Financial Structuring

1. Financial Structuring

2. Project Finance Terms in Private Analysis • The table below illustrates the type of terms that are in renewable project finance transactions.

3. Other Loan Examples – Spanish Wind Farm • The acquisition of 6 wind farms in Spain • Total Financing EUR 195 M • Total value of the transaction EUR235 M • Equity -- about EUR 40 M • Total 158 MW of Capacity • Generating about 350 GWh per year • Total cost 5 cents/kWh. • Compute • Sources and Uses of Funds and Leverage • Cost per kW of Capacity • Capacity Factor • Turbine Capacity

4. Dokie Wind Energy Project – Canadian Example • WestLB project financing for a wind farm in British Columbia, Canada. • Capacity: 150 MW • Sponsor: renewable energy developer EarthFirst Canada Inc. • Loans: $214 million including a two-year construction period and will have a 20-year final maturity • Average Life: 10- to 13-year range. • Purchase Price Agreement: A 20-year power purchase agreement with British Columbia-based electric utility BC Hydro, which has a rating of AA' by Standard & Poor's.

5. Example of Loan Life • BNP Paribas was in the market last week with a 144A for the Panoche Energy Center in California. • The deal is $330 million in size, • with a 21.5-year final, • 14-year average life maturity. • Standard & Poor's has a rating of BBB-' on the deal, which is expected to price this week.

6. Other Loan Examples – Spanish Wind Farm • The acquisition of 6 wind farms in Spain • Total Financing EUR 195 M • Total value of the transaction EUR235 M • Equity -- about EUR 40 M • Total 158 MW of Capacity • Generating about 350 GWh per year • Total cost 5 cents/kWh. • Compute • Sources and Uses of Funds and Leverage • Cost per kW of Capacity • Capacity Factor • Turbine Capacity

7. Dokie Wind Energy Project – Canadian Example • WestLB project financing for a wind farm in British Columbia, Canada. • Capacity: 150 MW • Sponsor: renewable energy developer EarthFirst Canada Inc. • Loans: $214 million including a two-year construction period and will have a 20-year final maturity • Average Life: 10- to 13-year range. • Purchase Price Agreement: A 20-year power purchase agreement with British Columbia-based electric utility BC Hydro, which has a rating of AA' by Standard & Poor's.

8. Example of Loan Life • BNP Paribas was in the market last week with a 144A for the Panoche Energy Center in California. • The deal is $330 million in size, • with a 21.5-year final, • 14-year average life maturity. • Standard & Poor's has a rating of BBB-' on the deal, which is expected to price this week.

9. FPL Example (2003) • DSCR • Average 1.86 • Minimum 1.74 • Bond Rating • Moody’s Baa3 • S&P BBB- • Reserve Accounts • 12 Months Debt Service Reserve Account • $15 Million Operating Reserve • Major Maintenance Reserve • Regulatory Support • Guaranteed by Sponsor • Covenants • Distributions allowed only if DSCR is above 1.3 times

10. Reserve Accounts – FPL Example • The debt service reserve covers 12 months of debt service • funded at closing, either in cash or an Letter of Credit. • The major maintenance account is funded at closing in the amount of $1 million initially to $3.5 million by 2020. • The special $15 million O&M reserve is funded at closing, with either: • cash, • a letter of credit , or • a guarantee from a corporate entity with a senior unsecured rating of at least 'BBB'.

11. FPL Example • Loan Amount $370 Million • Operating Reserve to Cover Expenses $14 Million • Debt Leverage – 52% • Capacity – 700 MW • Average PPA Tariff: $35/MWH (Excludes production tax credit) • Most Projects already completed and FPL guarantees completion (limited construction risk) • 2005 Loan • Higher Leverage – 65% • Additional Subordinated Debt – Total of 83% Financing

12. Disbursement Controls and Basic Covenants • Disbursement controls in the form of conditions precedent to each drawdown under the construction loan, such as requiring the borrower to present invoices, builders' certificates or other evidence as to the need and purpose for which funds will be used. • Borrower covenants not to amend or waive any of its rights under the principal project agreements without the consent of the lender. • Borrower completion covenants requiring the borrower to complete the project in accordance with project plans and specifications and prohibiting material alterations without the consent of the lender.

