Our Panel: Bruce Bedwell, Chapman and Cutler LLP Amy Maloney, Latham & Watkins LLP Jason Todd, Pacific Life Insurance Company Roald Nashi, Kirkland & Ellis LLP Moderator: Michael T. Reese, Pillsbury Winthrop Shaw Pittman LLP 1 Search for long-term yield in power sector
Trends in US Power Sector Increased U.S. production has lowered domestic natural gas prices and made coal less competitive. U.S. dry natural gas production increased from 2006 to 2015, and U.S. natural gas spot prices and consumer prices generally decreased during the same period. U.S. Energy Information Administration 2 Search for long-term yield in power sector
Trends in the US Power Sector 3 Search for long-term yield in power sector
Trends in the US Power Sector: Gas and Coal In 2016, more electricity was generated in the U.S. from natural gas than coal for the first time on record, and natural gas was the largest source of overall U.S. electricity generation. U.S. Energy Information Administration 4 Search for long-term yield in power sector
Trends in U.S. Power Sector: Nuclear Average age of U.S. commercial reactors is 37 years. With renewed federal support, 18 applications for combined licenses (COLs) to construct and operate new nuclear reactors were filed with the U.S. Nuclear Regulatory Commission since 2007. Hailed as the nuclear renaissance in the U.S. U.S. Energy Information Administration 5 Search for long-term yield in power sector
Trends in U.S. Power Sector: Nuclear Challenges Design safety in wake of Fukushima Low natural gas prices Ballooning construction costs Weakened industry Construction proceeding for only 2 reactors in the U.S. 6 Search for long-term yield in power sector
Trends in U.S. Power Sector: Renewables Political & Regulatory Support for Renewable Power Federal Tax Credits Investment Tax Credit Production Tax Credit Being phased out over the next few years Renewable Portfolio Standards 7 Search for long-term yield in power sector
Trends in U.S. Power Sector: Renewables www.dsireusa.org 8 Search for long-term yield in power sector
Trends in U.S. Power Sector: Renewables Decreasing Cost of Wind & Solar Cost comparison with 2013 estimates Overnight Capital Cost (2016 $/kw) 2016 Report 2013 report % Difference Onshore Wind $1,877 $2,354-25% Solar Photovoltaic (20 MW) $2,671 $4,450-67% Conventional Combined Cycle Natural Gas Fired Generation $978 $976 0.30% U.S. Energy Information Administration 9 Search for long-term yield in power sector
Polling Question 1. Over the next 12 to 18 months, what type of project in the U.S. will represent the largest new investment (by dollar amount) for your company? Conventional gas-fired plants Solar farms Wind farms Storage Other 10 Search for long-term yield in power sector
Polling Question 2. Over the next 12 to 18 months, what type of investments in power projects will represent the largest new investment (by dollar amount) for your company? Common equity Tax equity Senior secured debt (project level) Back leverage financing Other 11 Search for long-term yield in power sector
Bruce Bedwell, Chapman and Cutler LLP
What is Project Finance Highly structured, limited or non-recourse debt (i.e., no recourse against project s sponsor) Used to finance complex infrastructure projects Debt repaid almost exclusively from project s revenues so financing is based on expected project performance and not credit of the sponsors Debt secured almost exclusively by project s assets (including project agreements) and typically includes a pledge of the equity in the borrower Borrower is typically a special purpose entity engaged in a single line of business Equity/debt/credit enhancements (e.g., letters of credit; reserves; minimum debt to equity ratio; sponsor limited guaranty) 13 Search for long-term yield in power sector 13
What Makes a Project Financeable Focused line of business (e.g., power generation) Large infrastructure assets (e.g., generation facilities) Sufficient size to justify the level of debt Project-related risks allocated among project participants Proven and viable technology and suppliers Long-term, predictable revenue and cash flow sufficient to support debt and operating/maintenance costs (e.g., power purchase agreements, other offtake agreements, merchant) If an offtake agreement is in place, must ensure terminations/offsets to payment are limited (the stronger the agreement, the more financeable the project) Suitable debt service coverage ratio Material contracts with reputable suppliers/contractors Collateral sufficient to make lenders whole if default 14 Search for long-term yield in power sector 14
Project vs. Corporate Finance Corporate Finance Project Finance Borrower Multipurpose organization Single-purpose entity Basis of credit decision Focus is on balance sheet Focus is on project Source of repayment Borrower s balance sheet Project revenues Collateral None, some or all of borrower s assets Project assets only Size of financing Flexible Generally requires minimal critical mass Allocation of risk To borrower only To all project participants Dividend policy Autonomous from lenders Fixed, predetermined policy Operational decisions Opaque to lenders Highly transparent to lenders Finance structure Tend to be standard form Highly negotiated Transaction costs Lower Higher Cost of capital Relatively lower Relatively higher Debt to Equity Ratio Split between debt and equity Generally higher debt 15 Search for long-term yield in power sector 15
