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The Financing Proper Term Sheets (Mandate/Commitment Letters): –Confidentiality Agreement: Lenders need a basic amount of information about the project.

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Presentation on theme: "The Financing Proper Term Sheets (Mandate/Commitment Letters): –Confidentiality Agreement: Lenders need a basic amount of information about the project."— Presentation transcript:

1 The Financing Proper Term Sheets (Mandate/Commitment Letters): –Confidentiality Agreement: Lenders need a basic amount of information about the project and the developer in order to sign a meaningful term sheet, and hence first steps involve signing a confidentiality agreement to enable the lender to review basic information and project documents Cross Checks with Project Documents: Major project documents (PPAs, turbine supply, BoP, etc) will have their own confidentiality provisions –Typically provide that they can be disclosed to prospective lenders who agree to maintain in confidence –CA provisions of project documents should be reviewed to make sure written consent of counterparty is not required in order to disclose to lender and its counsel 1

2 The Financing Proper (cont) Term Sheets (cont): –Summary vs Detailed Terms: is it better to have a 10 page summary term sheet or a 60 page detailed term sheet? Bias for Summary Terms: market practice generally goes for summary term sheets, because: –Lack of Due Diligence: Until full due diligence is done, cannot be certain that all key terms have been identified or that the terms agreed to will not need to be significantly modified –Time Considerations: Borrowers and lenders are not often unwilling to spend significant time unless they know they have a basic meeting of minds, and the time it takes to negotiate a detailed term sheet requires too great an investment before the parties have signed a term sheet –Do it twice? Experience teaches that even with a detailed term sheet, the time needed for negotiation of the actual loan documents is not significantly shortened, so in a way you end up doing it twice and at considerably greater expense (remember: in these deals, time = money) –Nonbinding: terms sheets are nonbinding, so at best detailed term sheet “morally” binds lender, but not legally 2

3 The Financing Proper (cont) Coordination of Lender and Tax Equity –Mutual Interest: lenders and tax equity investors each have an interest in the structure and terms of the other’s transaction with the developer Lender focus: terms that affect take out of construction lending with tax equity investment at COD –Conditions precedent to Tax Equity funding: any that will be problematic to achieve in a timely fashion –Size of Tax Equity Investment: are there terms that would reduce the amount of the tax equity investment? »If so, how manageable are those terms? »What risk that ultimate investment will be insufficient to take out construction financing? –Tax Equity Financial Position: will the tax equity investor have the moneys to fund the investment at COD? –Market Reputation: does the tax equity investor have a good market rep as a “closer” rather than a “walker”? 3

4 The Financing Proper (cont) Coordination of Lender and Tax Equity –Mutual Interest (cont) Tax Equity Focus: terms of permanent loan that will restrict cash flow distributions and delay receipt of return on investment –Special Reserve Funds: are there unusual reserve funds to be funded out of project revenues? If so, what impact on timing of return? –Reasonableness of projections: are the project pro forma projections reasonable and founded on industry standard modeling approaches? –Soundness of tax analysis: is the tax analysis on which the tax equity structure is based conservative or aggressive? »Conflict: some tax equity investors take very aggressive (i.e., likely to lose on audit) positions, and this can be at odds with the conservative approach that lenders generally prefer –Track Record of Developer: if developer does not have track record, what arrangements have been made to ensure project success? –Conditions to Payment of Development Fee: since development fee to developer comes out of tax equity, many tax equity investors want the project to be “seasoned” and proved out before developer is allowed to take the developer fee 4

5 The Financing Proper (cont) Coordination of Lender and Tax Equity –Due Diligence Coordination: Eliminate Duplication: best if lenders and tax equity agree to use the same independent engineer, resources study consultant and tax equity modeling consultant –Helps control expense and also helps eliminate “dueling consultants” –Resource study consultants will vary from project to project: »Wind Projects: wind resource study, transmission/deliverability study »Geothermal Projects: geo resource study, transmission/deliverability study »Solar Projects: resource study, transmission/deliverability study »Biomass Projects: fuel study, transmission/deliverability study, by-products marketing study Written due diligence responses and due diligence discussions: best if the same written responses are given to lender and tax equity, and that both join in DD discussions –Not only eliminates duplication, but can avoid confusion by each party being given the same information 5

