The United States Department of Energy returned to the project finance business in 2005. It joins a list of government-owned credit providers that includes the US Federal Highway Administration’s TIFIA joint programme office, United States Export-Import Bank and the Overseas Private Investment Corporation.

But the DoE’s loan guarantee programme has faced considerable challenges. Its main remit is to support newer generation technologies, giving it an exposure to newer technologies that other governmental lenders do not. It has also grown up in the face of appalling conditions in debt markets.

The export credit agencies and TIFIA spent the boom years protesting their relevance amid patchy usage, but during the crunch became the linchpins of the sectors in which they operate. Progress on closing loan guarantees has been slower: Of an initial batch of applications, just one, solar panel manufacturer Solyndra ($535 million), has closed a deal. The department has also closed a $528 million loan for a hybrid car company, Fisker Automotive.

The 2006 vintage of applications, under section 1703 of Title 17 of the 2005 Energy Policy Act, were for new and unproven technologies, with low-emissions coal and biomass taking up the majority of pre-applications. The 2009 American Recovery and Reinvestment Act added a section 1705, with a broader range of eligible projects.

The loan guarantee programme has struggled to work out how much project finance discipline is required to bring deals to close. Project finance lenders cannot decide whether the new programme is an opportunity or a threat. Several project bankers have reinvented themselves as financial advisers to hopeful loan applicants.

The programme office’s first hire as director was David Frantz, formerly director of project finance at Opic, who joined in August 2007. In November 2009, however, the US energy secretary, Steven Chu, named Jonathan Silver executive director of the office. Frantz had reported to the department’s chief financial officer, while Silver reports directly to Chu.

Silver’s new processes

Silver’s background is not in banking. He started his career at McKinsey, before working at hedge fund Tiger Management, where he was chief operating officer. He was most recently a venture capitalist, at Core Capital Partners, which supported energy, telecoms, manufacturing and software start-ups.

The difference in background has been the source of sniping from banking quarters (“I know what conditions precedent are”, hissed one banker after seeing Silver describe the application process in March), but the changes to the organisation of the office are tangible, and have sparked grudging admiration from bankers who have dealt with the office.

Says Silver: “We embarked upon a process re-engineering, which was designed to streamline the review process and simplify the review structure. We’ve also tried to work on different aspects of due diligence in parallel, rather than sequentially” The office, which had 16 people in January 2009, now has roughly 105. “We have the capacity now to group our expertise by technology type, with different groups for wind, solar, geothermal, biomass, nuclear, and so forth.”

The experience of the other government lenders does not automatically translate. “Ex-Im and Opic have been around for a very long time, and their processes are highly refined and honed. We’ve certainly brought over a lot of people from them, and share a common heritage, as well as some basic policies, procedures and protocols. But there are differences in nature and style. The projects we have in front of us are often larger, use newer technology and have a different risk profile.”

The loan guarantee programme’s biggest departure from its predecessors, and the one that makes a classic project finance approach hardest, is its focus on newer technologies. This focus is not exclusive, since proven nuclear, renewable and transmission technologies are eligible and represented in large numbers, though by volume the technologically difficult projects have an outsize importance. Finding a way to mitigate technology risk and protect the US government’s interests is a challenge.

“We acknowledge there’s a tension in the way we need to deal with technology risk, but also realise that we’re dealing with a different set of metrics and outcomes. We are trying to meet social goals such as launching new technologies, creating jobs, and contributing to greenhouse gas emissions. We have to design credit processes around these goals and risks and price them accordingly.”

How to speed things up

Developers’ most frequent criticism of the programme is the time that the department takes to approve applications, as well as the time it takes to move from a conditional application to closing a deal. Project developers as diverse as Brightsource (for its Ivanpah solar project), First Wind (for a Hawaiian wind deal) and Southern company (for the Vogtle nuclear project) have received conditional commitments, and are waiting to close financings. First Wind’s $117 million conditional commitment covers a Hawaiian wind farm that uses 2.5MW Clipper liberty turbines, as well as a battery to allow it to store power. Its application was submitted roughly 19 months ago.

Silver likes to stress that many of the conditions precedent to closing a loan guarantee are outside the control of the department, with his favourite example being the Nuclear Energy Regulatory Commission’s approval of a license for a new reactor for which the developer has applied for a guarantee. He also points to instances, however, where a developer has to do more detailed design work and lower a project’s risk profile. Some conditions precedent, then, involve more box-ticking than others.

Still, the rather bespoke nature of the application process has allowed bankers, whether employed or self-employed, to pitch advisory services to hopeful developers. It has also created new openings for ratings agencies, because an indicative rating is central to receiving a loan approval. It has also tempted some lobbying firms to offer their assistance in navigating the DoE bureaucracy.

