Financing New Energy Projects: Current Trends in Financing Strategies

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1 Edwin F. Feo of Milbank Tweed Hadley & McCoy LLP 26-1 Financing New Energy Projects: Current Trends in Financing Strategies Energy in the Southwest 2006 Sante Fe, New Mexico July 14, 2006 Ed Feo About Milbank We are a leading legal advisor in the energy sector: International Law Firm of the Year (Legal Week). US Projects Firm of 2005 (Chambers USA) and Americas Project Finance Firm of 2005 (IFLR). Ranked Number One in Top 10 Legal Advisors for Renewable Project Finance Deals in (Renewable Project Finance). Nine Deals of the Year for 2005 (Project Finance). 2

2 Edwin F. Feo of Milbank Tweed Hadley & McCoy LLP 26-2 Overview Sources of Financing Trends and Structures Case Studies 3 Sources of Financing Market for debt and equity has changed dramatically over the past three years. On the debt side, sources include banks, insurance companies and funds. Bank market has come back from the grave after Enron, etc. Market can be divided among investment banks (acting as advisor or broker) vs. funding banks; domestic vs. international banks. Players include: Citi, JP Morgan, Goldman, Credit Suisse, WestLB, HVB, BLB, Dexia, others. 4

3 Edwin F. Feo of Milbank Tweed Hadley & McCoy LLP 26-3 Sources of Financing Debt sources: Life companies have tended to be holders of longer term paper, preferring investment grade, in private placements. Funds have been private equity or hedge, and funds specifically oriented to the energy business, largely participating in the B loan market. 5 Sources of Financing Equity has also been relatively deep, consisting of: Private equity. Hedge funds. Energy funds (and other long term funds). Strategic players (utilities in particular). Financial equity in tax deals. 6

4 Edwin F. Feo of Milbank Tweed Hadley & McCoy LLP 26-4 Trends: B loan market incredibly active. Monetization of multiple revenue sources PPA, REC, and market sales. Merchant financing has returned, but with strong support from financial hedges: Financial institutions aggressively expand range of products for hedging fuel/power market volatility. Credit sleeves, pre-paid PPAs, structured commodity hedges. 7 Trends: More products such as equipment, construction portfolio and back leverage loans. Multiple technologies coal, IGCC, renewables but the big money is going to coal. E.g. TXU, NRG deals. 8

5 Edwin F. Feo of Milbank Tweed Hadley & McCoy LLP 26-5 The B loan structure focuses on a medium term maturity, cash sweeps to accelerate repayment, and relatively high coupon. Structure is oriented to refinancing after a few years. Diverse universe of investors, but changing as sector matures. Rates were headed down, but now trending back up. 9 Market maturity has widened the sweet spot for financeability - can now handle construction risk, merchant risk and refinancing risk. Structural enhancements: First lien/second lien. Limited delayed draws. Equity co-invest. 10

6 Edwin F. Feo of Milbank Tweed Hadley & McCoy LLP 26-6 Investors still look for the following: Commercially well-conceived project. Cost competitiveness. Ready access to input and output markets. Strong, experienced management and sponsorship. Proven technology/creditworthy backstop. Ability to withstand rating agency scrutiny. Moody s and S&P ratings preferred, but not absolutely necessary. Fitch rating acceptable. 11 Examples of B loan deals: KGen Porttfolio of 5300 MW, three combined cycle plants and five peakers. Financed in August 2004 $150 mm Tranche A; $200 mm Tranche B. Spreads are 300 bp on Tranche A and coupon on 600 bp on Tranche B. PIK feature on Tranche B. Refinanced in June 2005 at a savings of 100 bp on the senior debt and 200 bp on the junior. 12

7 Edwin F. Feo of Milbank Tweed Hadley & McCoy LLP 26-7 Examples of B loan deals: LS Power DENA mid Portfolio of 6200 MW in Northeast and California. $950 million seven year Tranche A at 175 bp; $150 mm seven year Tranche B at 350 bp. Also $40 million first lien delayed draw facility, $450 mm letter of credit facility, and $100 mm working capital line. Assets include energy hedges with Morgan Stanley and Credit Suisse. Deal five times oversubscribed; pricing flexed down 50 bp for first and 75 bp for the second. 13 Examples of B loan deals: Coleto Creek Acquisition by ANP from Sempra of 632 MW coal plant. $735 million seven year first lien tranche at 275 bp over LIBOR. $200 million seven year second lien tranche at 300 bp. Originally structured as $935 million first lien only at 250 bp. Debt placement also has a discount on placement (99.5 on first and 97.5 on second). 14

8 Edwin F. Feo of Milbank Tweed Hadley & McCoy LLP 26-8 Evolving products in the traditional project finance market: Equipment financing: Turbine supply loan to fund deposits and payments. Advance rates are increasing, and commitments tend to be for less than full TSA cost. Secured by the TSA, perhaps by other assets, but trend is to go stand alone. Rates are higher than construction loan. 15 Examples of turbine loan: Dexia financing of Invenergy Wind TSA in Pricing around 200 bp. Advance rate 65%. Secured by TSA and project in late stage development. Rolled into project financing in four months. 16

