Financing renewable energy projects: Debt funding

Updated June 2011

Following on from our previous article which focused on raising new equity for investment in renewable energy projects, this note looks at the various considerations for debt funding, with particular emphasis on funding from commercial banks.

Bank funding is an on balance sheet funding option, and will inevitably require security to be given to the lender. Often the development will take place in a specially formed project company (which becomes the borrower) with the lender looking to take security over the project, the project company and (unless the loan is limited recourse) looking to the developer and its group as well.

A renewable energy project is typically capital intensive and to maximise returns developers will often look for debt funding. These projects require a great deal of up front capital expenditure with the debt being serviced from the revenue stream after commissioning.

Types of lending

There are three main types of lending:

• Bilateral loan - single lender.
• Syndicated loan – multiple lenders each providing a proportion of the loan. If one bank drops out the other banks are under no obligation to increase their shares of the loan to cover the lost amount.
• Sub-participated loan - either funded participation where a number of participating banks lend a proportion of the loan to the principal bank (used only where these is no undrawn commitment) or risk participation, where the participating banks merely guarantee a specified sum (being a portion of the capital sum) to the principal bank in return for a fee (can be used where there are undrawn funds).

Types of facilities

There are various types of facilities:

• Term loan - borrower draws an agreed lump sum for a set period requiring repayment at or by the end of the term. Lenders may offer options for interest capitalisation or interest only payment periods during a construction period.
• Revolving credit facility - a committed facility that provides for a specified maximum sum that may be borrowed over an agreed period. The borrower may draw and repay tranches up to the specified maximum amount of capital whenever it chooses throughout the term of the loan.
• Overdraft facility – an on demand facility which can be used to solve short-term cash flow problems.
• Swing-line facility - a committed facility used for short-term bridging purposes which will generally be part of a larger revolving credit facility and can be activated very quickly. It is unlikely to be seen as part of a facilities package in renewable energy projects.
• Standby/contingent or bridging facility - designed to be used only in very limited circumstances. Usually a revolving credit facility, therefore committed, to provide guaranteed funds if another method of raising cash falls through. This is often used as a form of security given by a borrower to key suppliers, such as a turbine supply contractor.
• Multiple option facility – a two stage facility, first, a formal, committed facility agreement (often a revolving facility), will be provided by a syndicate of banks up to a specified figure. The second stage of the facility is uncommitted.
• Forward start facility - a new loan may refinance all or part of an existing loan on maturity (including circumstances where the borrower is unable to repay the existing loan). This ensures continuity of debt funding.

Security and quasi security

• Secured loan – it is common for lenders to require a comprehensive security and guarantee package from the borrower as well as its parent company and/or any material subsidiaries. This is often a non negotiable part of a lender's credit proposal.
• Unsecured loan - the lender has no recourse to specific assets if the borrower fails to repay the loan.
• Guaranteed loan - a number of loans are unsecured but have the benefit of a guarantee, which is usually provided by the borrower’s parent company.

Bankability in Renewable Energy Projects

As stated above, developers will be asking a lender to advance significant sums at the beginning of a project in the knowledge that the debt will only be serviceable from the revenue streams generated in the future. The lender therefore will therefore look at all aspects of the project when assessing bankability. The key elements are the supply chain contracts and the ongoing operation and maintenance arrangements. In addition to these, the lender will want security over the assets of the project (in particular any interest in real property), and potentially over the developer itself.

At the supply stage, a lender will look at the technical risk, the ability of the contractor to claim additional costs or extensions of time, and price. If the lender is unhappy with any of the elements in the supply chain, it may require the developer to increase the amount of equity, thereby increasing the ratio of junior to senior debt.

At the construction stage, there could be different types of build contract. 

• EPC – a turnkey solution whereby a single contractor has responsibility for the design procurement and construction of the project. Often this will include a fixed price and fixed timetable with the EPC contractor guaranteeing performance. Risk is passed down to the EPC contractor meaning lenders favour these arrangements. EPC arrangements are not common with wind farm projects although more prevalent with solar PV farms.
• Multicontracting – less risk is passed down to the contractor in these arrangements. There is increased co-ordination risk as there are individual contracts co-ordinated by a project manager (under a development and management agreement).

The lender will assess the project structure, including any lease terms and power purchase agreement (looking at the power, and either purchase of the renewables obligation certificates, levy exchange certificates or feed in tariff agreement) to establish whether the risk profile is acceptable. In addition to standard form security, the lender will usually seek direct agreements so the lender can step into the shoes of the borrower if the borrower defaults. Collateral warranties are also sought so if the lender suffers a loss caused by one of the parties who designed, constructed and managed the project it has a direct contractual relationship with that contractor. The lender will look to ensure the borrower has a balanced risk profile, passing as much risk as possible to the contractors (for example under an EPC contract), having insured against risks or having provided a reserve fund. A lender will also normally seek to restrict any payments to the developer while any debt is outstanding, meaning those investing equity in the project are likely to see any returns deferred until after the bank has been repaid.

Contributor: Alex Watson

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at June 2011. Specific advice should be sought for specific cases; we cannot be held responsible for any action (or decision not to take action) made in reliance upon the content of this publication.

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