Players in Project Finance the sponsor the holding company the project company the borrower(s) any guarantor(s) the lender(s) the agent(s) (e.g., placement agent, collateral agent, administrative agent, arranger, underwriter, trustee, depositary bank, etc.) any letter of credit provider(s) any construction contractor(s) any equipment supplier(s) any operation and maintenance provider(s) any relevant governmental agency(ies) any utility(ies) any offtaker(s) any counterparties to other project agreements the title company the surveyor any independent consultant(s) (e.g., insurance consultant, independent engineer, operating or construction consultant) the legal advisors the insurance company any real property owner(s) any hedge counterparties any rating agency(ies) any prior owners of the project any prior lender(s) to the project the local community any activists or nongovernmental organizations any labor groups 16 Search for long-term yield in power sector 16
Typical Solar Project Structure Owner Group Owner Group Sponsor Holding Company Offtaker Power Purchaser Agreement Utility Interconnection Agreement Equipment Supply Agreement Equipment Supplier EPC Contract O&M Contract Material Counterparties Construction Contractor O&M Provider Equity Contribution Leases Landowners Lender Group (non-tax equity) Federal Regulatory Approvals Government and Regulators Lenders Note Agreement Security Documents Letter of Credit Collateral Agent/ Trustee Zoning/Building Permits Wildlife, FAA, Tax Incentives Historic, Environmental, Tax Incentives State Regulator Approvals State Public Utility Commission Federal Government Other Agents/ Consultants Letter of Credit Provider Local Government State Government 17 Search for long-term yield in power sector 17
Typical Project Assets Equipment/hard assets Collateral accounts/cash on hand Project agreements (e.g., offtake agreements, construction agreements, equipment supply agreements, operation and maintenance agreements, etc.) Real property rights (e.g., leases, easements, ROWs, etc.) Permits (e.g., building, siting, environmental, etc.) Regulatory/governmental approvals Intellectual property rights Warranties/guarantees Reports/studies/resource data 18 Search for long-term yield in power sector 18
Many Project Agreements (Solar) Power purchase agreements/ Solar leases Renewable energy certificate purchase and sale agreements Interconnection agreements Construction agreements Equipment supply agreements Operation and maintenance agreements Transmission agreements Ground leases, easements or other rights to land Power pool participation agreements Organizational documents 19 Search for long-term yield in power sector 19
Typical Project Structure Parent/Sponsor creates HoldCo and Project Company Parent/sponsor Equity Contribution HoldCo Equity Contribution Project Company Special Purpose Entity Owns or Holds All Project Assets 20 Search for long-term yield in power sector 20
Typical Project Structure (con t) Single purpose project company Reduces overall operational risk Helps to maintain corporate and regulatory formalities Isolates assets from third party creditors Single entity owning all assets Helps to ensure proper security interest in all assets Reduces UCC financing statements/security documents Streamlines foreclosure process if default Single holding company owning project company Streamlines pledge of project company ownership interests Streamlines foreclosure process if default 21 Search for long-term yield in power sector 21
Identifying and Understanding Key Project Risks Risk Analysis Is Critical: An Investor must identify and understand any risks associated with the project. As the operation of the project is critical for the continued generation of revenues and cash flows for servicing of the debt, the primary objective in evaluating a project is to identify and assess the risk to interruption of/variance in operation of the project or net cash. 22 Search for long-term yield in power sector 22
Identifying and Understanding Key Project Risks (con t) Allocation of Risk: The allocation of risk plays a substantial role in the crafting of project agreements and the loan documents. Typically, no one party will be willing to take on an undue amount of risk that is tantamount to recourse. It should be kept in mind that this is not a one-dimensional process -- there are other parties and credit enhancements that can and do absorb some of the risk. 23 Search for long-term yield in power sector 23
Protecting Against Project Risk Risk Mitigation: Once an Investor has identified and understands the various project risks associated with a project, it must take steps to protect itself against such risks. Not All Risk Can Be Mitigated: Note that Investors may not be able to protect themselves against all project risks. Each Investor will need to determine its own risk appetite. 24 Search for long-term yield in power sector 24
Security Packages A typical Security Package will include the following: Security Agreement - an all assets security agreement granting the lenders a lien on all of the borrower s personal property and asset. Pledge Agreement - one or more ownership interest pledge agreements granting the lenders a lien on the ownership interests of the borrower and other designated affiliates. Consents and Agreements - one or more consents and agreements with the counterparties to the material project agreements setting forth the rights of the lenders to take action under, or step into and assume, such agreements [Note: Generally a long lead time item]. 25 Search for long-term yield in power sector 25
