[Editor's note: Shortly after this focus went to press, the US senate passed tax legislation that included an extension to the cash grant for renewables projects. For more details of the programme, see below]

It has not been a great year for the US wind sector. Although it is still an active market for project finance banks, new installations have slumped to their lowest level since 2006. Installations between January and September decreased 72% on the same period the year before, to 1.6GW, according to the industry’s lobbying group, the American Wind Energy Association. During the period between July and September, just 395MW of wind capacity came online in the US, the lowest quarter since 2007.

The political, economic, regulatory and market environment is far from promising. Low gas prices, as well as the increasing presence of viable solar alternatives, have made utilities more hesitant to sign long-term power purchase agreements with wind generators. On top of this, mid-term elections resulted in a Republican-controlled House of Representatives, and bolstered Republican influence in the Senate, damaging the chances of an extension of the Treasury cash grant programme, which has propped up installation activity since February 2009.

Congress cooling on credits

That month, the passing of the American Recovery and Reinvestment Act gave the industry a boost, when it extended the investment tax credits (ITCs), already present in solar, to wind and other renewables technologies. Up until then, wind producers were limited to the production tax credit, which could be claimed based on a project’s first 10 years of output. The ARRA then gave projects the option of claiming a cash grant from the Treasury, in place of the ITC, an option sponsors eagerly embraced.

Under current legislation, the cash grant option is only available to projects that have reached a certain construction threshold by the end of 2010. The wind industry sees the extension of the grants as key to supporting up­coming projects, but the political consensus has seemingly moved towards an era of cuts, rather than support, for sectors such as renewables.

Many jobs have been created in the green power sector, but the US would not be the first country since the economic downturn to prioritise fiscal prudence over sustainable development objectives.

Shortly before Project Finance magazine went to press, US president Barack Obama announced a deal with Republican leaders to extend Bush-era tax cuts for individuals, and extend some unemployment benefits, but an ITC extension was not part of the deal.

Democrats in Congress have tried to get the renewables cash grant included, and according to Keith Martin, a partner at Chadbourne & Parke, frantic horse-trading could result in an extension to the renewables grant scheme, but the industry is now facing longer odds. Congress is hoping to adjourn for the year on 17 December, and an extension to the grant scheme becomes less likely in 2011 when new members take their seats, because Republicans have made it clear that reducing the fiscal deficit will be their priority, Martin says.

Dash for cash

Doubts over the extension of cash grants have fuelled a surge in wind project building, as developers push to reach the obligatory construction requirement by the end of the year. Treasury money is provided within 60 days of apply­ing for a grant on project completion, and will be available until 2012 for wind farms, compared with 2017 for solar. The grant is only awarded if the project can demonstrate building was underway by the end of December 2010. This can mean putting in place surrounding infrastructure, or showing at least 5% of the project cost has been incurred, to qualify.

Lenders expect a surge in wind deals in the first half of 2011, as the large number of developers that have fulfilled the prebuild conditions come to market to raise the rest of what they need. The pace of activity further out is much less certain. “The cost of capital will rise over time. There are 16 active tax equity investors in the market at the moment. Three to five have said they will drop out if there is no cash grant,” says Chadbourne’s Keith Martin. If projects return to using non-cash ITCs or PTCs, this will place greater demands on the scarce tax capacity of those remaining players, says Martin. While PTC deals did close in the period after the ITC became available, they were a distinct minority, and absorbed much greater amounts of tax equity than ITC deals.

One lender says while banks are currently comfortable providing bridge loans to projects with cash grants as the promised refinancing, they are less comfortable with bridg­ing projects to a tax equity take-out. “I think [some of those] projects on the margin will not get done, or will get slowed down,” he says. Many of the sponsors that chose the PTC as an alternative to cash grants used tax equity to refinance balance sheet funding rather than non-recourse construction debt.

Banks and their alternatives

Lenders active in the wind sector say that debt pricing has fallen around 50-75bp in the last year, with a levelling off in pricing in recent months to around 250bp over Libor. Upfront fees have seen a similar decrease in 2010, and are currently settling at around 200bp. “Even the BBB corporates are pricing at Libor plus 200-225bp. When you layer in the non-recourse risk, etc, [debt] is still pricing at Libor plus 250bp plus step-ups,” says one banker. Many bankers see pricing stabilising around this level going into 2011.

With banks putting additional capital against non-recourse deals following on from Basel III banking rules, in the context of higher funding costs, debt pricing may have found a floor, for now. “I have a very difficult time thinking we will get down to the price levels seen a few years ago,” the banker adds, hopefully.

Europe’s banks are the main providers of long-term debt for US renewables, and while it remains to be seen whether Europe’s sovereign debt crisis forces any of these banks to retreat to home markets, tenors for wind projects have increased since the tightening in 2008. Tenors are now as long as 17 years, with mini-perm structures becoming less and less common. As one banker says: “A typical long-term deal is 15-year amortisation, 15-year maturity.”

