Raising Mining Debt Capital

Raising Mining Debt Capital

Why raise mining debt capital?• its cost as opposed to cost of equity• potential tax advantages - including interest deductibility• avoid share dilution • increase the return from mining projects • facilitate risk diversity

Presentation Overview

This presentation will briefly consider the following 5 topics relating to raising debt capital in the mining industry

1. Types of Debt Capital2. Mining Project Finance Risks from a Lender’s Perspective3. Mining Project Finance Issues from a Borrower’s Perspective4. Some Key Items in Mining Project Finance Loan

Documentation5. Mining Project Finance Security Considerations

1. Types of Debt Capital

• Corporate Debt Financing• Loan made on the basis of borrower’s overall balance

sheet and creditworthiness • Project Financing

• Used because of capital intensive and risky nature of mining• Limited recourse or non recourse• Money loaned on the basis of projected revenues• Reliance on project assets for collateral

Project Financing in the Mining Industry

May involve the following debt financing arrangements: • Senior Debt• Mezzanine Debt• Second Lien Debt• Convertible Debt• Non Convertible Debt• Bridge Financing• Line of Credit/ Standby Credit Facilities

Project Finance Sources • Banks and non-bank financial institutions, such as

pension funds, insurance companies and private equity funds

• Syndicate of lenders• required for larger projects • spreads risk among a number of lenders• good business reasons for lead lenders and sponsors

• Multilateral development banks/international financial institutions involvement attracts commercial lenders

• Export credit agencies trade finance and risk management services

2. Mining Project Finance Risks – the Lender’s Perspective

• Lenders are last to commit their funds to a project• Provide more than 50% of the overall project costs• Lenders take a near-equity approach to their project

finance loans • Primary objective - ensure that the loan principal is

repaid with interest • Decision to lend based on

• assurance that the project will generate sufficient income• control over the project • security over all of the project assets

What are Lenders looking for?

Some critical matters to lenders in mining project financing, include:• Bankable project and bankable feasibility study• Special purpose vehicle structure• Life of mine plan• Hedging arrangements• Due diligence • Equity contribution and contingent support• Insurance coverage • Completion test• Comprehensive security

Bankable Projects and Bankable Feasibility Studies

• Is the project “bankable” ?• Is there a “bankable” feasibility study?• The word “bankable” is often used in the mining project

finance context but it is not defined• A general description of “bankable” might be a project

that is in form and has the content that lenders view as suitable for financing and conforms to mining market practice

• Whether or not a project is “bankable” is a fluid and subjective concept

Special Purpose Vehicle (SPV)

• SPV does not own any other assets other than the project and project related assets

• SPVs vary in form and what form should be used will ultimately depend on the type of project

• Incorporated companies are often used in mining project finance structures because• they have separate and distinct legal personalities• shareholders have limited liability• they exist in perpetuity

SPVs

Benefits for lenders• If project encounters financial problems allows exercise

of remedies, without interference from other creditors• post-completion the SPV borrower may be a bankruptcy

remote entity that will not be adversely affected if the parent sponsor company becomes insolvent

SPVs

Benefits for sponsor/borrower • loan can be made directly to the SPV borrower• Insulates sponsor from liability for the loan repayment • Sponsor can be released from its covenants and its

guarantee post-completion• If non-project assets held, security may be required• If other financing provided to the borrower, will need

intercreditor or subordination agreements

Hedging Arrangements

• Lenders will require borrower to establish a hedging program and enter into hedging arrangements with the lenders

• Provides protection from changes in currency, interest rates and metal prices

• Expected ancillary business as part of the project financing mandate

• Not unusual for lenders to require the borrower to hedge at least 50% of the projected production

Due Diligence, Sponsor Reputation and Management Team

• Post-completion lenders generally have recourse only to the project’s assets in the event of a default

• Lenders must perform thorough due diligence of the project before committing funds

• Lenders must be comfortable with the reputation of the project sponsor and have a high level of confidence in the sponsor’s and borrower’s management teams

