Debt

Balance sheet financing

Balance sheet corporate finance can be used only by financially strong sponsors with a significant base of assets, debt capacity, and internal cash flow, because the loans are secured by the financial credit of the borrower or a related entity

The corporate sponsor accepts the risk and potential reward of a project in its entirety, and will finance the project investment through a combination of corporate cash and some combination of new corporate debt or bond issuance. Any debt is underwritten by the overall creditworthiness of the corporation, not the specific project revenues.

Corporate financing can be executed quickly and the transaction costs are lower than those associated with other financing methods. Tax incentives (e.g., accelerated depreciation) and leasing structures can help improve the financials of renewable energy projects for corporate sponsors.

Debt-to-equity ratios vary depending on project size and corporate investment capacity, but they are often close to 50:50.   In addition, the loan duration is usually based on normal commercial terms, as the repayments schedule is not connected to project revenues.

Non-recourse project financing

Non-recourse project financing involves the use of a special-purpose project company that is set up specifically and solely to own the power project.  The loan is made to the project company with very limited recourse to the assets of the equity investors if the project under-performs or fails.

Typical project-finance requirements include the following:

• A long-term power purchase agreement obtained with creditworthy purchaser;
• A firm long-term fuel supply agreement (for biomass projects)
• Long-term resource assessments and technology performance assurances (for solar, wind, hydro and geothermal)
• Fixed-price, turnkey design and build contracts placed with experienced contractors;
• Guarantees, warranties, or bonds for completion and performance provided from sponsors and contractors;

All contracts and insurance polices are assigned to the bank, which allows the lender to take over the project in the event of non-performance by the project company.

With non-recourse project financing, the debt-to-equity ratio is relatively high (e.g. 80:20 to 70:30), and the loan duration is usually extended, so that the loan repayments can match the PPA revenue stream.

Project financing can be expensive and time-consuming because of the bank’s loan committee will normally require a high ‘burden of proof’ that all risks and contingencies are covered, as the bank is at risk if the project fails.   This burden of proof can be especially high for the first few renewable energy investments in a country.

Renewable energy project developers are typically under-capitalized and often unable to absorb these transaction costs. Capacity building within financial institutions to support of the needs and special requirements of renewable energy is important.   Also, public facilities that share the costs of the investment decision-making process can help bring bankable projects through to financial closure. 

Municipal financing

Standardized project financing

The process of financing small power projects can been simplified and speeded-up in cases where the development of multiple projects with similar characteristics can be expected.   In such instances, up-front work is done to develop pre-negotiated project financing agreements, based on the expected characteristics of typical projects.   If projects meet the expected characteristics, they become “qualified” to use the standardized agreement, which uses pre-determined terms and conditions for qualified projects and a streamlined approval process, which focuses only on areas where there may be acceptably small deviations from the expected project terms or characteristics.

Standardized project financing arrangements require an up-front investment to develop the standardized agreement and gain the acceptance of financial institutions to accept the agreement and the streamlined process.  In general, they are also greatly supported by other types of standard agreements, such as standardized PPAs and equipment purchase agreements.

Leveraging local financing

The financial institutions in many developing countries are unfamiliar with renewable energy technologies, are structured to require high levels of collateral, and provide relatively short duration loans compared to what is required by renewable energy projects.  Therefore, special loan programs are used to facilitate lending by these financial institutions to qualified renewable energy project developers.

The key impediments to lending, from the perspective of the local financial institutions, must be understood and lending programs designed to address these concerns. 

Capacity building components may need to be a part of these programs to support development of a better understanding of the specific resource, technology and operational risks of renewable energy projects and to support development of appropriate appraisal methods or loan procedures.

Building renewable energy investment capacity within a financing institution, requires a flexible approach, as different institutions follow different ‘product development’ paths.

To enter a new sector, some financing institution first focus on creating the right policies or strategies, while others focus on training personnel. Other approaches include learning ‘hands-on’ by taking first investments or developing specialized funds or loan portfolios.

Pursuing change in a financial institution takes time and commitment at all levels. To be successful across the institution, changes in the incentive structure are often needed. Although the CEO may be interested in renewable energy investment activity for its policy implications, loan officers often focus on narrower targets, such as simply meeting the traditional benchmarks of rapid loan disbursement with minimal risk.