6 Financing Structures: –Leveraged vs. Unleveraged: which structure is used will largely depend on the tax subsidy the project will utilize PTC Projects: For projects utilizing the production tax credit, unleveraged financings are the dominant model –PTC Unleveraged Structure: since tax equity commits prior to construction but does not fund until Commercial Operation, construction financing is still needed in this structure »Construction lender takes risk that conditions for tax equity funding will not be met and lender will thus be an inadvertent “permanent” lender »Thus due diligence and documentation for construction loan is same level of scrutiny as long-term leveraged financing The Financing Proper (cont) 6

7 Financing Structures (cont) –Leveraged vs. Unleveraged (cont) ITC Grant: Dominant model consists of: –ITC Grant Construction Loan: a construction equal to approximately 90% of the ITC grant, with this loan being taken out when ITC grant is received »ITC Grant Sizing: 10% haircut (or more) is prudent, especially if an aggressive tax position has been taken on the sizing of the ITC Grant (e.g., large developer fee included which may be disallowed by Treasury) »Serves as Equity: in the underwriting process, the ITC grant functions as equity in much the same way as tax equity does for depreciation and/or PTC monetization –Mini-Perm Loan: the balance of non-equity funds are provided through a mini-perm loan that has a long term amortization schedule (12 to 20 years, with 15 years as the norm) but with a balloon payment in year 5 or 7 »Reasons for Structure: the mini-perm structure results from the 5 year recapture period for the ITC grant and the fact that most depreciation is used up after seven years »Refinancing at Tax Equity Takeout: tax equity hopes to be taken out at refinancing, but cannot have a right to be taken out The Financing Proper (cont) 7

8 Financing Structures (cont) –Tax-exempt Bond Financing: aside from special, temporary laws (e.g., Recovery Zone bonds), only available for projects that qualify as solid waste disposal facilities Governmental Issuer: to be tax-exempt, the bonds must be issued by a state or local government –Conduit Structure: Governmental entity issues the bonds and loans the proceeds to the developer; government not liable to pay the bonds except out of loan repayments made by developer Biomass Projects: if feedstock/fuel qualifies as “solid waste”, can use tax-exempt bonds to finance a major portion of the facility –Examples:Feedstocks/fuel that potentially qualifies as “solid waste” includes: »Waste Wood: hog fuel, mill waste, construction debris, forest cleaning debris »Municipal Solid Waste: residential, commercial and industrial garbage »Agricultural Waste: rice hulls, animal manure »Food Waste: food waste from restaurants, supermarkets and food processing facilities The Financing Proper (cont) 8

9 Financing Structures (cont) –Tax-exempt Bond Financing (cont) “Solid Waste” Defined: to qualify as “solid waste”, the feedstock/fuel must have NO VALUE at the place where it is generated –Cannot Pay for Feedstock: If the project pays ANYTHING for the feedstock itself (even $0.01 per ton), it does not qualify »Value Determine At Time Of Bond Issuance: If feedstock has no value at the time the bonds are issued, subsequent changes in the market that give it value will not affect its status as “solid waste” for tax-exempt bond purposes »Wood Waste can have no value or great value depending on the particular market and economic circumstances at the time »Tip Fee Payment to Developer: for many types of solid waste (e.g. food waste), generators will pay a tip fee to the developer to take it, since the alternative is for generator to pay an even higher tip fee to have the waste disposed of in a landfill –Transportation Costs: developer can agree to pay for the loading and transportation costs, provided the feedstock itself is free »Such arrangements must be scrutinized to ensure transportation costs are not disguised payments for the feedstock The Financing Proper (cont) 9

10 Financing Structures (cont) –Tax-exempt Bond Financing (cont) Eligible Portions: only those portions of the project that consist of solid waste disposal facilities can be financed with tax-exempt bonds –Rule of Thumb: All facilities needed to convert the solid waste to useable fuel can generally be financed, but not the facilities that convert the fuel to electricity »Example: In a waste wood fueled biomass facility, the receiving yard, yard loaders, conveyor system and boiler together with any structures that house the same (or ratable portion of the structure housing these elements together with non-qualified elements) can be financed with tax-exempt bonds; the facilities for transporting the steam from the boiler to the turbine and all facilities conveying the electricity to the delivery point cannot be financed with tax-exempt bonds –Percent Eligible: The elements that qualify for tax-exempt financing will vary depending on the particular project configuration, but a decent rule of thumb is that approximately 60% will qualify Taxable Tail: balance of debt financing for project often provided in the form of taxable bonds called “taxable tails” The Financing Proper (cont) 10