3. Mining Project Finance Issues – The Borrower’s Perspective

Understanding the Mining Project Finance Process• Borrower’s objective - obtain project financing on as

favourable terms as possible in a cost and time efficient manner

• Many companies do not have experience with the rigours and intensiveness of the project financing process

• Expectations may be based on prior equity experience

Understanding the Mining Project Finance Process

• Fundamental differences between equity financings and project financings• Equity financings - investors

• look at the long term prospects of project company• share in upside if project is successful

• Project financing - lenders• do not share in the project upside (unless they hold some

form of equity securities or other ancillary business) • want their loans repaid in full with interest

Managing the Process

• Understand extent of and reasons for the lenders’requirements

• Anticipate requirements as far in advance as practical and structure the project to meet those needs

• Retain experienced financial and legal adviser to assist with some of these matters

Risk Allocation & Mitigation

• Central to any project financing is a myriad of agreements including:• loan and security documents• off-take agreements• construction agreements• equipment agreements• operating agreements• maintenance agreements• power purchase agreements

• All parties are expected to assume risks that are customarily allocated to appropriate project participants

Risk Allocation and Mitigation

• For example, risk allocations may involve • reserve risk lenders• completion risk sponsor (completion guarantee)• construction risk construction contractor• insufficient mineral demand risk off-taker• permit and concession risk mine operator• political risk sovereign guarantees, IFIs and export

credit agencies, or private market political risk insurance

Equity Contribution and Contingent Support

• Equity contribution required by the project sponsor• invested in the project prior to the first drawdown

• Requirement that at least 1/3 of the total project cost be paid up by the sponsor before any bank financing is available would not be unusual

• Borrower/sponsor required to provide contingent support to fund possible construction cost overruns and commissioning delays• provided by cash in a secured account, letter of credit or

performance bonds• Sponsor guarantee and covenants

• may be released post-completion

Life of Mine Plan

• Borrower will be required to prepare a life of mine plan• Life of mine plan will reflect the project’s ore reserve

model and must be materially consistent with the feasibility study presented to the lenders during due diligence

• Borrower must notify the lenders of any material revisions to the life of mine plan and must obtain their consent prior to implementing such revisions

Financial Model

• Borrower required to develop a financial model to analyze the economics of the project and to calculate pro forma financial covenants

• The financial model is updated in accordance with the terms of the finance documents to reflect• changes to the project’s assumptions• recommendations arising from the due diligence

review completed by the independent engineer• The initial financial model is used to assess the project’s

performance relative to the financial covenants

Governing Law of Primary Financing Documents

• What laws should govern the primary financing documents such as the loan agreement?

• Where there is a Canadian sponsor and the project is located outside of Canada foreign banks may be accustomed to English or New York law

• However, Ontario or British Columbia law may be viable alternative

• If Ontario or BC law is used English or New York counsel will not be required and there will be a financial benefit to the sponsor

4. Some Key Items in Mining Project Finance (MPF) Loan Documentation

The documentation process for a mining project financing will usually involve• the negotiation, preparation of settling of the commitment

documents• definitive finance documentation• satisfaction of conditions precedent to financial closing

and the initial advance

Some Key Items in MPF Loan Documentation

• Structure of the loan or credit agreement for a mining project financing is generally similar to non-mining project financing loan agreements

• Loan agreements that are used for mining project financings will incorporate additional provisions relating specifically to the mining project finance including:• Independent Engineer• Project Accounts• Insurance Requirements


Conditions Precedent are extensive and may include• authorizations and approvals; loan and security document• independent technical consultant report; financial model report• insurance consultant report; title to the project assets• project documents; no material litigation• no material adverse change; no default• models and budgets; fees and taxes• environmental report; accounts• legal opinions; insurance• due diligence; hedging documents and program


Representations and warranties may include• authorizations for the project• mining claims• feasibility study • life of mine plan, financial model, development plan• project information• title to the project and project assets• compliance with environmental laws


Affirmative Covenants may include• construction progress reports• development plan• financial model• environmental compliance• construction and acceptance of the project• material project documents


Reporting Covenants will be included dealing with budgets, operating reports, the life of mine plan, the financial model and the development plan, including updates and changes to them


