, Bonollo energy SPV. And a typical, a dual stage syndication for the bank, the bank syndicate. In addition to this you can imagine, we have, the power plant that uses as raw materials, biomasses coming from Bonollo distilleries. It transforms it in order to generate simultaneously, that's why it is a cogeneration plant. Steam on one side, and that renewable power on the other side. So by looking at the business model, you can appreciate that the key contracts and must supervise, first of all the construction. And the construction was set to up, using a standard, EPC turnkey construction contract with STC, which was a, reputable contractor, in the Italian market with long experience, for the construction of these plants. The second key contract, that you have to set up, is the, contract, that was key for the success of this project, regarding the supply of raw materials. So the exhausted grapes, that you can use in order to burn them, and to use them to produce power. And in this case, the supply agreement was a setup between, Bonollo Distilleries on one side and Bonollo Energia on the other side for the bio mass. Sale agreement, then you must set up the contracts to sell the production in two ways, on one side you have extra production that will not be used, by Bonollo Distilleries. So you have, one sale agreement between the SPV on one side and Bonollo. Because Bonollo buys the power for self consumption. You have another power sale agreement on the free market, for what concerns the production that is in excess, of what they need. And from this point of view there was a service contract for energy and green certificate sale, that was entered by Alerion Clean power by Bonollo because Alerion is a key player in the energy market. And so, it was helping the SPV to find an outlet for the excess production of the power. And finally, a typical O&M agreement that was, pretty natural to be managed by the same Bonollo distillers because if you look at the plant, there is a perfect I would say. Proximity between the distilleries on one side and the power plant on the other side. So it is a typical kind of cogeneration plant with key contracts typically involving the same project sponsors that want to extract as much money as possible from the project itself. In this respect can you say something more on the incentives at work. Because we see that Bonollo plays multiple roles, and in particular, as a sponsor it gets dividends from the project. And then as a counterpart in the sale and the supply agreement, so that on the one side it, it sells its products of the distillation process to the SPV as by the masses. And on the other side it grants a stable and green source of energy. So how do you see this situation in terms of incentives? Is it good or bad for us. Let's speak to the discussion in this sense. You are asking me, your main point is Bonollo is involved massively, in this project and indeed, most of the key roles are performed by the same sponsor. Itâs an operator and maintenance agent, it buys the steam, it buys power from the power plant and at a certain point, it provides also the scraps that are needed in order to run the project. So, you are asking me Any pros or any cons? So let's split the discussion. So, put yourself in the shoes, of a creditor. One of the banks, that are involved in the syndicate. You have seen for example, that was, arranged by general electric interbanca. So, put yourself in the shoes in the mandator, of the mandator who arrange. Give me one typical con so that I can, counter argument with a possible pro. A potential con could be that Bonollo could have the incentives to sell to the the SPV. It's products of an installation process at high costs because it wants to maximize its profit on the selling of the bio-masses. Exactly, this is in essence I would say a typical conflict of interest. So from this point of view, you cited the case, I have biomass, the biomass is absolutely needed in order to effectively and successfully run the project. I could be tempted to extract more value, by selling the raw material, at a higher price than comparable prices for the same biomass available in the market. Yes it is, but in order to follow with your topic I could also say. I could impose an O&M fee at a higher level than what normally is practiced in the market. Conflict of interest is indeed, there and so from this point of view having the sponsor playing a dual role of sponsors and O&M agent, a sponsor and supplier, sponsor and buyer, exposes creditors to a possible conflict of interest. But, let me say, the other way around. If Bonollo is really covering most of the roles inside the project. You must understand that is I would say he's gaining a lot of money. But if he does, if it really wants to get such big amount of money, it must perform at best, in order to avoid any negative occurrence in the project life. So I have the raw material, I have all the interest to provide it. Because if the project performs well, I will typically extract, more value because I will be paid for that. And so, there is a certain, I would say alignment of interests, between the sponsor on one side, and the creditors on the other side. By doing my own interest, I do also good thing for the creditors. But will be pretty happy to accept it, provided that, the soundness of the sponsor is sufficiently high, so as to avoid some possible troubles later on in the process. Otherwise the risk is that, if you consolidate too much counterparty risk, the risk is that for, if for what ever reason Bonollo gets in trouble you have big problems with the SPV itself. So Carlo, I think that, this discussion was pretty useful from our point in order to raise some of key questions that typically creditors look at. By looking at the typical deal structure in project finance. Maybe during our further discussion, we'll have the possibility to go in more depth, with some additional features of some of the projects that can enable us to get more acquainted with the typical intricacies of the structuring and financing.
