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
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
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
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
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
The Financing Proper (cont)
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
6
The Financing Proper (cont)
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
7
The Financing Proper (cont)
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
8
The Financing Proper (cont)
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
9
The Financing Proper (cont)
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”
10
The Financing Proper (cont)
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
11
The Financing Proper (cont)
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
12
The Financing Proper (cont)
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
13
The Financing Proper (cont)
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
14
The Financing Proper (cont)
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
15
The Financing Proper (cont)
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
16
The Financing Proper (cont)
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
17
The Financing Proper (cont)
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
18
The Financing Proper (cont)
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
1/6th of next interest due and 1/12th 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
19
The Financing Proper (cont)
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
20
The Financing Proper (cont)
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
21
The Financing Proper (cont)
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
22
The Financing Proper (cont)
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
23
The Financing Proper (cont)
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
24
The Financing Proper (cont)
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
25
The Financing Proper (cont)
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
26
The Financing Proper (cont)
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
27