Europe harbours global turbine manufacturers like Siemens and Vestas, and some US projects are exploring the option of ECA financing, which would bring low rates and long tenors. But compared with standard commercial bank financing, negotiations on ECA-funded deals can take time. Bankers note that Europe’s banks’ funding costs are now at a considerable spread to Libor, as much as 100bp by some estimates, which makes the narrower debt spreads on ECA-backed projects less attractive for banks than they might have been in previous years. Some, but not all, ECAs will be able to lend directly to projects, and have been asked to do so in greater volumes since the crisis.

Bond markets are providing an increasingly viable alter­na­tive, and two of this year’s largest US wind deals are structured around a combination of bank and bond tranches. Terra-Gen’s $1.2 billion Alta Wind portfolio reached financial close in July, and the $1.9 billion Shepherds Flat project, developed by Caithness Energy and GE Financial Services, is expected to close in December.

The $1.9 billion Shepherds Flat project is billed as the largest wind plant in the US and its financing is currently out to market. The 845MW project, located in Oregon, is the first US wind farm to go out to bond and bank markets with a Department of Energy loan guarantee included, and given the small number of closed guarantees so far, the deal may remain a rarity, particularly since construction for qualifying projects must begin by the end of September 2011.

Citi, WestLB, bank of Tokyo Mitsubishi UFJ and the Royal Bank of Scotland have asked 15 banks to take tickets of between $25 million and $40 million on a $360 million commercial debt tranche, with a tenor of construction plus 12 years. The grant for the project comes to around $500 million and around $250 million will come from equity, according to one source. The remaining financing consists of the bank debt tranche, a private placement portion and letters of credit. The DoE loan guarantee covers around 80% of this non-equity portion, though the banks providing the $360 million debt tranche take on full project risk.

The project has a 20-year power purchase agreement with Southern California Edison, which has been a source of many of the most bankable power purchase agreements in the US.

Wind, gas and silicon conspire against developers

California has onerous renewable portfolio standards, which mandate that its utilities must buy high proportions of their power from renewable sources. But generators else­where in the US struggle to persuade utilities to sign long-term PPAs with lender-friendly pricing. The recession curbed energy demand, and some expect gas prices to remain at low levels. Merchant wind projects in US’ deregulated markets are not currently bankable on a non-recourse basis, lenders say. Investment banks have strug­gled to persuade sponsors to sign price hedges with them in these markets, after making considerable progress in the 2005-7 period.

Some US states are now targeting a minimum solar power purchase requirement, and some larger wind developers are widening their search for offtake contracts and expanding into solar, says Chadbourne’s Keith Martin. “They are looking at other places where they might be able to secure contracts and deploy their development teams, which can use the same skills to develop a solar project as a wind farm,” he says.

Lenders and developers in the US have had to adjust to spells of poor wind speeds in recent years. Some of the independent engineers that provide wind pro­duction fore­casts have revised their methodology, to take into account poorer-than-expected performance, includ­ing factor­ing in performance of turbines and the effect of turbine posi­tioning. Lenders say that, in the current market, they would generally finance deals at the P99 confi­dence level, with a debt service coverage ratio of around 1x. They may consider lower confidence levels, but they would expect higher DSCRs, for example around 1.4x for P95 or P90.

“In our experience, sponsors tend to structure their deals based on a base case of P50, but will do stress cases at P95 or P99 (varies between 1 and 10 year basis) to see if obligations can be met,” says Standard and Poor’s analyst Marc Sonnenblick, who rated Terra-Gen’s Alta wind deal, which closed in July. “Alta was structured by the sponsor using P50, but S&P’s rated case focused on wind power production at a P90 one-year level. Since debt service is paid semi-annually the one-year P-90 more accurately reflects the risks to bondholders,” Sonnenblick says. The Shepherds Flat deal is based a P90 model, mainly in order to achieve the investment grade rating needed to support a private placement, according to one banking source.

One of the aspects of the Alta deal that supported an investment grade rating was the substantial wind output history in the Tehachapi region, S&P highlights in its ratings report. “The Tehachapi region has a 25-year oper­ating history with 700MW of current generating capacity via some 3,300 installed turbines ...Terra-Gen has supplied eight years of operating data at the project sites. We believe that the extensive operating history of the Tehachapi region is positive for credit quality, as many new projects have only one or two years of data, which can lead to production levels well below forecast,” the report says.

The change in methodology of forecast providers, in­cluding market leader Garrad Hassan, highlights one area where the wind sector has continued to mature. Under-performance may be more of a risk for equity investors, but lenders are scrutinising more than ever on the reports of the forecasters.