11 Financing Structures (cont) –Tax-exempt Bond Financing (cont) Documentation: because of the governmental issuer/conduit structure, the financing documents are structured differently than conventional project financing, but in substance bond issues are the same as conventional financing with a “bond overlay” –Typical Documents: »Trust Indenture: between governmental issuer and bond trustee; provides for issuance of bonds and specifies their terms, security, defaults and remedies of trustee (acting on behalf of bondholders) »Loan Agreement: between governmental issuer and developer; provides for loan of bond proceeds to developer, repayment of loan, financial and project covenants, defaults and remedies of trustee (acting on behalf of bondholders) »Security Documents: from developer to trustee (or to governmental issuer and assigned to trustee); provides mortgage and security interest creating fist lien on project assets »Tax Agreement: numerous technical legal requirements that must be met to maintain tax-exempt status of bonds The Financing Proper (cont) 11

12 Financing Structures (cont) –Tax-exempt Bond Financing (cont) Documentation (cont) –Typical Documents (cont) »Official Statement/Private Placement Memorandum: the prospectus disclosing all material information about the project and the developer, used by underwriter/placement agent in marketing the bonds to the investors »Bond Purchase/Placement Agreement: among governmental issuer, developer and underwriter/placement agent; provides for sale or placement of bonds by underwriter/placement agent to investors Benefits/Detriments: –15 to 20 year fixed rate debt; no LIBOR risk as with conventional debt –Alternative in markets where conventional lenders are scarce –Tend to be “junk” bonds (unrated, unenchanced) and thus can be more expensive than conventional debt »This is offest by lower tax-exempt rates and, in current markets, low overall interest rate levels that result in attractive rates even though comparatively higher than conventional bank rates The Financing Proper (cont) 12

13 Financing Structures (cont) –Vendor Financing: generally only available when manufacturer seeks to prove new technology Examples: –Offered when Europoean and Japanese wind turbine manufacturers first sought to sell new wind turbine technology in the US before it was widely utilized here (circa 1998-2003) –Beginning to see vendor financing offered by Chinese turbine manufacturers as they seek to sell their turbines in the US –Manufacturers of biodigesters often offer financing Forms of Vendor Financing: –Deferred Payments Until Commercial Operation: vendor dispenses with customary up front and progress payments, and defers all or a substantial part of the payments until Commercial Operation is achieved »Performance: Project must often meet certain performance standards before full payment required »Take Out Financing: Since vendor takes construction risk, permanent take-out financing is easier to secure The Financing Proper (cont) 13

14 Financing Structures (cont) –Vendor Financing (cont) Forms of Vendor Financing (cont) –Loans or Tax Equity: vendors with finance affiliates may offer construction loans or tax equity financing through the affiliate »Availability: Generally limited to markets where there is lack of demand for the equipment, and hence utilized by manufacturers to secure sales that would not otherwise be made Issues to be addressed: –Balance of Plant Financing: developer still needs loans or equity to cover the costs of the balance of plant construction »In slow construction markets, can sometimes obtain deferred payment arrangements from BOP contractor –Take Out: if project does not perform to the required level or other problems encountered (e.g., cost overruns that stress the underwriting pro forma), take-out loan may not be sufficient to make deferred payments in full, and hence it will be necessary to sort out the lien positions/creditors rights of the lender and the vendor The Financing Proper (cont) 14

15 Creating a Sealed System: to achieve limited recourse, lender must be assured that the project will produce the revenues needed to pay O&M and debt service –Getting There: this requires: Exhaustive Due Diligence: a project that is well-vetted in the due diligence process to ensure there are no technical, operational or legal defects Bankruptcy Remote Project Company: creation of a project company to own all project assets and contracts and that is insulated from any bankruptcy or financial issues its owners may encounter –Single Purpose Entity: The project assets must be the only assets of the project company and its sole business must consist of owning and operating the project –Independent Board Members: appointment of independent board members to reduce prospects that project company will be treated as mere alter ego of its owners and thus the separate entity not respected if financial difficulties encountered by owners The Financing Proper (cont) 15

16 Creating a Sealed System (cont) –Getting There (cont) Pound of Flesh: all project assets and all project revenues must be locked up for the benefit of the lender – a “sealed system” where nothing can escape –First Lien: Accomplished by lender taking first lien position in: »Project real estate or site rights (mortgage or leasehold mortgage) »Project equipment and fixtures »Assignment of all key project documents (turbines supply agreement, construction contracts, power purchase agreement, interconnection agreement, fuel supply agreement, transmission agreements, etc) »Assignment of equity interests in Project Company »Lock box arrangement to capture all project revenues and effect first priority security interest in all such revenues »Requiring that equity be deposited with lender’s administrative agent or trustee with disbursement of equity controlled by financing documents The Financing Proper (cont) 16

