The use of bond financing for large investment projects viola-funding November 19, 2023

The use of bond financing for large investment projects

Bond financing for large-scale projects
Bond financing for large-scale projects

Bonds are an alternative to a bank loan, but their buyers (capital providers) are usually financial market entities. These capital providers include mutual funds, investment fund companies, asset management companies, insurance companies, banks, and individual investors, allowing issuers greater flexibility in this instrument, as well as lowering the cost of funding. investors and project owners are specifically in search of bond financing for large-scale projects

Bond financing for large-scale projects, especially in the oil and gas industry has gain momentum  in the contemporary world for many years.

However, many companies consider this financing method problematic, including in the context of finding investors to buy bonds.

This method is often compared with long-term loan. There are many reasons why issuing bonds can be beneficial to the issuer.

Bonds are an alternative to a bank loan, but their buyers (capital providers) are usually financial market entities.

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Some advantages of bond financing

Throughout the life of the bonds (usually 3-5 years), the issuer can transfer funds between its projects or companies, depending on the needs, without having to take out several loans or get bank approval each time.

Bondholders are willing to be more flexible with regard to hedging. The ability to issue unsecured bonds reduces costs, including the absence of collateral and monitoring costs. At the same time, the issuer releases free assets that can be used as collateral for obtaining other financing.

The above advantages of bonds have a significant impact on the perception of the cost of financing by project participants. Most often, the interest rate on bonds is higher than the interest rate on loans.

However, in the case of an investment loan, it is worth remembering that any company operating on a large scale must actively work to obtain numerous loans.

The above are several factors for using bond issuance to finance large projects. Management should not compare only the standard interest rate on bonds, but should also take into account the associated costs and non-financial aspects that affect business performance.

The most important advantages of Bond financing for large-scale projects  is that bond financing can be used flexibly and efficiently.

Income bonds as a tool for financing large-scale investment projects

The issue of income bonds can only be carried out by entities acting in the public interest (especially of an infrastructural nature), such as municipalities and other local governments. It is advisable to fully use this tool in commercial projects, of course, with an appropriate balance of benefits and risks arising from this and ensuring the interests of creditors.

Income bonds financing for large-scale projects are additionally characterized by two essential features:

• The issuer of income bonds may limit its liability for obligations arising from the bonds to a certain amount of income or the value of project assets.

• The holder of an income bond has an advantage over other creditors. Satisfaction of their requirements can be carried out at the expense of the assets of the company or the project, which is fully or partially financed through the issuance of bonds.

The source of financing can be internal resources of the company or financial resources attracted from outside (the so-called debt financing). A common form of debt financing of investment projects is the issuance of bonds.

The basis for the implementation of any investment projects is to ensure smooth and uninterrupted financing throughout the entire life cycle.

The use of bond financing of local government projects

When a local government signs a loan agreement with a bank, it knows that it will definitely receive the money on the required terms and within the required time frame. Issuing bonds, if not guaranteed, may seem more risky from a local government perspective because the project may not find investors. In addition, banks are actively interested in lending to local governments, as they are an excellent customer in terms of risk and solvency.

Their balance sheet and their level of debt is usually controlled by the requirements of public finance legislation, and this is actually considered by banks as a reliable “financial shield“.

It should be noted that local governments vary greatly in terms of their powers, financial situation and investment opportunities, depending on the legislative framework of a particular country. Some local governments, mostly in large wealthy municipalities, invest heavily in construction, energy, infrastructure and far outperform many commercial borrowers in terms of economic performance.

Thanks to a clear legal framework, it is very easy for banks and potential investors to assess the financial situation of local governments. This can be much easier than for private companies. With regard to bankruptcy, legislation usually provides a mechanism for distributing the debts of an insolvent local government to other bodies. This is also a significant benefit for capital providers.

The liquidity of specific bonds in the market, along with the level of confidence in specific local governments, opens up ample opportunities for financing investments beyond loans and alternative financial instruments.

Bond financing of large-scale projects is largely based on financial market factors.

Public information about the level of risk of a particular project is also important. Investors know how much an issuer’s debt is worth in a particular risk class assessed by a rating agency.

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