Project Finance: Lending Against Cash Flow, Not the Borrower's Balance Sheet

Project finance is a structure in which the lender looks not at the sponsor company's books but at the future revenue of a specific asset: a plant, a power station, a toll road or a residential complex. The money is lent to a separate legal entity set up for that asset (an SPV, or project company), and the project's own cash flow is the source of repayment. The sponsor's liability is limited: recourse to its other assets is either excluded altogether or narrowed to specifically agreed cases. That explains everything distinctive about the structure: complex documentation, a pledge over almost everything the project company owns, and tight lender control over every rouble in its accounts.

How it differs from an ordinary corporate loan

A corporate loan is backed by a track record: the bank reads the financial statements, calculates leverage and examines profitability over past periods. A project company has no past — it was set up yesterday and earns nothing until the asset is commissioned. The object of analysis therefore becomes the financial model: forecasts of revenue, prices, capacity utilisation, operating costs and the construction schedule. The lender stress-tests the model against deteriorating conditions and requires debt service coverage from cash flow never to fall below the level set in the loan agreement. Each bank sets the exact minimum itself, and it is usually not disclosed publicly.

The second difference is security. The lender takes a pledge over the shares or ownership interests in the SPV, rights under the project documentation, equipment, land, and rights under contracts with the contractor and the offtakers. The point is not to sell off the collateral but to allow the lender, if the project falters, to take over management and complete the asset itself.

Risk allocation and the cash flow waterfall

Project finance is built as a risk map in which each risk is assigned to the party best able to manage it. Completion risk is covered by a fixed-price EPC contract with liquidated damages payable by the contractor. Market risk is covered by long-term offtake agreements or a regulated tariff. Input-cost risk is covered by supply contracts. In infrastructure, political and regulatory risk is borne by the state through a concession agreement or a public-private partnership (PPP) agreement.

Cash moves through the project in a predetermined order of priority known as the cash flow waterfall. Operating costs and taxes come first, then interest, then repayment of principal, then top-ups of the reserve accounts, and only what remains goes to shareholders. As long as the covenants are not met, no dividends leave the project at all. For an investor holding the sponsor's shares, this matters more than the size of the project: a large construction programme can deliver nothing to shareholders for years, even after the asset is already operating. Such restrictions have to be checked in the financial statements and the notes to them — in the issuer disclosures section they are usually described in the parts covering borrowings and related parties.

The Russian framework: where the structure is used

In Russia, project finance has been institutionalised in several forms at once. In residential construction financed by buyers' equity participation, the escrow model under Federal Law 214-FZ applies: buyers' money sits in escrow accounts until the building is commissioned, while a bank lends for the construction. In infrastructure there is the VEB.RF Project Finance Factory, created by a government resolution in 2018, in which risks are shared among a syndicate of banks, the development institution and the budget. The legal framework for syndicated lending was established by Federal Law 486-FZ of 2017; before it, banks had to assemble syndicates under foreign law.

The public debt market sees these projects as concession and infrastructure bonds issued by the project company itself. They can be found in the bonds section: structurally these are SPV securities rather than the corporate risk of the parent group, and their amortisation is usually tied to the project schedule. The yield on such issues is sensibly compared not with the bonds of large issuers but with the OFZ curve: the spread over it is precisely the payment for project risk and for liquidity. On the tax side, the treatment for a private investor is the same as for other debt instruments — the investment income tax base is determined as 13%.

How an investor should read project debt

It is useful to distinguish project debt from group debt. If the SPV's obligations are not consolidated or are secured on a non-recourse basis, a deterioration in the project hits the value of the stake but does not bring down the parent company's balance sheet. If, however, the sponsor has provided a guarantee, completion guarantees or an undertaking to cover cost overruns, the risk has returned to its balance sheet and has simply been hidden in off-balance-sheet items. The second reference point is the stage. Before commissioning, a project consumes cash; once it reaches design capacity, it starts generating it, and between these two states the financial statements look completely different even though the underlying economics are the same. The third is the source of revenue: a tariff, a long-term contract or the open market. This determines how predictable the cash flow is, and therefore how much debt the project can carry.

One caveat: comparable public data on the project debt of Russian issuers is scarce. Syndicate terms, coverage levels and covenant thresholds are disclosed selectively, so conclusions have to be drawn from the notes to the financial statements and from issuer announcements — these are easy to follow in the news feed and the events calendar. The terminology of the structure — SPV, recourse, covenant, waterfall — is worth keeping to hand in the glossary.

Project finance rarely exists in its pure form: between the senior debt and the equity, deals often include an intermediate layer carrying a higher interest rate and an option on an equity stake. How this layer works and what the borrower pays for it is covered in our piece on mezzanine financing.