Security Packages (con t) Account Control Agreement - an account control or similar agreement perfecting the lenders lien on the collateral accounts and granting lenders the right to control the direction of such accounts Note: These may work differently in different deal structures. Mortgages - one or more mortgages granting the lenders a lien on the real property rights associated with the project. Real Property Consents and Agreements - one or more real property consents, estoppels, subordination agreements and/or non-disturbance agreements with the counterparties to certain real property documents setting forth the lenders rights vis-à-vis such real property documents. 26 Search for long-term yield in power sector 26
Security Package (con t) Title Insurance Title insurance policy indemnifying lenders against defects in the real property rights and the invalidity or unenforceability of the mortgage(s). Fixture Filings - any fixture filings required to perfect the lenders lien with respect to any fixtures located on any real property associated with the project. Financing Statements - any UCC financing statements required to perfect the lenders lien with respect to the personal property associated with the project. 27 Search for long-term yield in power sector 27
Amy Maloney, Latham & Watkins LLP
Structure A common structure couples a large notes offering with a smaller pari passu revolving credit facility Notes offer long-term, fixed rate financing Credit facilities offer shorter term, floating rate financing with revolving loan and letter of credit capacity Projects with sizable capital needs may utilize large note offerings alongside comparably large construction or term loan facilities 29 Search for long term yield in power sector
Documentation Hybrid deals can be documented in a number of different ways: Combined credit and note purchase agreement Separate credit agreement and NPA Separate credit agreement and NPA with common terms agreement Structure and target syndicate usually determine which documentation route is chosen A separate credit agreement and NPA will necessitate an intercreditor agreement between noteholders and lenders to govern the sharing of collateral and exercise of remedies 30 Search for long-term yield in power sector
Timing of funding For construction projects, credit facilities offer periodic draw construction loans to allow borrowers to avoid borrowing more than needed at a time Notes can be structured to similarly allow for limited delayed notes issuances Hybrids with construction loans and notes are often structured to have the notes facility fully utilized before first draw on the construction loans 31 Search for long-term yield in power sector
Prepayments / offers to prepay Prepayment vs. Offer to Prepay Lenders require mandatory prepayments of loans upon the occurrence of certain events (e.g., casualty events) Noteholders typically require an offer to prepay upon the occurrence of those events Prepayment Premiums Lenders (at least in the term loan A market) will typically not attach any prepayment premium to optional or mandatory prepayments Noteholders typically require make-whole premiums with optional prepayments and certain mandatory prepayments Change of Control Lenders typically trigger an event of default upon a change of control Noteholders typically trigger an offer to prepay upon a change of control 32 Search for long-term yield in power sector
Voting Class voting vs. combined voting; block voting Class voting offers each class of debt its own vote on a matter, while combined voting tallies the votes across the classes as a whole When block voting is instituted, all of the votes of a class are voted in a combined vote whichever way the majority of that class votes; minority classes often oppose voting in blocks so that they stand a better chance of having their votes count Lender consent matters vs. noteholder consent matters Strictness of covenants depends on a variety of factors (e.g., rating, single asset vs. portfolio, construction vs. operation) Lenders sometimes bargain for tighter covenants (i.e., more consent rights) than do noteholders 33 Search for long-term yield in power sector
Exercising remedies Credit facilities typically require a majority vote to accelerate loans, whereas notes are typically able to be accelerated at lower thresholds (e.g., for a payment default, a single noteholder can often accelerate on its own) Exercising foreclosure remedies is typically at the direction of the majority across the classes (often with block voting) Noteholders and lenders may negotiate a standstill provision that allows the minority class to commence the exercise of foreclosure remedies after a certain amount of time has elapsed without a combined majority decision to exercise 34 Search for long-term yield in power sector
Refinancing For short term credit facilities coupled with longer term notes, documentation will need to allow for a refinancing of the credit facilities without noteholder consent (subject to compliance with discrete parameters) The intercreditor agreement needs to be drafted to seamlessly slot in refinancing facilities 35 Search for long term yield in power sector
Jason Todd, Pacific Life Insurance Company
Why we like Project Finance Duration and diversification Uncorrelated asset class; defensive, non-cyclical Strong collateral value Private infrastructure debt can provide illiquidity premiums Defaults tend to be limited with high recovery rates Higher yields 37 Search for long term yield in power sector