13. Covenants that Restrict Dividends and Additional Debt • Borrower covenants restricting the payment of dividends or other distributions by the borrower during construction and, thereafter, only after satisfaction of required debt service and other reserves, debt service coverage ratios and certification of no existing defaults. • Borrower covenants prohibiting incurring of additional liens and debt or issuing guarantees. • Requirements that project participants affiliated with the project sponsors enter into subordination agreements under which certain payments to such participants from the borrower under project agreements are restricted (either absolutely or partially) and made subordinate to the payment of debt service. • The project loan typically will be secured by all project assets, including a mortgage on the project facilities and real property; assignment of operating revenues; liens on all personal property; and assignment of all project agreements and project permits, including any letters of credit or performance bonds to which the borrower is the beneficiary.

14. Cash Flow Waterfall – FPL Example • The flow of funds is not standard but acceptable. American Wind will repay debt once annually, due in part to the annual variation of wind and thus power production. However, the issuer desires to make bi-annual distributions, and has structured the flow of funds accordingly. • The trustee allocates funds monthly in the following priority; • O&M expenses, • the debt service fund (1/12 of the debt service requirement), • debt service reserve, • major maintenance reserve, • special O&M reserve, • an optional additional payment into the debt service funds, • payment on permitted debt (other than senior secured obligations).

15. Equity Returns and Re-Financing

16. Project Finance Modelling of Renewable Resources

17. Teaching Objectives of Model Construction • The best and perhaps the only real way to learn modeling is under the tense pressure of a real transaction – when a model must be created and audited under a tight deadline. • Notwithstanding this, the exercises and lecturers are intended to provide: • A head start for those who have not created models and will have to learn the hard way. • Helpful ideas to experienced model builders in designing and structuring more efficient, stable, transparent and accurate models. • The discussion covers how to build a well structured financial model that clearly delineates inputs, effectively presents key value drivers, uses separate modules to organize various components, accurately computes cash flow that is available to different debt and equity investors, and presents results of the analysis that accurately display risks of the investment.

18. A Financial Model is a Statistical Tool • In developing a financial model, the basic thing you are doing is summarizing a complex set of technical and economic factors into a number (such as value per share, IRR or debt service coverage). • Forecasting has become an essential tool for any business and it is central to statistics -- in assessing value, credit analysis, corporate strategy and other business functions, you must use some sort of forecast. • Some believe economic forecasting has limited effectiveness and worse, is fundamentally dishonest because uncertain unanticipated events such as the internet growth, high oil prices, sub-prime crisis, falling dollar continually occur. • The whole idea of modeling, like statistics, is quantification. If a concept cannot be quantified, it is a philosophy. The fundamental notion of statistics is presenting and summarizing information, this is the same as a financial.

19. Danger of Believing too Much in Models • Alan Greenspan, Financial Times. • “The essential problem is that our models – both risk models and econometric models – as complex as they have become – are still too simple to capture the full array of governing variables that drive global economic reality. A model, of necessity, is an abstraction from the full detail of the real world.” • Nicholas Taleb: • In the not too distant past, say the pre-computer days, projections remained vague and qualitative, one had to make a mental effort to keep track of them, and it was a strain to push scenarios into the future. It took pencils, erasers, reams of paper, and huge wastebaskets to engage in the activity. The activity of projecting, in short, was effortful, undesirable, and marred with self doubt. • But things changed with the intrusion of the spreadsheet. When you put an Excel spreadsheet into computer literate hands, you get projections effortlessly extending ad infinitum. We have become excessively bureaucratic planners thanks to these potent computer programs given to those who are incapable of handling their knowledge.