17 Creating a Sealed System (cont) –Lock Box Arrangements: requires all project revenues to be deposited as and when received in an account controlled by the lender Typical Structure: the credit agreement establishes a Revenue Fund held by the administrative agent or trustee into which all revenues are deposited and disbursed by administrative agent or trustee as per the “waterfall” (discussed below) –Perfection of Security Interest: the possession of the revenues by the administrative agent/trustee serves to perfect the security interest Control Agreements: because project will often be located far away from the locale of the administrative agent/trustee, developers often need to maintain accounts to cover day-to-day expenses with a third party bank located near developer’s operations –Can maintain perfected security interest in such accounts by having the depositary bank enter into a custody/control agreement with the administrative agent/trustee that meets the requirements of the applicable Uniform Commercial Code The Financing Proper (cont) 17

18 Creating a Sealed System (cont) –The Waterfall: credit agreement provides that moneys deposited in the Revenue Fund will be periodically (usually monthly) applied by administrative agent/trustee by making transfers to the following sorts of funds in the order of priority set forth below: O&M Account: first priority, to be disbursed to pay current operation and maintenance expenses –Amount: amount to be transferred may be based on annual project budget, or may be based on actual expenses incurred »In either case, must have provisions for dealing with situations where expenses unexpected exceed budget or are higher than available amounts »Can use special reserves or “spill backs” from accounts with lower priority –Exclusions: Payments to developer (e.g., for management services) are typically: »Excluded from this level of priority transfer, or »Limited to specified amounts with any balance owing deferred and made up later The Financing Proper (cont) 18

19 Creating a Sealed System (cont) –The Waterfall (cont) Debt Service Payments: second priority; to be disbursed to pay debt service when due –Frequency: while transfers to this account are made monthly, disbursement to pay debt service depends on timing of debt service payments »Pro Rated to Periodic Payments of Debt Service: If debt service payable other than monthly, transfers to this account will be a pro rated portion of the periodic debt service payments »Example: if interest is payable semiannually and principal is payable annually (typical bond structure), then monthly transfers to this account are 1/6 th of next interest due and 1/12 th of next principal due –Variable Interest Rates: where the interest rate varies (e.g., tied to LIBOR), if interest not payable monthly then amount of monthly transfer to this account will be based on some convention (e.g., average rate over last 3 months) with a make-up provision for the last transfer prior to the due date of the interest The Financing Proper (cont) 19

20 Creating a Sealed System (cont) –The Waterfall (cont) Debt Service Payments (cont) –Cash Sweeps: in variable rate financings, it is typical to have a minimum principal amortization schedule with cash sweeps of excess monthly revenues transferred to Debt Service Account and used to prepay principal »Optimizes principal amortization for lenders where variable interest rate swings can make greater or lesser revenues available from time to time to amortize principal –Interest Rate Swaps: lenders often require that variable interest rate risk be hedged via a swap, in which case the swap payments are treated as debt service (if paid by developer to the swap counterparty) or as project revenues (if paid by the swap counterparty to the developer) –Other Hedges: payments will be dealt with under the accounts that relate to the nature of the hedge in question »Example: Fuel hedge payments and receipts would likely be dealt with through special provisions in the O&M account, as fuel costs are an O&M expense The Financing Proper (cont) 20

21 Creating a Sealed System (cont) –The Waterfall (cont) Debt Service Payments (cont) –Subordinated Debt Service: if there is subordinated debt, funding of that debt service is handled on a subordinated basis to: »Funding of senior debt service, and »Funding or replenishment of reserves for senior debt Reserve Accounts: typically will have various reserve accounts based on the particular requirements of or risks associated with the project in question and funded on a third or lower priortiy basis. Common examples include: –Debt Service Reserve Account: generally funded out of revenues until the amount on deposit equals 6 to 12 months of debt service payments »Drawn upon by administrative agent/trustee to pay debt service when amounts in Debt Service Account are insufficient –Major Maintenance Reserve Account: funded out of revenues to a specified level (usually based on independent engineer’s recommendation) and used for anticipated or unanticipated major repairs and maintenance The Financing Proper (cont) 21

