International International Center For Center For

Environmental Environmental Finance.Finance.

Series A – Course #2 Types of Financing

Types Of Financing.Types Of Financing.There are five ways to finance There are five ways to finance projects.projects.

• GrantsGrants• BondsBonds• Subsidized (sub-market rate) LoansSubsidized (sub-market rate) Loans• Market Rate LoansMarket Rate Loans• Loan GuarantiesLoan Guaranties

Grants.Grants.

• Grants are sums of money Grants are sums of money awarded to finance a particular awarded to finance a particular activity or facility. activity or facility.

• Grant awards do not need to Grant awards do not need to be paid back. be paid back.

Grants.Grants.

Pros:Pros:• Do not need to be repaid.Do not need to be repaid.• Improve project cash flow by Improve project cash flow by

eliminating loan repayments.eliminating loan repayments.• Facilitate projects that are Facilitate projects that are

otherwise not affordable.otherwise not affordable.

Grants.Grants.Cons:Cons:• Foster dependence.Foster dependence.• Encourage overbuilding of projects.Encourage overbuilding of projects.• Often disregard costs of operation and Often disregard costs of operation and

maintenance.maintenance.• Generally, very specific requirements and Generally, very specific requirements and

conditions attached.conditions attached.• Requirement to meet specific goals of Requirement to meet specific goals of

the particular federal agency or private the particular federal agency or private organization.organization.

• For programs with fixed capital, once For programs with fixed capital, once grant is made, funds are gone.grant is made, funds are gone.

Bonds.Bonds.

Bonds are Bonds are loansloans made on: made on:

1.1. StandardizedStandardized documents to documents to borrowers whoseborrowers whose

2.2. credibility is publicly knowncredibility is publicly known. .

Bonds.Bonds.

Pros:Pros: • Are very liquidAre very liquid• Encourage growth of financial Encourage growth of financial

markets, especially secondary markets, especially secondary marketsmarkets

• Bonds allow borrowing for longer Bonds allow borrowing for longer maturities and larger amounts than maturities and larger amounts than market rate loans.market rate loans.

Bonds.Bonds.

Cons:Cons: • Borrowers must submit to public Borrowers must submit to public

credit analysiscredit analysis• Borrowers must use internationally Borrowers must use internationally

accepted accounting standards.accepted accounting standards.

Subsidized Loans.Subsidized Loans.

• Loan made to a qualified Loan made to a qualified borrower at below- market borrower at below- market interest rate.interest rate.

Subsidized Loans.Subsidized Loans.Pros:Pros:• Improve project cash flow by decreasing Improve project cash flow by decreasing

loan payments.loan payments.Cons:Cons:• Generally, requirements and conditions Generally, requirements and conditions

attached.attached.• Requirement to meet specific goals of Requirement to meet specific goals of

the particular federal agency or private the particular federal agency or private organization. organization.

• Encourage financial dependence.Encourage financial dependence.• For programs with fixed capital, fewer For programs with fixed capital, fewer

loans can be made.loans can be made.

Market Rate Loans.Market Rate Loans.

Loan made to a qualified Loan made to a qualified borrower at current market borrower at current market interest rate. interest rate.

Market Rate Loans.Market Rate Loans.Pros:Pros:• Easier to obtain than grant, subsidized Easier to obtain than grant, subsidized

loan, or loan guarantee.loan, or loan guarantee.• Generally, has no or limited conditions Generally, has no or limited conditions

regarding the way projects are carried regarding the way projects are carried out.out.

• For programs with fixed capital, more For programs with fixed capital, more loans can be made.loans can be made.

Market Rate Loans.Market Rate Loans.

Cons:Cons:• Decrease project cash flow by Decrease project cash flow by

increasing loan payments.increasing loan payments.• Requires higher loan repaymentRequires higher loan repayment

Loan Guaranties.Loan Guaranties.

A financial guaranty is a promise from a guarantor to make payment to the funds providers in case of non-payment by the borrowers.

Loan Guarantees.Loan Guarantees.Pros:Pros:• Lower interest rates than market rate loans.Lower interest rates than market rate loans.• Longer terms and,Longer terms and,• For larger amounts.For larger amounts.

Cons:Cons:• Higher loan repayments than for subsidized Higher loan repayments than for subsidized

loans.loans.• Generally, requirements and conditions Generally, requirements and conditions

attachedattached

Financial Simulation.Financial Simulation.

Following financial simulation Following financial simulation will be used to show the will be used to show the differences between:differences between:

• Market rate loans,Market rate loans,• Grants,Grants,• Subsidized loans,Subsidized loans,• Loan guaranties.Loan guaranties.

Assumptions and Assumptions and Conventions.Conventions.

Grant/ loan/subsidy/guaranty Grant/ loan/subsidy/guaranty

Pro FormasPro Formas

1. Government contributes $100,000,000 in 1. Government contributes $100,000,000 in year 0year 0

2. All loans/guaranties made in each year on 2. All loans/guaranties made in each year on 31 December31 December

3. Tenor of loans: 5 years, level principal 3. Tenor of loans: 5 years, level principal methodmethod

Assumptions And Assumptions And Conventions.Conventions.

4. For loan guaranties, estimated average 4. For loan guaranties, estimated average project size: $5,000,000project size: $5,000,000

5. Interest rate on subsidized loans: 0%5. Interest rate on subsidized loans: 0%

6. Interest rate on market rate loans: 10%6. Interest rate on market rate loans: 10%

7. Interest Rate on Guaranty Fund: 5%7. Interest Rate on Guaranty Fund: 5%

Assumptions And Assumptions And Conventions.Conventions.

