The secondary market for Spanish solar power projects was boosted late in 2008, when the country's government slashed tariffs for new projects.
A surge of new projects had been commissioned when tariffs were more favourable and when equity markets began to stagnate in the downturn and asset prices dropped, asset sales picked up. HgCapital bought five Spanish solar farms in March and April, and sources say that there is no shortage of sellers, nor lack of interest from financial investors seeking stable long-term returns.

Although equipment prices have fallen since 2008, and many potential buyers have reined in their equity outlays, infrastructure and renewables funds have been cherry-picking some of the best assets.

The smaller size of solar projects does means that some banks prefer to concentrate their energies on larger prospects like wind portfolios. But infrastructure and renewables funds, an occasionally attractive client base, are heavily active in the solar sector. The steady cash flow and low maintenance requirements of renewables projects makes them attractive to pension fund investors, says Ben Warren, partner at Ernst & Young.

"Renewables projects are not, in most jurisdictions, impacted by volatility in underlying energy prices...the certainty of income is pretty robust, and wind farms and solar projects are low-geared, operationally," Warren says. Spain's solar market enjoys feed-in tariffs fixed at 25 years plus a further 15 years at a lower rate.

Comparatively, the solar tariff in neighbouring Portugal is fixed until the plant reaches a production level of 21GWh per installed MW, which typically means the fixed-price ends in year 12, according to one developer. The tariff following this guaranteed period is, as yet, undefined and unregulated, and this means that most projections will consider the worst-case scenario, a switch to a spot market price. Projects during this period can face a drop of up to 80% drop in revenues, and some investors will not be interested in this market risk in the current climate.

Cuts mean prizes

Spain's long-awaited drop in solar photovoltaic (PV) tariff prices in September 2008 led to a drop of as much as 30% in the projected revenue profiles of greenfield plants. The move took few lenders by surprise. The project finance market had anticipated the government would drop its tariffs to rein in the growth of the solar sector after relatively high tariff rates set in 2007 saw developers flood into the market.

The low barriers to entry for Spanish solar projects meant many property and construction firms developed projects on-balance sheet, as a periphery to their core businesses. But many projects rushed to meet the deadline for the favourable older power tariff of 28 September 2008, and did not focus on construction quality, using substandard equipment as they raced to complete construction, says Tom Murley, head of HgCapital's renewables fund.

"We decided to wait and start identifying which projects were going to be built well, with good equipment and likely to meet the deadline, and try and buy those once they were built, " he says. "They started to become attractive last fall, when people knew they had qualified for the tariff and had lots of assets on their hands," Murley adds.

And just as Spain announced its new tariff program, financial markets the world over were in turmoil. Many of those real estate and construction firms with wind farms and solar projects on their balance sheets felt the effects of the downturn keenly, Murley says: "The secondary market for renewables assets is particularly strong in Spain, for solar and wind, because companies are looking to shed assets to repay debt or refocus on their core businesses."

HgCapital's Renewable Power Partners Fund bought its fifth Spanish solar project in April, a 5.25MW plant near Toledo, bringing its solar capacity in Spain to 42MW. The fund bought the plant from Spanish holding company Montebalito and Invercartera Energia, a subsidiary of Caixa Catalunya, for Eu35 million ($47.1 million). The project's original developer was Proener and HgCapital's acquisition used an 18-year non-recourse loan from Caixa Catalunya. The debt to equity ratio on the deal was around 80/20.

The transaction was agreed in the wake of HgCapital's acquisition of four Spanish PV projects from AIG Financial Products for Eu300 million, in March. The fund has invested in renewables assets worth Eu550 million in the 12 months until May 2009.

Typically, the longest tenors currently achievable for Spanish solar projects are 17 years, with cash sweeps starting around years 10-12, Murley says. For Spanish wind projects, tenors out to 15 years are achievable, with cash sweeps starting in year 10, he adds. Upfront fees are generally equal to starting margins, in the 250bps-300bps range, says Murley. Murley notes "the banks typically require that you hedge at least 60-75% of the principal for the life of the debt to eliminate that Libor risk."

As banks have become risk averse and offered smaller debt tickets, club deals are making the process slow on large deals, sources say. "The problem is not finding banks, the problem is trying to reduce the number of banks we get in the financing," says one developer.

Market participants say the European Investment Bank is likely to step in as lender to many of the larger greenfield projects, which should encourage commercial bank involvement. The multilateral has increased its annual target for renewable investments to Eu800 million in 2009, and amongst other pledges, said it would increase its maximum financing share of renewables projects from 50% to 75%.

Riding the storm

Whilst HgCapital used a wait-and-see approach to Spain's solar market, Macquarie's Eu77 million refinancing for a 10MW PV plant in Cadiz, which closed on 1 July, marked the end of a long negotiation process through difficult market conditions and changes to Spain's power market regulation. The club of mandated lead arrangers on the refinancing was Barclays Bank, Unicredit/HVB and Bank of Ireland.