22 Creating a Sealed System (cont) –The Waterfall (cont) Reserve Accounts (cont) –Special Reserve Accounts: established as needed in light of particular risks of the subject project; may include items such as: »Fuel Expense Reserve: to provide headroom for unanticipated increases in fuel costs »Wind Integration/Congestion Charges: if there is concern about the imposition of such charges and developer’s ability to pay them, reserves can be established for this purpose »Well Depletion/Recharging Reserve: for geothermal projects, to provide a source of funds for additional drilling that may be required to restore or recharge the reservoir in the event of unexpected depletion Surplus/Distribution/Sweep Account: revenues remaining after all higher priority accounts have been funded are transferred here –Cash Sweeps: if the financing has a cash sweep structure, the designated amount of cash is swept from this account on a periodic basis and applied to prepay principal The Financing Proper (cont) 22

23 Creating a Sealed System (cont) –The Waterfall (cont) Surplus/Distribution/Sweep Account (cont) –Distributions to Developer: are made from this account »Restrictions on Disbursements to Developer: typically include the following: »No distributions if any higher priority accounts have not been fully funded »Distributions limited to no more frequently than quarterly »No distributions if debt service coverage ratio not met as of the distribution date »Exceptions to Restrictions: usually are limited exceptions to allow developer to withdraw moneys sufficient to meet income tax liabilities –Management Fees: are typically paid from this account, often on a priority basis over other distributions from this account other than distributions to pay income taxes –Sweeps to Fund Higher Priorities: If higher priorities are not fully funded, any accumulated cash is swept from this account to make up such deficiencies The Financing Proper (cont) 23

24 Disbursements of Construction Loan: –Conditions to Disbursements: typically include: Waivers of Lien: the general contractor, subcontractors and materialmen must provide effective waivers of mechanics liens under applicable local law –If state law is such that effective lien waivers cannot be obtained, may be able to address by having contractors, subs and materialmen certify to lender that the amount paid is all that is due and owing at the time IE Sign Off: a certification by the Independent Engineer that the work done has been inspected, is not defective and was properly done in accordance with the plans and specs Title Policy Endorsement: to increase coverage to all amounts disbursed to date and provide mechanics lien protection (if available under applicable law) Balancing Test: a certification (usually from the IE) that the undisbursed loan amount plus undisbursed equity is sufficient to pay the remaining project costs The Financing Proper (cont) 24

25 Financial Covenants –Debt Service Coverage Ratio: developer required to maintain a specified debt service coverage ratio The Ratio: the annual project revenues remaining after payment of all O&M expenses must at least equal 1.X time the annual debt service –Levels: Typical ratio levels range from 1.2 to 1.5, but in certain cases can be as high as 2.0 –Failure to Meet: if the ratio is not met, it is typically not an immediate event of default so long as the ratio is at least 1.0 (i.e., so long as current revenues are at least sufficient to pay O&M and annual debt service) »Rather, the immediate consequence is to limit distributions to the developer and implement cash sweeps from the disbursement account »Developer may also be required to produce plan satisfactory to lender to restore compliance with the ratio, often based on a report and recommendation of a qualified independent consultant acceptable to the lender The Financing Proper (cont) 25

26 Financial Covenants (cont) –Other Financial Covenants: vary and are tailored to the project and the developer, but typically include items such as: Limitations on Incurrence of Other Indebtedness No amendment of key project documents without prior lender consent No disposition of project assets –Exception for assets replaced in ordinary course due to wear and tear Maintaining all required permits in full force and effect No default under key project documents If there is a guarantor: –Maintenance of guarantor’s net worth and/or credit rating –Cross default if guarantor defaults on debt in excess of a specified amount –Cross default if guarantor insolvent or bankrupt –Can often cure guarantor related defaults by providing substitute security or guarantor The Financing Proper (cont) 26

27 Conversion to Permanent Loan: –Conditions to Conversion: typically include: Achievement of Commercial Operation: the project has achieved commercial operation –Substantial Completion: COD usually achieved at substantial completion, with final completion to follow once punch list items completed –IE Confirmation: usually includes requirement that Independent Engineer certify that project has been completed in accordance with plans and specifications Tax Equity Funding: all conditions to funding by tax equity investor have been met and tax equity investor actually makes investment prior to or concurrently with conversion Title Policy Endorsement: to cover final permanent loan amount No Defaults: no events have occurred that do or with the passage of time will constitute an event of default Payment of lender fees and expenses The Financing Proper (cont) 27


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