Advisory bankers will be heartened to learn that Silver has more sympathy for them. “One of the bigger misconceptions we’ve encountered is that some developers think that hiring outside voices can have an effect on our judgements. We’d rather that developers hired some additional technical or financial advisers than lobbyists.” Under most of the calls for applications, the Federal Financing Bank, which lends to the different parts of the federal government, would fund the loans, rather than a commercial lender, so bankers will mostly be paid for their advisory services.

FIPP’s formation

The most promising opportunity for commercial lenders comes from the Financial Institutions Partnership Program, or FIPP. The FIPP would cover 80% of a loan to a qualifying project, primarily using proven generating technology, equivalent of 64% of project costs, or 50% of that project is eligible for a cash grant. Banks can bring transactions that look promising to the department for development. FIPP was first pitched as giving the department access to outside credit expertise to the process, especially as the office built up its staffing.

But as Silver sees it FIPP allows the department to reach a greater number of potential applicants. “For us, it’s a chance to open up a new distribution channel for the guarantee product, since we’re not out in the field originating business.”

Still, the clash between credit cultures and the policies of the US government and commercial banks has been profound. While banks have been encouraged to bring their credit culture to bear on FIPP applications, they have had to seek guidance from the department on collateral-sharing arrangements, as well as the ability of guaranteed lenders to strip and sell on their exposures.

It is likely to be a small part of the office’s work, particularly as commercial lenders start returning to the renewables market.

One large deal, Caithness Energy’s Shepherd’s Flat project, an 845MW facility that Caithness wants to build in once phase, has applied for a FIPP loan through arrangers BTMU, Citigroup, Credit Suisse, Morgan Stanley and Royal Bank of Scotland. In that instance, sheer size rather than technological difficulty (Caithness is using lots of proven GE 1.5MW turbines) is guiding the leads towards looking at FIPP.

Opportunity or threat?

“We ought to exit some sectors as they become more robust. There was, for instance, a relatively robust commercial wind market before the crunch. To the extent that a sector has recovered we would look to leave it.” With lenders to US wind projects again routinely offering 17-year tenors, sponsors rushing to get projects eligible for the cash grant, and the route to a loan guarantee still long, this migration to commercial banks should happen naturally.

The first borrower to close a guarantee, Solyndra, is still aiming for an initial public offering. Solyndra’s most recent public filing included a note from its auditors, PricewaterhouseCoopers, that there was substantial doubt about its ability to continue as a going concern. While the language is boilerplate, and other would-be equity issuers, most notably First Wind, have been confronted with similar warnings, the possibility of default is real enough that the DoE will need to have policies in place to deal with work-outs.

Commercial lenders want to know how the US government will interpret its rights under loan agreements. The US Department of Transport, faced with its first default on a TIFIA loan, for the South Bay Expressway, says that it will vigorously defend the interest of the US government as lender. The TIFIA loans have a springing lien, under which the US is subordinate in cashflow position, but ranks pari passu in the event of a default. Banks have usually been able to sign agreements with tax equity providers and TIFIA office that allow them to close financings with difficult security-sharing questions, but will initially be wary.

The upcoming slate of nuclear financings could have provided the earliest test of the department’s stance towards third-party lenders. So far, the question has been punted. For the Vogtle 3&4 nuclear units, the DoE has extended a conditional commitment to Southern Company for its $6.1 billion share of the $14 billion project. The remainder will come from Oglethorpe Power Corporation, the Municipal Electric Authority of Georgia and Dalton Utilities, which will fund their commitments with municipal bond issues.

The public and private utilities own undivided interests in the plant, and sharing security over the asset, even if it was not subject to nuclear construction and operational risk, would be complicated. The proposed DoE financing sidesteps that issue by relying upon a corporate guarantee from Southern. Nuclear deals have attracted the highest ratings of any to seek the imprint of the ratings agencies, and not because of their baseload dispatch profile. None have yet proposed asking the DoE, headed by a Nobel-winning physicist, to accept nuclear risk. For these sponsors, debt pricing, rather than risk transfer, is the most important priority.

Silver, asked whether he can see the department ever doing a non-recourse guarantee for a nuclear project, hedges. “We have a strong interest in being part of the approach to relaunching the nuclear industry in America. But it’s a unique proposition and requires enormous amounts of work dealing with operators, investors and contractors. So never say never.”

Some banks think the same about losing business to the DoE. Their perception is that applications that went in at the nadir of the credit crisis might end up back on their desks, if it takes too long to clear the DoE. “You can sink a half million in legal fees into an application, and you might want to stick with it, but the market has come back quickly, and some sponsors might be tempted to change their mind.” The DoE will be tempted to concentrate on technologies like nuclear, geothermal, solar, and possibly offshore wind, that are less tested but may support more US jobs. It still has to make good on the existing project pipeline, however.