Beyond the Documents: Fundamental Credit Quality of a Project Construction vs operating Who is the sponsor? Who is the developer? What do we think of the technology? Why was the project built? Offtaker risk? Who will be operating the project? What are risks to performance? Independent Engineer Report and Market Studies Financial, liquidity and collateral analysis 38 Search for long-term yield in power sector
When Bad Things Happen to Good Projects Projects are rarely bulletproof (despite the sales pitch) Controllable and uncontrollable events Back to the documents Rights and remedies Consensual or adversarial parties? Where is the value? How to maximize recovery? 39 Search for long-term yield in power sector
Ensuring Appropriate Risk Adjusted Returns Meeting investment objectives is critical Risk appetite Investment grade or high yield; rated vs unrated Sufficient yield Priced correctly Identifying appropriate comparable investments Alternative opportunities Competition among investors Remain disciplined 40 Search for long-term yield in power sector
Roald Nashi, Kirkland & Ellis LLP
Typical back leverage financing structure Many renewable energy projects qualify for the investment tax credit ( ITC ) Sponsors are generally not equipped to realize the ITC benefits available to the project. An equity investment in the project by an institutional investor capable of benefitting from these tax incentives (the Tax Equity Investor ) allows the Sponsor to monetize the tax benefits they could not otherwise realize themselves. A typical structure for such investment is the partnership flip Sponsor and Tax Equity Investor form a partnership that indirectly owns the project. Tax Equity Investor receives a large portion of ITC benefits and income from the partnership until Tax Equity Investor reaches a target after-tax return. Once the target return is reached, the partnership flips and the Tax Equity Investor s allocation of income and tax benefits from the partnership is reduced to a very small portion. Sponsor receives nearly all partnership benefits following the flip. 42 Search for long-term yield in power sector
Simplified Structure Chart TAX EQUITY INVESTOR SPONSOR Class A Interests Class C Interests MANAGING MEMBER TAX EQUITY VEHICLE Class B Interests HOLDCO BORROWER PROJECT COMPANY Black Levered Loan PROJECT LENDERS 43 Search for long term yield in power sector
Tax Equity Documents: Key Provisions 1. Tax equity cash waterfall / distribution blocks 2. Indemnities / cash sweeps 3. Transfer restrictions 4. Change of managing member 44 Search for long term yield in power sector
Differences from a senior secured project financing structure Collateral Unlike project level loans, Back leverage loans are not directly secured by the underlying project assets. Holdco Lenders typically receive a pledge of the equity in the Holdco Borrower, a pledge of bank accounts of the Holdco Borrower, and the interest that the Holdco Borrower holds directly in the Tax Equity Vehicle. Loan Repayment Project level loans are paid directly from the revenue of the project and are structurally senior in the order of repayment to any distributions to equity. The Holdco Borrower is simply a holding company and must rely on distributions from its subsidiaries to pay its obligations to the Holdco Lenders. These distributions are often subject to claims by the Tax Equity Investor. Control Over Project Company Project level lenders have significant consent rights over the actions of the Project Company. In contrast, Holdco Lenders have only limited control rights indirectly through the covenants in the back leverage financing agreement and the voting rights of the Holdco Borrower in the Tax Equity Vehicle. 45 Search for long-term yield in power sector
Back Leverage Financings: The Special Case (Minority Interest Financings) General Approach - Sponsor holds the management rights in the Tax Equity Vehicle (the Managing Member owns the Class C shares). Special Case - The Tax Equity Investor holds the majority interest and management rights in the Tax Equity Vehicle (e.g., Class A interest holds 51% and Class B interest holds 49%; no Class C interest). Special Case Issues - The Tax Equity Investor is outside of the credit structure and is not constrained by the covenants in the loan documents, but once the Tax Equity Vehicle acquires the project, it is subject to these constraints. In this scenario, the Borrower may not have control over whether the Tax Equity Investor causes the Tax Equity LLC to breach the terms of the loan documents. Solution - Create a negative control right for the Borrower. Major decisions under the Tax Equity Operating Agreement will require the consent of each member of the Tax Equity Vehicle. If the major decisions under the Tax Equity Operating Agreement align with the negative covenants in the Credit Agreement applicable to the Tax Equity Vehicle, the Borrower can withhold consent for any action by the Tax Equity Vehicle that would breach a negative covenant. Step-by-step review of each negative covenant against each major decision to eliminate any gaps in coverage. 46 Search for long-term yield in power sector
Polling Question 3. What is the issue that is most negatively affecting your company s desire to make new investments in the U.S. renewable industry over the next 12 to 18 months? High prices / low returns Phase out of tax credits Reduced appetite for tax equity due to tax reform Trade tariffs on solar panels Political uncertainty Other 47 Search for long-term yield in power sector