The European sovereign and bank crisis has reverberated in the world of project finance. The large-scale sales of project finance portfolios by several major European banks suggest that permanent changes are under way. These conditions require sponsors and structuring banks to become far more creative in sourcing project finance, particularly for large projects.

This is best illustrated with the experience of recent renewables deals in Canada. The Canadian renewable energy market has thus far been sustained largely with the support of European project finance banks, especially in the long tenor (15-year+) range. However, the latter half of 2011 represented a low point for European lenders and liquidity dried up in the third quarter, especially in North America, with many banks unable to fund themselves in US or Canadian dollars at reasonable rates.

For Canadian wind projects this represented a significant challenge. At least two wind projects were in the process of closing financings in Quebec in the third quarter, the C$725 million ($716 million), 272MW Seigneurie de Beaupre (SdB) project and the C$240 million, 100MW Kruger Monteregie project. A third similar project, the C$455 million, 140MW Le Plateau project, sponsored by Invenergy, closed with a combination of a one-year construction facility and 10-year mini perm facility in May.

At this time the relevant CDS index of European banks, which serves as an indicator of funding costs, rose from a low of 120bp to a high of over 350bp and appetite dropped sharply. The two projects needed to raise a total of nearly C$1 billion of construction plus 18-year debt. The challenge was to finance both of these projects, which were structurally very similar, virtually on the same timetable, while maintaining the pricing and terms agreed many months prior to close.

Deutsche Bank provided the two with roughly C$400 million of underwriting commitments, was one of three documentation banks on Seigneurie de Beaupre and was sole underwriter on Kruger Monteregie.

Structural similarities

The two projects had very similar characteristics. Both were to be built with Enercon turbines, partially sourced from Germany and partially from Quebec. In each case the offtaker was Hydro Quebec. The sponsors of both projects wanted to find long-tenor financing of construction plus 18 years to lay off refinancing risk.

The sponsors of the projects Gaz Metro and Boralex for SdB and Kruger for Monteregie are all experienced in owning and operating wind farms. Combining the sponsors experience with the strong reputation for reliability of Enercon turbines and the well- rated offtaker meant that each project had robust fundamentals.

Financing sources

The Canadian PPP sector has benefited a relatively buoyant financing market in recent years, sustained by strong appetite from Canadian life insurance companies, which are willing to fund over long maturities. On PPP transactions, which are typically rated in the A- range, the life insurance companies have extended tenors to the end of the 30-year range in capital markets offerings, leaving banks able to fund only the short maturities, where revenues are based on the receipt of milestone payments from a concession grantor.

However, the life companies have typically been reluctant to play a similar role in wind. The experience of ratings agencies is more limited in this sector (irrespective of geography), resulting in less favourable rating outcomes compared to internal ratings by banks, which usually have a wealth of internal data upon which to draw.

Without the certainty of an investment grade rating, life insurance companies and other real money investors are constrained in their decision-making with respect to wind projects and, with some notable exceptions, there are few examples of institutional

Without the certainty of an investment grade rating, life insurance companies and other real money investors are constrained in their decision-making with respect to wind projects.

The exceptions are mainly in the United States, for instance the 570MW Alta Wind II-V portfolio, which was financed in 2010. But these reflect a significantly deeper pool of real money investors than is available in Canada, as well as the structural enhancements that are required to secure an investment grade rating.

Notwithstanding these barriers and with an eye on the future, some of the Canadian life insurance companies have been interested in increasing their exposure to wind, and renewables in general. The 100MW Mont Louis windfarm in Quebec was an earlier example from 2010, and the Monteregie project also secured a participation from Canada Life.

Canadian banks have also in the past refrained from participating in projects with long tenors. At construction plus 18 years, the key financing sources for Canadian renewable projects have been European and Japanese banks. As some major European banks dropped out over the course of these financings, a shortage of debt capacity appeared in the long-tenor funding market. The only ways to close the funding gap were to rely more heavily on the remaining lenders (for instance Deutsche Bank increased the size of its commitments) and to diversify into alternative financing sources.

Export credit agency cover

A unique feature of these projects was the use of export credit agency (ECA) cover, which is more often a feature of emerging markets financings. The OECD guidelines for eligibility and terms of cover for standard projects, include specific carve-outs allowing latitude for renewables projects (including longer tenors of up to 18 years), as long as they continue to meet equipment sourcing criteria. In the wind sector, certain ECAs such as Euler Hermes (the German ECA) and EKF (the Danish ECA) have been active in supporting the manufacturing activities of major wind turbine manufacturers such as Enercon, Siemens and Vestas.

Under the Hydro Quebec power purchase agreements for these projects, a certain proportion of project content had to be Quebec sourced, while the rest could be sourced from Enercons manufacturing facilities in Germany. This German content allowed the projects to work with Hermes, and a tranche of the senior debt could now benefit from the AAA German sovereign rating.

Compared to a purely commercial loan financing, the ECA route typically takes a little longer, because it has additional approval requirements, has to comply with OECD consensus rules and has a more structured process. Requirements vary based on the particular agency, but a greater focus, for example, on environmental diligence is the norm. In the current market many of the ECAs have been overwhelmed with requests for cover.

As one of the larger ECAs, Hermes has been active in providing medium- and long-term guarantees. In the first half year of 2011 alone it covered a volume of Eu8.9 billion,with an increase of 26% over 2010. This is significantly higher than some of the other active guarantors of wind farm financings, such as EKF of Denmark.

But advance planning and careful structuring are essential in holding agencies attention; early guidance on requirements from staff at an agency is useful in making the financing process run more smoothly. With these caveats, however, this process can be accommodated within a standard financing timeline.

In these cases, the additional planning paid off for the projects. Credit enhancement through involvement of Hermes had two effects: it increased the credit appetite of existing lenders and broadened the appeal of this tranche to lenders outside the niche project finance banks.

Public sector financing

Though Hermes cover accounted for a significant minority of the funding requirement, the two projects still each needed to raise a large commercial uncovered debt tranche. While the banks participating in the deal were comfortable with the credit, they were constrained by their own ability to fund the overall deal volume.

However, the nature of renewable energy as a sector contributing to sustainable economic development, combined with the reduced capabilities of the bank financing market played a role in securing the participation of state-owned entities.

The deals were strongly supported by KfW-Ipex, the German state- owned lender, which acted as a documentation agent, along with Deutsche Bank, on the SdB project. Caisse de Depot et Placement du Quebec was a member of the financing group, and Investissement Quebec, a Quebecois economic development agency, participated in both transactions.

Flexibility is key

These transactions are an indicator of the way forward for future financings. There is a fundamental shift in the project finance market, such that sponsors cannot rely upon the standard bank loan-based solutions of previous years. Flexibility is required in using different financing sources and the unique features of individual projects must be exploited in achieving this diversification. ECA-covered debt, life insurance companies and public sector funding are all likely to be an increasing part of this new world. Finally, retaining optionality in using financing sources, where possible, is more important than ever before.