9 Edwin F. Feo of Milbank Tweed Hadley & McCoy LLP 26-9 Examples of turbine loan: HVB financing of Airtricity TSA in Pricing around 100 bp. Advance rate 75%. Secured by TSA and project in middle stage development. 17 Evolving debt products: Construction financing is common, but new terms: Take out typically is via firm equity commitment and/or term financing commitment, but the trend is toward soft takeout or even no takeout. Secured by all project assets, with the project ready to go. Interest rates depend on sponsor support, size of contingency, construction period, strength of contractor. But trend is down. 18

10 Edwin F. Feo of Milbank Tweed Hadley & McCoy LLP Evolving debt products: 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, lower pricing and transaction costs. More typical for operating assets, but seeing use in construction financing. 19 Examples of portfolio deals: TXU current. Proposes to build 11 coal fired power plants. Financing commitment by Morgan Stanley and Citigroup for $11 billion construction and term loan facility. Will utilize senior/junior structure. 20

11 Edwin F. Feo of Milbank Tweed Hadley & McCoy LLP Examples of portfolio deals: Noble Environmental current. Proposes to build five wind projects in New York. Bank financing by Dexia, HVB and HSH Nordbank for $500 million construction and term loan. Pricing will be 125 bp, escalating. Portfolio will be merchant but supported by a 10 year financial hedge and a five to ten year REC contract. Senior debt only with ten year maturity after COD. 21 Examples of portfolio deals: FPL Wilton Wind Energy Two operating wind projects with long term PPAs. Private placement with life companies. $186 million 24.5 year tranche at 6.665%. $20 million 15 year subordinated tranche at 7.51%. 22

12 Edwin F. Feo of Milbank Tweed Hadley & McCoy LLP Evolving debt products: Back leverage debt. Involves financing of equity interests where there is no project level financing. Loans are usually capped at certain percentage of the value of the equity interest. Loans are secured by borrower s equity interest in the project entity and a sweep of all cash distributions. Repayment is subject to the partnership distribution terms and management rights. 23 Equity Equity trends: Private equity and hedge funds came into the market through acquisition of distressed debt and asset acquisitions. Examples include Matlin Patterson/KGen, KKR- TTP/Texas Genco (purchased for $3.75 bn). Fund objectives tend to be relatively high return (20% plus) and a three to seven year investment horizon. Have gravitated toward the discounted merchant asset opportunities. 24

13 Edwin F. Feo of Milbank Tweed Hadley & McCoy LLP Equity Equity trends: Longer terms funds have also focused on the sector, such as EIF, Arclight, Macquarie and Babcock. Target returns tend to be less, and hold period is longer (seven to twenty years). In the case of Australians, mandatory pension contribution law has lead to an abundance of capital needing a long term, low risk home. 25 Equity Equity trends: Strategic investors have re-emerged: Revamped independents such as NRG, ANP, LS Power and Mirant. NRG purchased Texas Genco for $5.8 bn from its private equity owners. ANP purchase of Coleto Creek from Carlysle/Riverstone/Sempra for $1.14 bn (sellers paid $430 mm in 2004). 26

14 Edwin F. Feo of Milbank Tweed Hadley & McCoy LLP Equity Equity trends: Financial equity has emerged. Both cash and tax investors. Participants are financial institutions and industrials, funds and cash equity players. Useful of monetization of tax benefits in renewables. Rate of return varies on structure and technology, but can be as low as 7% on an after tax basis. 27 Equity Equity trends: Financial equity terms. Leveraged vs. unleveraged structures. Energy project returns compare favorably to alternative tax investments. Pricing trend is down. Flips are common oriented to a predetermined target return with disproportionate allocation of cash and tax. In project leveraged deals, debt/equity issues. 28

15 Edwin F. Feo of Milbank Tweed Hadley & McCoy LLP Equity Equity trends: Overall, the trend on prices is up, returns are trending down. Hedge funds are now looking for the next opportunities outside of the sector. Re-emergence of strategics plus long term investment funds means lower return expectations but still plenty of capital. Availability of financial equity means that value can be derived from non-cash benefits, resulting in more efficiency in the capital structure. 29 Conclusion The capital markets are supporting new project financing, and acquisitions of existing assets. Three years ago we were concerned about the availability of capital for new investment, whatever the regulatory climate. Today, we are more concerned about political, legal and regulatory impediments to new investment. Sounds like 1998! 30

16 Edwin F. Feo of Milbank Tweed Hadley & McCoy LLP QUESTIONS? 31 Milbank Contacts Ed Feo Project Finance Partner, and leader of its renewable energy practice Simon Friedman Tax Partner Allan Marks Project Finance Partner Los Angeles Los Angeles Los Angeles Mark Regante Tax Partner Jonathan Maizel Project Finance Partner Karen Wong Project Finance Partner New York Washington, D.C Los Angeles

17 Edwin F. Feo of Milbank Tweed Hadley & McCoy LLP Milbank Locations New York Los Angeles Washington, D.C. London Frankfurt Munich Tokyo Hong Kong Beijing Singapore 58