Macquarie European Infrastructure Fund bought the plant from Endesa Ingenieria early in its construction phase in mid-2008, with a 100% equity bridge. The plant went online before the September 2008 tariff deadline, obtaining the more favourable tariff rates.

With the equity bridge in place, Macquarie went to the debt markets to seek lenders. Because of stagnant debt markets in late 2008, the deal team had to accommodate higher due diligence requirements, and this was one of the main reasons for the long negotiation period, says Daniel Wong, head of utilities at Macquarie Capital Advisers.

"For the small asset-based financings, you need to tick off on every permit, every lease, every final detail of the engineering, procurement and construction contract, and make sure the power purchase agreement is robust as well," says Wong. The club deal of three banks with equal lending amounts also took time to agree on all details, he says.

The tenor on the loan is 20 years, and the debt-to-equity ratio is 70/30. The pricing on the debt is at 315bp over Euribor, and ratchets up to 360bp over time, says one source close to the deal, and its base rate is swapped. The project might have gained pricing at around 150 to 200 bps before the crunch, adds the source.

According to HgCapital's Murley, European renewables projects have had to typically absorb a net increase in the cost of debt of around 75bp-100bp since 2008 highs. "If your project margins can't take a 75bp increase you probably shouldn't build it in the first place – it is negligible," he says.

The new regime

As well as debt market issues, the Cadiz deal had to negotiate changes to Spanish power market regulation. The deal was one of the first to close since a Spanish Royal Decree in April, which laid out terms and conditions of the last resort supplier regime in Spain, designed to support the separation of electricity supply from distribution.

To support the process, the government has named five utilities (Endesa, Iberdrola, Union Fenosa, Hidrocantabrico and E.On) last resort suppliers, should a generator not be able to meet its spot market obligations. However, implementing legislation will be required to define how power payments will travel under the scheme, and what the last source supplier will charge, industry sources say. The decree was meant to come into force on 1 July 2009, but under another Royal Decree, of 19 June, this deadline was extended until later in the year.

Since a market counterparty could potentially default on payments, the proportion of total payments received from this counterparty, as opposed to from market regulator OMEL, needs to be clarified, says one source close to the deal.

Since the connection point of the Cadiz plant is with Endesa, the utility becomes the last resort supplier. Some projects might need to rethink the structure of their last resort supplier agreement to respond to new rules, says Linklaters' Ben Crosse, who represented the lead arrangers on the Cadiz deal. "Based on the implementing legislation, it could make a difference as to whether you chose a market-based counterparty or a last resort supplier," he says.

The squeeze is coming

The downturn has meant asset prices in some renewables markets have fallen by as much as 20% since their 2008 highs, says Ernst & Young's Warren. Since the credit crunch ate into equity prices, many developers have fished for investors to take stakes in projects, or buy up whole portfolios of operational plants. Industry sources say there are bids for some of the larger Western European wind assets at around 20% below their highs. Still, high-quality solar assets are selling at around 5-10% below their highs, according to HgCapital's Murley.

Very aggressive assumptions also meant project buyers were paying too much for earlier sets of projects, says HgCapital's Murley. "Renewable energy has clearly gone through a bubble cycle. Very high prices were paid on some fundamentally incorrect assumptions," he says. One banker says that whilst potential risk profiles of solar plants look relatively good, there are sometimes questions about the quality of sponsors' research.

Irradiation is less volatile than wind as a natural feedstock, but some developers do not perform enough analysis, he says: "There are sponsors who don't scrutinise irradiation and just look at public databases, which are probably not good enough- it is not treated appropriately," he says.

With the large amounts of wind and solar assets already operational in Spain, it is a more fertile ground for secondary activity than, say, France, where the renewable sector is at a less advanced stage, Murley says. Whilst HgCapital monitors renewables opportunities across Europe, unresolved legislative issues in France regarding wind farm permitting mean the fund is not likely to acquire wind assets from the limited stock there in the short term.

Greenfield developers had hoped that lower equipment prices might compensate for reduced lender and developer interest, but industry sources say lower prices have not yet filtered fully down to the newer European projects. Some developers near project completion are looking for equity injections, says Macquarie Capital's Wong. "As you would expect the developers are getting squeezed, and in some cases they are squeezed right out and need to sell earlier than project completion," Wong says.

But the good news is that greenfield debt pricing is likely to follow equipment prices downwards. Many market participants think new projects are unlikely see a large drop in debt pricing this year. Some lenders are likely to return to primary and secondary markets in the second half of 2009 and debt terms for developers may improve slightly, they say. Pricing for solar and wind projects is likely to drift off and stabilise at around 250bp above going into the fourth quarter, participants say, unless there are more market shocks around the corner.