Download commercial debt finance for district energy

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COMMERCIAL DEBT FINANCE FOR DISTRICT ENERGY UK Local Authority District Energy Vanguards 21s November 2013, Glasgow Mark Cumbo, Director – Renewable Energy Santander Corporate & Commercial Banking Context….Who am I?
Dedicated Energy Professional
•  Finance renewable generation and
energy efficiency projects
•  Support low carbon generation - both
electricity and heat
•  I am transactional and only look at
energy projects
Mandate
•  UK only
•  Spectrum of Generation Technologies
•  £3m to £30m debt sizes
Funding Structures
•  Transactional Lending
•  Specialists in Project Finance & Asset
Finance
Experience
•  Energy Efficiency
•  Campus DH
•  Social Housing schemes
Technologies
•  Financing solutions across a number of
technologies
•  Energy Efficiency technologies include:
•  CHP
•  Biomass
•  Energy efficient boilers/BMS/Lighting
•  Generation technologies including:
–  On-shore Wind
–  Solar PV
–  Hydro
–  Biomass
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NOT a Sales Pitch
n  An honest appraisal of the role that senior debt can play.
n  Where it can work, and
n  Where it can’t!
n  A ‘Basic’ overview of how a Bank approaches DH projects
n  A focus on commercial discussion versus credit process
n  Not a solution, BUT hopefully promotes debate and discussion
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The Challenge – Environmental, Economic & Financial
n  Challenge
n  “In 2009, our domestic buildings were responsible for 25% of the UK’s
greenhouse gas emissions.”
The Carbon Plan: Delivering our Low Carbon Future
n  Rising Fuel Poor
n  Opportunity
n  “We could be saving equivalent to 22 power stations through, socially costeffective investment in energy efficiency.” Edward Davey, Secretary of State for Energy & Climate Change
n  Some of the Bank’s do ‘get it’ and genuinely want to support the
segment……but do they have the tools?
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The Challenge – Environmental, Economic & Financial (2)
n  Market Dynamics
n  Fluid support policy (FITs, RHI, RO’s, EMR & CfD, ECO, Allowable
Solutions, etc)
n  Basel III - Lack of ‘long term’ bank capital
n  Historic low levels of long term ‘cost of funds’ BUT rising market
n  Development of frameworks (RE:Fit, CEF, etc)
n  Introduction of catalyst organisations/departments (Green Investment
Bank, DECC: Heat Network Delivery Unit, EST: Warm Homes Fund)
n  So….how do we introduce Commercial Debt to support DH?
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Commercial Debt?
Equity
Venture
Capital / PE
Cost of Funds / Return
High
Mezzanine
Finance
Senior Debt
Low
High
Repayment Risk
Low
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Commercial Debt?
n  ….we charge lower margins but we expect minimal default risk, minimal
performance risk and a strong security position….
n  Senior debt will not compete with PWLB on price or tenor
n  If project is de-risked it can get close
n  If used it will increase project returns and allow PWLB to be used for
‘core’ services
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Senior Debt Hallmarks
n  Low risk of default!
n  Where risks exist – mitigation!
n  Full (and first ranking) security package – minimise LGD (“Loss Given
Default”)
n  “Scorched Earth” scenario’s – Step in rights, project control
n  The debt is made available, priced and structured on the basis we will
be repaid in full
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Introducing Senior Debt “SD” into your DH scheme (1)
n  No ‘market standard’ solution, no existing ‘rule book’
n  Cost savings project NOT income generation project
n  Activity in the market – Campus Scheme versus City Scheme
n  A danger in assuming public funds will be made available to support the
scheme
n  SD only part of the solution – likely to be a minority portion of funds
introduced
n  Allocate SD to the right ‘asset pool’
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Introducing Senior Debt “SD” into your DH scheme (2)
n  Propose alternative to blanket underwriting of schemes from public
funds
n  Propose adoption of ‘commercial principles’ to de-risk projects –
allow SD to compete with public funding
n  The challenge for DH is heightened – a viable project demands long
term & low cost capital
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Commercial Principles (1)
n  Risk – conflict between the end user group / delivery organisation /
funders
n  The Challenge – To access third party finance – end user group &
delivery organisation to accept higher level of risk share
n  Particularly in early years
n  BUT the current model of developing schemes uses PWLB or revolving
facilities derived from the project sponsor
n  Therefore – full project risk sits with project sponsor anyway
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Commercial Principles (2)
n  Tailor the approach, the documentation suite and delivery mechanisms
to access alternative capital
n  Replace your own constrained funds – with third party debt
n  I propose a ‘perfect world scenario’……for the funder
n  Move away from this scenario:
n  Gearing level reduced
n  Cost of capital increased
n  Or, fail to secure third party capital
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Perfect World (1)
n  Heat off-take risk
n  Guarantee minimum level of heat requirement
n  Penalty payments, risk take on future demand side improvements
n  Payment Risk
n  Credit quality – LA versus domestic user
n  Payment obligation regardless of underlying performance – a ‘hard deck’
n  Introduction of indexing cashflows – attract institutional investors
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Perfect World (2)
n  Occupation Risk
n  Anchor tenants (good quality & credit worthy)
n  No vacancy risk
n  Substantial tenancy periods
n  Heat Generation/Conversion Risk
n  End user group must accept fuel risk
n  Acceptance of price, quality & volume risk
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Perfect World (3)
n  Project Default Risk
n  Require appropriate default/termination provisions
n  Performance Risk
n  Acceptance and mitigation of technical performance risk
n  Engagement of credible & credit worthy counterparts – warranty provision
n  Mitigation of future expansion or connection risks
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Perfect World (4)
n  Funders 1st Ranking
n  Senior Debt will be senior in ranking
n  Senior facilities repaid in advance of other capital
n  1st Security Charge registered against generation assets
n  Documentation Risk
n  Standardisation is paramount
n  Get good legal advice…..early
n  Documentation must be acceptable to senior debt funder AND secondary
(institutional investment) market
Funders Risk Assessment
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