How It Works

• Non-recourse funding, also called non-recourse debt, is a form of financing used by companies and governments as a way to pay for projects intended to generate income. In this respect, the collateral on a non-recourse loan is usually the project's projected income stream. In the event that this income stream is insufficient to cover payments of principal and interest, the lender has no recourse (hence, the name); unable to claim any of the borrower's additional assets, the lender must sustain a loss.
  
  

Example

• Suppose Company ABC plans to undertake a project with a total cost of $1M. Company ABC secures a non-recourse loan for $1M from Bank XYZ with a payment of principal and interest totaling $10,000 each month for 120 months. Once completed, the project is expected to have a monthly yield of $15,000. Bank XYZ holds this income stream as collateral in the terms of the loan. Provided that the actual revenue stream equals or exceeds $10,000 each month, Bank XYZ will receive timely principal and interest on the loan. If the project generates less than $10,000 in a given month, the loan will go into default, and Bank XYZ will be unable to recoup the loss.
  
  

Recourse vs. Non-Recourse Funding

• The role of collateral in lending is to protect the lender from losses that might result from the borrower's failure to pay interest and principal in full and or on time. In recourse funding, the lender reserves the right, in the event of default, to liquidate the collateral on the loan. By contrast, non-recourse funding involves no such collateral save the income from the project being financed. Should default occur on the part of the borrower, the lender has no recourse because no assets can be claimed as collateral.
  
  

Implications for Borrowers

• Companies and government entities frequently finance specific projects with non-recourse funding, particularly where uncertainty exists with regard to the income the project is expected to generate upon completion. Non-recourse funding provides the borrower with the money needed to complete a project while protecting other assets from being claimed and liquidated as collateral in the event of inevitable default. Borrowers should be aware, however, that lenders, under such an arrangement, typically charge a substantially higher interest premium on non-recourse loans as compensation for the risk assumed.
  
  

Implications for Lenders

• The lending parties in a non-recourse funding arrangement take the greatest financial risk when issuing non-recourse loans, because their only assurance of repayment is the faith they place in the borrower and the revenue viability of the project being undertaken. In addition to a higher-than-average interest rate, many lenders will finance only a percentage of a project's total cost in a non-recourse manner. Such a practice is common where the value of a project is likely to fluctuate in relation to the total amount loaned.