Trapped Cash Project Finance - Financial Window

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Trapped Cash in Project Finance

Trapped cash in project finance refers to funds generated by a project that cannot be freely distributed to equity holders due to contractual restrictions outlined in the financing agreements. These restrictions are designed to protect lenders by ensuring the project maintains sufficient liquidity to meet its debt obligations and operational expenses.

Several factors contribute to trapped cash. The most common are covenants within the loan agreements. These covenants often include:

Debt Service Coverage Ratio (DSCR): This requires the project to maintain a certain ratio of cash flow available for debt service to the actual debt service payments. If the DSCR falls below the agreed-upon threshold, cash distributions are restricted.
Distribution Tests: These tests specify conditions that must be met before distributions can occur. These may include minimum cash balances, completion of specific project milestones, or satisfaction of certain operational performance metrics.
Cash Sweep Mechanisms: These mechanisms require excess cash flow, above a specified level, to be used to prepay debt. While beneficial for reducing the overall debt burden, it reduces immediate returns for equity investors.
Reserve Accounts: Project agreements typically mandate the creation and maintenance of various reserve accounts, such as debt service reserve accounts (DSRA), operating reserve accounts, and major maintenance reserve accounts. These accounts tie up cash and limit its availability for distribution.

The impact of trapped cash on equity investors can be significant. It reduces the immediate return on investment and can affect the project’s overall attractiveness. Investors need to carefully analyze the financing documents to understand the potential restrictions on cash distributions.

Project sponsors can mitigate the impact of trapped cash through several strategies:

Negotiating Favorable Covenants: During the financing phase, project sponsors should negotiate realistic and achievable covenants that allow for reasonable cash distributions while protecting lenders’ interests.
Optimizing Cash Flow Management: Efficient management of project operations and expenses can maximize cash flow and increase the likelihood of meeting distribution requirements.
Refinancing: As the project matures and its financial performance improves, refinancing the existing debt on more favorable terms can ease restrictions on cash distributions.
Equity Cure Provisions: Including equity cure provisions in the financing agreements allows sponsors to inject equity into the project to remedy breaches of financial covenants and unlock trapped cash.

In conclusion, trapped cash is a critical consideration in project finance. Understanding the factors that contribute to it and implementing strategies to mitigate its impact is crucial for both lenders seeking security and equity investors seeking returns. A well-structured financing agreement balances the needs of both parties, ensuring project viability while providing reasonable returns to investors.