8. Leverage ratios for loan guaranties:8. Leverage ratios for loan guaranties:

#Of loans under coverage ratio#Of loans under coverage ratio guarantyguaranty

0-200-20 100%100%20-3020-30 90%90%30-4030-40 80%80%40-5040-50 70%70%50-6050-60 60%60%60-7060-70 50%50%70-8070-80 40%40%80-9080-90 30%30%90-10090-100 20%20%100+100+ 10%10%

Simulation Results: Simulation Results: Grants.Grants.

Year 0 1 2 3 4 5 6 7 8 9 10

Opening Balance 100 0 0 0 0 0 0 0 0 0 0

Interest Earned 0 0 0 0 0 0 0 0 0 0 0

Principal Repaid 0 0 0 0 0 0 0 0 0 0 0

Total Funds Available 100 0 0 0 0 0 0 0 0 0 0

New Grants Made 100 0 0 0 0 0 0 0 0 0 0

Ending Balance 0 0 0 0 0 0 0 0 0 0 0

Grants Made 20 0 0 0 0 0 0 0 0 0 0

Total Grants Made 20 0 0 0 0 0 0 0 0 0 0

Simulation Results: Simulation Results: Subsidized Loans.Subsidized Loans.

Year 0 1 2 3 4 5 6 7 8 9 10

Opening Balance 100 0 0 4 2 1 2 1 2 0 4

Interest Earned 0 0 0 0 0 0 0 0 0 0 0

Principal Repaid 0 20 24 28 34 41 29 31 33 34 33

Total Funds Available 100 20 24 32 36 42 31 32 35 34 37

New Loans Made 100 20 20 30 35 40 30 30 35 30 35

Ending Balance 0 0 4 2 1 2 1 2 0 4 2

Outstanding Loan Balance 100 100 96 98 99 98 99 98 100 96 98

Loans Made 20 4 4 6 7 8 6 6 7 6 7

Total Loans Made 20 24 28 34 41 49 55 61 68 74 81

Simulation Results: Market Simulation Results: Market Loans.Loans.

Year 0 1 2 3 4 5 6 7 8 9 10

Opening Balance 100 0 0 2 1.9 2 4.4 1 1.5 0.7 3.9

Interest Earned 0.0 10 11 11.9 13.1 14.4 15.6 17.5 19.2 21.2 23

Principal Repaid 0.0 20 26 33 42 53 46 53 60 67 73

Total Funds Available 100 30 37 46.9 57 69.4 66 71.5 80.7 88.9 99.9

New Loans Made 100 30 35 45 55 65 65 70 80 85 95

Ending Balance 0.0 0.0 2 1.9 2 4.4 1 1.5 0.7 3.9 4.9

Outstanding Loan Balance 100 110 119 131 144 156 175 192 212 230 252

Loans Made 20 6 7 9 11 13 13 14 16 17 19

Total Loans Made 20 26 33 42 53 66 79 93 109 126 145

Simulation Results: Loan Simulation Results: Loan Guaranties.Guaranties.

Year 0 1 2 3 4 5 6 7 8 9 10

Opening Fund Balance 100.0 100.0 105.5 111.4 117.5 124.1 131.2 138.9 147.0 155.8 166.2

Interest Earned 0.0 5.0 5.3 5.6 5.9 6.2 6.6 6.9 7.3 7.8 8.3

Guaranty Fees Earned 0.0 0.5 0.6 0.6 0.7 0.9 1.1 1.2 1.5 2.6 8.3

Closing Fund Balance 100.0 105.5 111.4 117.5 124.1 131.2 138.9 147.0 155.8 166.2 182.8

Leverage Ratio 100% 90% 90% 80% 70% 60% 60% 50% 30% 10% 10%

Maximum Guaranties 100 117 124 147 177 219 231 294 519 1662 1828

Begin Guaranties In Use 0 100 115 123 145 176 218 231 293 516 1659

Guaranties Released 0 20 27 33 44 58 57 63 82 132 372

Guaranties In Use 0 80 88 90 101 118 161 168 211 384 1287

New Guaranties Issued 100 35 35 55 75 100 70 125 305 1275 540

End Guaranties In Use 100 115 123 145 176 218 231 293 516 1659 1827

Guaranties Issued 20 7 7 11 15 20 14 25 61 255 108

Total Guaranties Issued 20 27 34 45 60 80 94 119 180 435 543

Analysis.Analysis.Year 0 1 2 3 4 5 6 7 8 9 10

Total Subsidized Loans Made 20 24 28 34 41 49 55 61 68 74 81

Total Market Rate Loans Made 20 26 33 42 53 66 79 93 109 126 145

Total Guaranties Issued 20 27 34 45 60 80 94 119 180 435 543

Total Grants Made 20 0 0 0 0 0 0 0 0 0 0

0

50

100

150

200

250

300

Num

ber o

f Gua

rant

ies/

Loan

s Is

sued

in e

ach

perio

d

20 0 0 0 0 0 0 0 0 0 0

Period of Years

Number of Guaranties/Loans issued each year under different financing alternatives

Number ofSubsidized Loansmade each period

Number of MarketRate Loans made ineach period

Number ofGuaranties Issuedin each period

Number of Grantsmade in eachperiod

0 1 2 3 4 5 6 7 8 9 10

0

100

200

300

400

500

600

Tota

l Num

ber o

f G

uara

ntie

s/Lo

ans

Issu

ed

Period of Years

Total Number of Guaranties/Loans Issued Under Different Financing Alternatives

Total Number ofGrants Made

Total Number ofSubsidized LoansMadeTotal Number ofMarket Rate LoansMadeTotal Number ofGuaranties Made

Conclusion.Conclusion.

Loan guarantiesLoan guaranties are far more are far more efficient than grants, efficient than grants, subsidized loans, or market subsidized loans, or market rate loans.rate loans.