20. General Objectives of Model Analysis • How to screen projects and value projects • How to structure the financing of projects • How to analyze risk using models • How to develop detailed financing provisions • A database of information on the project

21. Financial Modelling Outline • Developing the structure and layout of alternative types of models • Notes on model structure, programming practices and model periods • Organizing time periods in a model • Value drivers and model inputs • Debt modules -- sweeps, traps, defaults and debt IRR • Fixed asset modules and depreciation and amortization • Income statement and tax schedule • Cash flow and waterfall • Balance sheet and other auditing tools • Presenting key valuation outputs of a model • Performing sensitivity and scenario analysis on model outputs

22. Introduction • General Comments about financial models • “It all has to make sense in a financial model” • One of the benefits of project finance is the transparency of the cash flows as shown in the model • Major financial failures have occurred because the investors had no idea what was driving the value. Once problems occur when financial presentation is not transparent, panic often occurs. • In understanding a transaction and writing language for project finance contracts (construction contract, loan agreement, concession agreement, purchase power agreement) cash flow is the ultimate issue. One must understand how much cash flow is generated, who gets the cash flow and the priorities each party has to the cash flow.

23. A Central Question in Economics and Finance is How to Evaluate Risk • As the growth of trade transformed the principles of gambling into the creation of wealth, the inevitable result was capitalism, the epitome of risk-taking. But capitalism could not have flourished without two new activities that had been unnecessary so long as the future was a matter of chance. • The first was bookkeeping, a humble activity but one that encouraged the dissemination of the new techniques of numbering and counting. • The other was forecasting, a much less humble and far more challenging activity that links risk taking with direct payoffs. • “The Remarkable Story of Risk”

24. Financial Perspective on Renewable Investments • Lessons from Financial Crisis on Risk Assessment • Complex Structuring • Risk Analysis • Financing and return requirements • Evaluation of risks of capital investments • Capital Intensity of Renewable • Which Risks are Most Important • Rate of return required by private investors in wind farm investments • Criteria for bankers in wind farm investments in order to accept risk

25. Financial Models – Standard and Poor’s • A good financial model should: • Be relatively simple • Focus on key cash flow drivers • Clearly convey assumptions and conclusions • Alternative Models • Back of the Envelope • Quickly run the impact of an acquisition on debt service coverage • Sensitivity of earnings to commodity price swings • Deterministic • Set a number of assumptions and translate into financial ratios and cash flow • Stochastic • Develop a range of possible inputs using Monte Carlo simulation. Used where there is a good and predictable history for value drivers.

26. Fundamental Financial Issues and Modelling • Financial issues that must generally be addressed in valuation, financial structuring and credit analysis include: • What is the minimum level of the project IRR that is acceptable (relative to the weighted average cost of capital) • What is the level of the minimum required equity IRR with different amounts of debt on the balance sheet • What is the debt capacity of a project for senior debt and subordinated debt as measured by the minimum DSCR or the LLCR • What should be the credit spread on senior and subordinated debt • What is the tradeoff between risk and return in evaluating covenants

27. Resolution of Fundamental Financial Issues • There are various ways to resolve the basic financial issues presented on the last slide: • Financial theory • Financial theory dictates that the CAPM should be used to compute the WACC, that the un-levered beta should be used to estimate equity returns, that options pricing models should be used for credit spreads, debt capacity and covenants. • Mathematical Models • Mathematical models include beta adjustments for the CAPM, statistical models for credit analysis, Monte Carlo simulation and value at risk. • Practical Market Information • Practical market information can be used to gauge required equity returns, required credit spreads, required financial ratios to achieve investment grade rating and other issues. • Direct Evaluation with Financial Models • Use of financial models to directly assess risks through sensitivity, scenario and simulation analysis.