Negative Covenants• will limit financial indebtedness, liens and payments• restrictions on payments may prohibit any payments

(other than permitted payments) prior to the later of completion and the first principal repayment

• payment restrictions may be relaxed after completion


Financial Covenants relating to the project may include• Debt service coverage ratio• Loan life coverage ratio• Project life coverage ratio• Reserve tail ratio

Financial Covenants for project sponsor may consist of a tangible net worth covenant pre-completion


Events of Default will include• failure to satisfy financial tests• breach of representations and warranties• breach of finance documents• failure to achieve completion by the stipulated completion date• breach of material project documents• cancellation or repudiation of mining claims or authorizations• the occurrence of an expropriatory event by a governmental

authority• any unscheduled stoppage or disruption to mining/production for

greater than a stipulated period of time


Completion Test• typically cover technical aspects of the project such as the

physical facilities, production tests (such as mining, milling, recovery, unit cost and concentrate quality tests), financial matters and legal compliance

• satisfaction of the completion test may trigger • a step down in interest rates• release of the project sponsor from its guarantee and

covenants• entitle borrower to make certain permitted payments


Sponsor Requirements• sponsor will be subject to most of the representations and

warranties, affirmative, reporting and negative covenants and events of default that apply to borrower

• certain financial covenants• sponsor may be released from its obligations and

guarantee post-completion

5. Mining Project Finance Security Considerations• Lenders require effective and comprehensive security over all of the

assets that the borrower owns or may own in the future• Includes security over

• real property• deposits• mine output • mine licences, permits and concessions• project contracts• bank accounts (onshore and off-shore) • securities of subsidiaries• shareholder and intercompany loans• insurance proceeds

• Demonstrates why preferable to use a SPV as the borrower

Mining Project Finance Security Considerations

Challenges to a full security package• Civil codes of certain jurisdictions do not provide for an

effective security interest over every type of asset such as common law concept of a floating charge or debenture

• Foreign investment legislation may prevent strategic assets – mineral deposits– from being mortgaged in favour of foreign lenders, or owned by them following foreclosure• Attempt to allay this problem by having an onshore

entity hold the “restricted” assets in trust for offshore lenders


Challenges to a full security package• Contractual rights and permits issues

• Assignment of rights by way of security is not sufficient

• Without a direct contractual link with the counterparty, lenders can face difficult situations• Unable to deal with borrower defaults

• Lenders insist on direct contractual relationships with counterparties to key contracts and permits


Direct Agreements• Generally known as direct agreements, tri-partite agreements,

consents or collateral warranties, these documents should provide for • Consent to the security• Consent to assign to a purchaser• Appropriate grace periods & right to cure the borrower’s default• Counterparty to continue performing its obligations with a

successor to the borrower


Direct Agreements• Borrower’s responsible to obtain direct agreements in a form

satisfactory to the lenders• Borrower should anticipate the requirement to obtain a direct

agreement • Include in the material contract an agreement to negotiate in good

faith a mutually acceptable direct agreement • Obtain this at the time of negotiation of the material contract and

not when preparing the finance documents• Avoids potential costs/concessions and delays

• Contractors operating on international mining projects are accustomed to negotiating direct agreements


Direct Agreements• Lenders take a realistic view as to what can be obtained

and over what time frame• Only require direct agreements with counterparties to

material contracts and key permits• In certain countries, concessions or licences granted to

a mining company are not transferable

SUMMARY CONCLUSION

• Due to the nature and extent of the risks that lenders face in mining project financings the requirements to obtain project financing are considerable and the process is intensive

• The mining project financing process can proceed much more efficiently and effectively if borrowers understand the lenders’ requirements and anticipate those requirements as far in advance as possible

Fasken Martineau has expertise in mining debt financings

• Fasken Martineau DuMoulin LLP: “Global mining law firm of the year” for third consecutive year by the 2007 Edition of International Who’s Who

• Fasken Martineau DuMoulin LLP, with offices in all of Canada’s major centers as well as in London and Johannesburg, has the expertise and experience to assist you with your mining debt financings

Please visit us at: www.fasken.comContact: John Elias: [email protected]

Raising Mining Debt Capital

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