Debt and Equity Finance - A Market Update

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1 About Milbank Debt and Equity Finance - A Market Update Ed Feo efeo@milbank.com Renewable Energy Finance Forum New York June 23, 2005 We are a leading legal advisor in the wind energy sector: Over 80 renewable energy project transactions globally Ranked Number One in Top 10 Legal Advisors for Renewable Project Finance Deals in (Dealogic) and (Renewable Project Finance) Eight Deals of the Year for 2004, including North America and Latin America Renewable Deals of the Year 2 1

2 What s The Big Picture? Where s the Money? Very robust financing market in 2005 by comparison with 2004 Renewable sector is becoming more mainstream for lenders and equity investors Increased competition in equity and debt markets is driving down margins Increased use of structures that permit diversification of risk for lenders and equity investors What we are seeing: Debt financing: More banks and insurance companies in the market More products such as construction, portfolio and back leverage loans Equity financing: Strategic investors diversifying risk More financial investors, and continued reliance on structures to optimize tax and cash value 3 4 2

3 Debt Financing Debt Financing Bank financing market for wind projects is still dominated by European banks or offices (Fortis, Dexia, BLB, HVB, HSH Nordbank, RBS, WestLB, Calyon, Standard Chartered) Japanese institutions (UFJ, Sumitomo, BOTM) are participating Canadian insurance companies (Sunlife, Manulife) as well as U.S. institutions (Hancock, NY Life) are in the market The principal driver: lenders are back in the energy project business, but there is not an abundance of product 5 Construction Financing Pricing is based on LIBOR plus margin (or for institutions, U.S. Treasuries plus margin); pricing trend is down Typical take out is via firm equity commitment and/or term financing commitment Soft take out deals are being done 6 3

4 Debt Financing Debt Financing Term Financing Pricing is based on LIBOR plus margin (or for institutions, fixed rate based on Treasuries plus margin), depending on credit and term. Pricing trend is down Term is 8 15 years, dependent on offtake arrangements. Institutions may go longer term Deals have heavy reliance on contracted output (energy, RECs or PTCs), but starting to see merchant deals Typical debt service coverage ratio is minimum, average Interest rate protection at least 75% on floating rate Reserve accounts: 6 months O&M Reserve 6 12 months DSCR Multiple Asset Financing Trend towards warehouse facilities (standard terms with same lenders/developers for several projects) or portfolio facilities (a single facility for a holding company owning interests in several projects) Portfolio facilities allow better diversification of risk for lenders and, therefore, more attractive pricing 7 8 4

5 Debt Financing Debt Financing Back Leverage Financing Involves financing of cash equity interests in one or more project entities where there is no project level financing Loans are usually capped at certain percentage of the value of the equity interest (usually around 80%) Loans are secured by borrower s equity interest in the project entity and a sweep of all cash distributions allocable to borrower (subject to certain excluded fees, operating expenses) Back leverage structures can be applied for both single-asset and portfolio deals Challenge for lenders understanding partnership mechanics and negotiating consent rights with other equity investors in the project entity. Subordinated Financing Financing may be at the project entity or holding company If at holding company, may have a liquidation claim into the project company Terms of subordination will include deferral of payments, distribution blocks and standstill on remedies. Subordinated lenders may also obtain cure right, buyout right, and fish or cut bait on senior debt

6 Equity Trends Equity Trends Strategic Equity An evolving roster of strategic investors M&A is a current strategy for acquiring presence in the business (AES) or in a region (PPM) or obtaining a deal pipeline (Goldman) Asset swaps are also being used as a means of diversification Load serving utilities are buying assets for own account Financial equity has emerged Both cash and tax investors Participants are financial institutions and industrials (Goldman, Aegon, JPMorgan, Citigroup, Prudential, Northwestern, Edison Capital, GECC, UBOC), funds (Marathon, Riverstone, Trimaran, Whitney) and cash equity players (Babcock, Macquarie, EIF)

7 Financial Equity Financial Equity Financial equity terms Leveraged vs. unleveraged structures a continuing debate Returns in recent wind deals are in the range of 7.75% to 9.5% IRR unleveraged. The trend appears to be down Wind project returns compare favorably to alternative tax investments Flips are common oriented to a pre-determined target return Disproportionate allocation of cash and tax is common Cash/Tax Structure Equity Flip x%, flip to y% on Target Investor Return Sponsor Partnership or LLC Project Tax Investor a%, flip to b% on Target Investor Return

8 Financial Equity Looking Ahead to 2006 Tax x%, flip to y% on Target Investor Return Cash 100% until return on capital, then follow tax Sponsor Modified Flip Partnership or LLC Project Tax Investor Tax - a%, flip to b% on Target Investor Return Cash 0% until Sponsor return on capital, then follow tax Will there be sufficient product to warrant continued investor interest, considering: PTC extension (or lack thereof) Number of financeable contracts Availability of equipment Opportunities elsewhere in the energy sector Will deal structures further evolve: Portfolio financing becoming corporate finance? Debt financing becoming less contract oriented? Financial equity becoming more flexible, fungible?

9 Milbank Contacts Milbank Locations Los Angeles: Washington, DC: Edwin F. Feo Jonathan A. Maizel direct dial direct dial Simon Friedman London: direct dial John Dewar direct dial New York: Mark L. Regante direct dial 17 New York Los Angeles Washington, D.C. Palo Alto London Frankfurt Munich Tokyo Hong Kong Singapore 9