28. Equity Returns for Tollroads • The following slide illustrates equity IRR’s on selected toll-roads. This information more relevant than theoretical weighted average cost of capital calculations

29. Debt Service Coverage Criteria • Standard & Poor's considers that minimum DSCR threshold tests for most contract-driven projects to be around 1.30 times (x), provided that this figure holds under stress analysis. • Such levels are too low for merchant projects. Instead, minimum DSCR levels for equity distributions may need to exceed 1.70x for investment-grade transactions, depending on the industry. • For example, one financial institution suggests that under base case assumptions the DSC should show not less than 1.2:1 for every year of operation during the loan life, and no less than 1.4 on average. • Under a Downside Case, with up to 5 years added to the repayment period, the DSC should be no less than 1.0:1 for every year or less than 1.15:1 on average during the life of the loan. • Projects with merchant exposure may find that leverage cannot exceed 50% if investment-grade rated debt is sought. On the other hand, contract-revenue driven projects, on the other hand, typically have had leverage levels around 70% to 80%.

30. Study of Problems with Project Finance Models • Assumptions not Documented in Databook • No Integrated Cashflow, P&L, Balance Sheet • Significant Tax Errors • Incorrect Accounting • Deferred taxes • Fees • Operating Reserves • No Flexibility for Breakeven Analysis and Other Risk Analysis • Effect of cash flow sweeps, covenants and reserves • Poor Presentation of the Model to Senior Management • - Scope of Model • - Model Conclusions

31. Example of Cash Flow Waterfall

32. Structure of Project Finance Models

33. Basic Model Structure • A project finance model should correspond to the fundamentals of project finance: • Different equations for different phases of the project • Uses and sources of funds to define how project is financed • Repayment of debt corresponding to cash flow • Compute debt capacity and equity IRR • Account for the effect of covenants, cash flow sweeps and other debt features • Incorporate debt service reserves and operating reserves

34. Sheet Layout – Project Model • Contents • Input Sheets (Assumption Book) • Different colors, Arranging of inputs • Working Sheets • Arrangements by revenues, expenses and capital expenditures • Arrangements by capacity, demand, and cost structure • Sources and Uses of Funds (Monthly Construction Expenditures) • Conversion from Annual • Computation of Interest During Construction • Debt Schedule (Sources of Funds) • Depreciation Schedule • Financial Statements • Income Statement • Balance Sheet • Cash Flow -- Waterfall • Output Sheets • Valuation – IRR, Debt Service Coverage Ratios

35. Structure of a Project Finance Model Profit and Loss Revenue, Expense and Capital Expenditure Analysis Inputs: Operating Drivers from Contracts and Other, EPC Contract, S-Curve, Interest Rate Tax Taxes Paid, Taxes Paid and Taxes Deferred Working Capital Analysis Debt and DSCRA Schedule Cash Flow Statement With Waterfall, Debt Defaults, Sweeps etc. Sources and Uses of Funds During Construction Including Interest Roll-up Fixed Assets Interest Capitalized Fees and Other DSCRA Balance, Debt Balance Equity Balance Balance Sheet Equity IRR DSCR, LLCR

36. Model Sheets in Project Finance Model Debt Schedule – Debt Balance From Drawdown Debt Balance, Interest Expense Inputs – Prices, Costs, Capacity, Technical Parameters Outputs – Free Cash Flow, Equity Cash Flow Value (IRR), DSCR Working Sheet to Derive Revenues Expenses and Working Capital Depreciation – Depreciation Expense Plant Balance Annual Financials – Income Statement, Cash Flow (CASH WATERFALL) and Balance Sheet Source and Use of Funds – Draw down, IDC, Equity Issues and Capital Expenditures

37. Table of Contents – Example of Different Periodic Statements Note that financial assumptions separated from operational assumptions Different time period for different statements

38. Sources and Uses Example – Summarizes the whole project The source and use statement together with the DSCRs and the IRR summarize the project and is the beginning of the analysis

39. Summary of Modelling Practises

40. Good ModellingPractise • Divide the model into separate modules, beginning with an input section. • Compute how the value drivers determine operating revenues, operating expenses and capital expenditures in a separate “working” module rather than in financial statements. • Understand the starting point of the model as it relates to the valuation issue (balance sheet, sources and uses statement or both). • Carefully define the time period of the model using codes that define alternative phases of the analysis. • Work through every single balance sheet item showing the opening balance, changes and the closing balance for each the accounts. This analysis should be made for everything ranging from cash accounts to common equity. • Include separate modules for debt issues, fixed plant assets, working capital and cash balances.

