A&L Goodbody’s recent experience is that lending activity in the Irish onshore wind sector appears to have picked up to some extent, with a number of projects set for a 2012 financial close. While it is true to say that this sector will continue to be challenging both on the ‘project’ and the ‘financing’ side, it is evident that this is not insurmountable for the right project.
In this article, we discuss some of the recent changes we have encountered in the lending environment in the wind sector on the island of Ireland, as well as touch on a few market issues which are influencing deals.
The right project
Without doubt the economic crisis has seen a reduction of the number of truly active lenders. This reduced pool of lenders are also being very selective in the projects which they will look at financing (generally larger scale with low risk construction and offtake counterparties and shorter term firm grid access) and also the project sponsors who they will lend to (the current trend seemingly being to private equity backed projects or projects under development by utilities).
Of course, margins have increased from those offered three to four years ago, some would say to a more realistic level. While primarily a reflection of the increased liquidity and capital costs for lenders, factors such as decreased competition in the lending market, the market concerns touched on below and sometimes even country risk are also at play. Conversely, interest rates and pricing for long-term swaps are very low and construction costs have by and large fallen. So while investor returns have certainly come under more pressure, it appears not prohibitively so for good projects with lower capital costs and higher yields.
Probably the most significant development is the reduced debt tenor being offered by many lenders and the introduction of ‘soft’ and ‘hard’ mini-perms. While these ‘mini-perms’ still allow debt sizing, debt sculpting and swap profiling based off a longer tenor (generally the term of the power purchase agreement), they impose either mandatory cash sweep (soft) or mandatory repayment after 5-7 years; either case being effectively a forced refinancing at borrower risk. Not all lenders are requiring mini-perm structures, however it is an increasing feature and certainly more common in ‘club’ lending deals (see below) where not all club lenders may be able to lend for the longer term.
In our experience gearing levels have not changed significantly, although the lenders appear to be preferring private equity backed deals where greater equity commitments can sometimes be available.
Concerns about costs and tenor of funding, as well as regulatory capital requirements (such as the potential impact of Basel III) are causing lenders to be more focussed on provisions in loan agreements dealing with increased funding costs, market disruptions and increased regulatory costs. Lenders are also being required to maintain flexibility for loan transfers/deleveraging which can cause tension with borrowers who are increasingly concerned about maintaining the long-term involvement of the relationship bank.
Lenders are increasingly constrained on the level of debt they can underwrite or provide. Accordingly larger projects often require two or more lenders. With syndicated deals in this sector largely a feature of the past, club deals are becoming typical for larger projects, where the loan is pre-marketed and entered into at origination stage with a small number of relationship banks. This requires up-front consensus and input from all club banks and it is a truism in this context to say that the club is only as strong as its most conservative lender.
While our experience is that true relationship banks will work hard at managing other club lenders on behalf of the borrower, it is always tempting for other lenders to fall in behind those club lenders requiring more onerous terms or positions. Agreeing commercial terms, negotiating documents with multiple lenders and managing multiple credit processes can make club deals particularly difficult and time consuming to get to financial close.
On the plus side there is no syndication process, there is greater spread of underwrite risk and certainty of funding and also the opportunity to carve a better borrower / lender relationship in the ongoing long-term management of the loan.
Export credit financing of wind projects in Ireland is increasingly being investigated by developers as a means to reduce funding costs and attracting lenders. Certain lenders are also actively marketing a project finance/ECF package as an introduction into deals. While the structures and terms of export credit financing is worthy of a separate article in itself, a typical export credit deal in this sector would involve an export credit agency (usually governmental or quasi-governmental) in the country of manufacture of the wind turbines providing financial support to a project using those turbines. The financial support is typically either by way of a loan directly to the overseas purchaser (in this case the wind farm developer entity), by a guarantee to the lender providing finance to the overseas purchaser or a form of default insurance to exporters in the event of non-payment by the overseas purchaser.
While we are not aware of an export credit financed wind project in Ireland having yet closed, it will not be long and certainly one project in which we are involved is actively pursuing this route.
Some market issues
The issue of constraints and curtailment of windfarms and the potential impact of these on project feasibility is currently one of the most difficult issues in the all-island renewables market. Anyone involved in the sector will be aware of the long-running and ongoing consultation by the SEM Committee in relation to priority dispatch and the treatment of curtailment in tie-break situations. Similarly, anyone currently involved in developing and financing projects will know the difficulty of concluding appropriate curtailment assumption levels for financial modelling purposes. While the final decision by the SEM Committee may make or break some future projects, it is at least hoped that a decision will be made soon in order to give certainty to the market.
In Northern Ireland it remains to be seen whether or not the recent decision to reduce the ROC support for onshore wind and move post 2017 to a FIT CfD support model will have an impact on project deal flow. In Ireland it appears that the established suppliers are not attributing the same value to the REFIT 2 support as the REFIT 1 support (aside from the obvious non-indexation of the Balancing Payment) and therefore power purchase agreement prices being offered, particularly for large scale projects, are lower than REFIT 1. Developers turning to so called ‘supplier lite’ structures are proving very challenging for lenders as they grapple with issues such as working capital management in the REFIT ex-ante estimation and ex-post reconciliation structure.
Finally, lenders certainly have an eye on post 2016 and how the requirement to comply with the Single European Target Market Model might impact on the structure of the Single Electricity Market and project revenue structures. Consultation is ongoing but with no real clarity as yet. While it is unlikely that existing renewable support schemes will not be grandfathered, it is a piece of longer term regulatory uncertainty which is resulting in more stringent change of law protections in loan agreements and power purchase agreements.
Ross Moore, Partner, Utilities and Infrastructure Group, A&L Goodbody
Tel: +353 1 649 2117
Kevin Feeney, Partner, Utilities and Infrastructure Group, A&L Goodbody
Tel: +353 1 649 2241
A&L Goodbody’s Energy and Natural Resources Group is a market leading all-island regulatory and transactional energy practice. Ranked in the top-tier by all major legal directories, A&L Goodbody has been at the forefront of the significant developments in this dynamic and ever changing sector on the island of Ireland and has been involved in the most complex, demanding and innovative transactions.