Banks used to lend long term on the expectation of a rapid take-out through refinancing, albeit this was subject to project performance. This was a reasonable assumption in the pre-crisis market. A margin step-up after a period of 7 to 15 years to "force" a refinancing was a common feature.
Mini-perms are an extension of this approach. A short period (3-5 years) after construction completion, there is an aggressive margin step-up and cash sweep ("soft mini-perm"), or even a compulsory refinancing with the ability of the banks to call the project into default if it does not occur ("hard mini-perm"). Often, no principal repayment is envisaged during this period.
The rationale is to increase the probability of an early exit for the lenders and avoid locking the project into unfavourable conditions in the long-term. This would mean, in effect, that bidders are taking the risk that the market will recover at or before the mini-perm refinancing horizon.
The issues are about who takes the refinancing risk and associated costs. In principle the bidders (sponsors) should underwrite the risk in full, through a commitment to provide additional equity if needed or, at least, accept a deterioration of their equity return. However, in most cases, the authority bears the costs of increased margins as they are embedded into the base case.
Sponsors seem to have accepted this risk up until now, in the belief that current conditions are likely to improve significantly in the next few years. They may see this situation as an opportunity, with the expectation of windfall refinancing gains.
It is, however, important that the procurers ensure that (for soft mini-perms):
■ Refinancing risk is fully underwritten by the sponsors
■ The bidders' refinancing assumptions are transparent and realistic and the financing can sustain a significant downside case. The finance plan should detail the mitigation measures provided to cover such a downside, e.g. additional equity, which should be tested against the sponsor's or guarantor's balance sheets
■ The benefit of the primary refinancing is factored into the price, or the additional short term costs still provide value for money.
■ Refinancing benefits, at least over and above what is assumed in the base case, are shared in an equitable way1. The first part of these refinancing gains, simply generated by markets returning to "normal", should principally accrue to the authority.
Hard mini-perms can bring value by reducing short term financing costs and by putting added pressure on all parties to rapidly improve financial terms. However, when banks are fully compensated in case of company default, they may effectively transfer the refinancing risk to the procurer. The potential cost benefit to the authority is very difficult to ascertain, short of running comparative "short term" and "long term" tenders. Care should be taken not to effectively allow a "free exit option" to the banks, while leaving the procurer with an unquantifiable bet on the future.
PROS: Mini-perms, subject to the provisions above, are advantageous for the procurers when the cost of the refinancing factored into the bid price is acceptable. However, there is little they can do to encourage them, short of sharing the refinancing risks, and benefits, with the bidders (see 2.5.2)
CONS: They are more complex than a long term transaction with a potential higher execution risk. The authority remains the lender of last resort, should things go badly wrong.
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1 Bearing in mind that a likely scenario for the next few years is that base interest rates (EURIBOR/LIBOR) should start moving up again while margins should go down, mainly through a reduction of the embedded funding costs. The two movements could, at least, partially offset each other.