41. Simple Formulas • The modeling practices are discussed in another sheet named spreadsheet conventions. • The most important is keeping the formulas simple and making the sheets transparent and easy to read. • The following should be in many other lines.

42. Balance Sheet Accounts and Cork Screws • It is good practice to have accounts for all balance sheet items • Some examples include: • The plant balance • The debt balance for each issue • Debt service reserve balances • Maintenance reserve balances • The NOL balance • The Un-amortised debt fee balance • The basis for changes in working capital • Common equity balance

43. Example of Terms for Wind Project • Typically, the length of a loan is between 10 and 15 years, but loan terms have become longer as banks have become more experienced in the wind industry. • The interest rate is often 1-1.5 per cent above the base rate at which the bank borrows their own funds (referred to as the interbank offer rate). In addition, banks usually charge a loan set-up fee of around 1 per cent of the loan cost, and they can make extra money by offering administrative and account services associated with the loan. Products to fix interest rates or foreign exchange rates are often sold to the project owner. • It is also typical for investors to have a series of requirements over the loan period; these are referred to as ‘financial covenants’. These requirements are often the result of the due diligence and are listed within the ‘financing agreement’. Typical covenants include the regular provision of information about operational and financial reporting, insurance coverage and management of project bank accounts.

44. Development Analysis and Time Period Definitions in Models

45. Switches in Alternative Models • Switches for time periods in alternative models • General Corporate Models • Switch for History versus Forecast • Switch for Terminal Period • Project Finance Models • Switch for Development Period • Switch for Construction Period • Switch for Operation Period • Switch for Debt Repayment Period • Leveraged Buyout Models • Switch for Transaction Period • Switch for Holding Period • Switch for Terminal Period

46. Steps in Project Financing • Step 1: Development, Feasibility and RFP • RFP issues – bid evaluation system, communication, scoring, requirements, cost, stages • Step 2: (Financial Close) Construction Financing • Funding provided progressively with drawdown procedures that carefully test that money has been spent. Capital market financings can involve up-front money. • Capitalize interest, finance up-front fees. Can have take-out at completion. • Step 3: (Completion Test) Completion of the Project • “Performance completion test.” Before test is satisfied, there is careful allocation of debt and equity and there often is recourse to a credit worthy company for cost over-runs. • Step 4: (Commercial Operation Date) Project Financing • Cash flows used to cover debt service. If do not meet completion test, do not become project financing.

47. Steps in Development Phase

48. Valuation of Development Expenditures and Probability of Proceeding • Simple approach • If 10% chance of proceeding, development expenditure is worth 10 times as much as other construction expenditure. • Example: 2% of development cost really has a cost of 20% of the project

49. Uncertainty of Costs and Time to Development

50. Project Finance Timing and Finance • Finance is critical path. • After the Commercial Operation Date, the Permanent Loan is Repaid. • The slower the loan is repaid, the better the financial results of the project. • Bankers are reluctant to make loans with tenors that extend for the life of the project. • After the Commercial Operation Date, the Project can Begin to Pay Dividends • Dividends or Distributions Define the Equity Cash Flow of the Project. • Dividend Payments can be Limited by Covenants and Cash Flow Sweeps. • Financial Metrics in Project Finance • Equity IRR – The amount of money you invest relative to the amount you get back. • Debt Service Coverage – The cash flow of the project on a year to year basis relative to the amount of money (interest and principal) you have to repay.