Accessing finance for renewables projects - hard or soft?
In the past, government procurers would leave the funding solution to the bidding developer consortia, however, this is changing, with procurers becoming increasingly prescriptive in terms of what financing solution they expect the developers to provide as part of their bid submissions for their projects, says Robert Harker, Partner, Project Finance, DLA Piper
In recent years, there has been a dramatic rise in the number of renewables projects which have been tendered, financed, commissioned and which are now operational in the Middle East and North Africa (MENA). This is testament to the progressive approach a number of the governments in the MENA region have adopted, under which renewables projects have become an inescapable part of the energy mix. In the space of the last five years, renewables projects (particularly solar PV) have moved from small, 10 MW financings to utility scale-scale transactions in excess of 1 GW. Indeed, the region is poised for a series of very significant renewables projects, building on previous projects and ambitious renewables programmes.
In this context, and given the capital expenditure required, the issue becomes how best to approach the financiers and the credit markets in order to ensure the projects can be financed in a timely fashion, but also establishing a financing market which is both competitive and liquid. Leaving aside certain nascent technologies like battery storage (which we are now seeing being procured both on a standalone basis and as part of a wider solar procurement), regional and international commercial banks, together with export credit agencies and multilaterals are increasingly comfortable investing in the renewables sector.
The question which remains, particularly where financial institutions are constrained by the burden of enhanced regulation for long term tenor debt, is how government procurers can facilitate a competitive banking market, whilst recognising the on-going capacity constraints affecting the commercial bank market. In the past, government procurers would (largely) leave the funding solution to the bidding developer consortia, however, this is changing, with procurers becoming increasingly prescriptive in terms of what financing solution they expect the developers to provide as part of their bid submissions for their projects.
For some time now, through the global financial crisis and increasing regulation and capital adequacy of long term lending under the Basel regulations, procurers have actively encouraged the use of mini-perm financings to ameliorate the lack of liquidity in some quarters, where traditionally the expectation was of the provision of financing on tenors of 15 years or more.
Against this backdrop, the market has favoured the "soft" mini-perm financing. A soft mini-perm financing is essentially bank debt which has a similar legal maturity as traditional long-term debt but with a much shorter initial maturity (typically between 4 - 7 years in duration). What this means is that most banks can treat this internally as a much shorter tenor transaction even though legally the tenor is the same as has been seen historically.
The effect of this is principally twofold: (i) a mini-perm financing means a larger number of banks can potentially participate in the project and support the various bidders as they are not constrained by long tenors which should in theory allow more developers to bid for projects; and (ii) this creates a more competitive banking market which should allow for keener terms and therefore, ultimately, a lower tariff.
An important feature of a soft mini-perm financing is that the structure anticipates a "target" refinancing date at the same time as when the shorter, initial maturity expires. However, failure by the developer to achieve a refinancing on or before this target date does not result in an event of default. Rather, such financings are typically structured with a low margin during the initial period and, if the refinancing is not implemented on the target date, the margin will automatically increase (often significantly) from that date and the increased margin will continue to be payable until (i) refinancing occurs or (ii) the debt is fully repaid at the end of the long term legal maturity. In addition to the margin ratchet, the developer will also suffer a cash sweep of all available cash (which would otherwise be distributed as a dividend to the developer), after which some or all (typically around 90%) of such free cash flow will be used for the mandatory prepayment of the senior debt. In this way, the developer is incentivised to refinance the debt as quickly as possible.
Therefore, the developer will have to balance (i) the desire to benefit from lower margin financing thereby producing a more competitive bid; against (ii) the assumption of the refinancing risk and having to negotiate the macro-economic conditions prevailing at the time of the target refinancing date. In an increasingly competitive market, such risk is regularly assumed by developers.
In contrast, what is seen far less in the market is the "hard" mini-perm structure. This structure is predicated on bank debt with a short legal maturity (4-7 years) at the expiry of which: (i) the vast majority of the debt is still outstanding; and (ii) the developer will trigger an event of default if the debt is nor refinanced at the end of the tenor. Clearly this has a far less benign outcome than the soft mini-perm, and could have potentially far-reaching consequences in relation to the on-going operation of the project.
However, the pricing on what is truly short-term debt will be even lower than the margin on a soft mini-perm, resulting in an even more competitive financing solution. The question for each developer is the following: if such structure is permitted by the procurer, will the enhanced competitiveness of the pricing be worth the risk of a potential event of default further down the track?