The Name is Bond, part II: Financiers find biofuels financing options in bond market
In part one of “The Name is Bond” we looked at the crisis in biofuels financing, its causes and included an overview of possible solutions. Today, we look in more depth at a particular bond-market solution developed by a team at Stern Brothers, Mintz Levin and Kreig DeVault, which has the potential to clear the logjam that has been bedeviling the industry since 2008.
The crisis
Although equity investors (primarily strategics and venture capitalists) and the government grant market has continued to participate strongly in biofuels investing, the debt market that typically represents up to 80 percent of commercial scale financing has virtually shut down.
In part, the crisis stems from the general lack of bank liquidity since the global financial meltdown of 2008, but the problems in biofuels are more complex.
In project finance, with interest rates in the 6-8 percent range, just a few hundreds of basis points above rock-solid Treasuries or rated corporate debt – banks cannot afford more than a 1-2 percent default rate, else they are driven out of business, or at least into crisis mode. Conversely, 12-15 percent rates that would cover the bank risk, would drive biofuels projects into the ground.
The guarantor
Biofuels projects have risk all over them. There is feedstock risk – of the type that drove VeraSun Energy and others into bankruptcy and liquidation. There is offtake risk – where uncertain prices at the pump give wildly differing scenarios on how much money a biofuel project can sustainable repay. There is also the “first-of-kind” technology risk. Locked in commodity contracts can help with the market risk of feedstock and off-take, but the technology risk is difficult to get around. As one wag put it, “the banks are lining up to finance everyone’s second project.”
Enter the guarantor. It isn’t much different in theory than a student loan – where the student, though headed for a (hopefully) high-paying job in the future, lacks the credit history or income to justify a high-ticket loan for tuition. So, the guarantor steps in to absorb the risk, usually a family member.
Because biofuels projects cost in the hundred of millions, the “family member” guarantor of choice, in the US, is Uncle Sam – the one with the balance sheet and the policy interest to make commercial biofuels happen.
The government has developed a number of biofuels loan guarantee programs. They have not worked out. “U.S. $65 Billion in ARRA funds, without considering substantial separate appropriations, has been committed to renewable energy projects and clean technologies, and to date, only U.S. $18 Billion has been issued by the DOE and other US funded agencies,” states Morgan Stanley, adding that “the total CAPEX required for US renewable energy projects is expected to be approximately U.S. $15.8 trillion.”
Yet only a handful of projects have received DOE loan guarantees. The USDA has had several small loan guarantee programs, and recently the 9003 program was developed out of the 2008 Farm Bill, but they have not been able to translate policy ambition, and loan guarantee authority, into dollars on the street.
There are fee issues, processing issues and structural issues, but the structural issues are the most difficult to resolve.
The ‘Bigger projects, smaller banks’ problem
At the heart is the system of ag banks that have historically participated in USDA “business & industry” loans. They are generally small, far too small to take on either the complex due diligence and the risk associated with, ultimately, trillions in financing opportunities.
Also, there are DOE and USDA program restrictions, which have reduced the universe of lenders who can and would work within the program. In short, lenders have fallen by the wayside and the bank market simply isn’t there.
The Fix: the Stern Brothers, Mintz Levin, Kreig DeVault solution
1. The lender steps outside of its traditional role of lending its funds to an eligible borrower.
2. Instead, the lender (the team confirmed that it expects to use a commercial/investment bank and have “a top 5 major commercial bank working with us”) acts as a trustee.
3. In this role, the project company issues taxable corporate bonds (placed by Stern Brothers) to accredited investors (but $1 million net worth investors–under SEC rules– would represent the floor, while generally the bonds will be placed/sold to institutional investors).
4. The investors place the purchase/sales proceeds into an account with the trustee bank. The trustee bank then on-lends the bond proceeds into the project.
5. The USDA and/or DOE, as part of the financing, places the loan guarantee(s) over the bonds.
6. Thus, the generally low-rated bonds essentially would become AAA-rated under the full faith and credit of the US government.
7. The trustee bank would hold legal title to each of the bonds, mortgages and other required project security during the entire term of the bonds and loan guarantee(s).
8. The bond holders similarly would hold beneficial title to the bonds during the same periods.
9. The bonds approximately would have up to a 2% lower interest rate than the 7% plus currently available as commercial lending rates.
10. They would have maturities of 15-25 years, instead of the 1-7 year tenures which banks currently are forcing renewable energy projects generally to accept (and which shorter tenures will not permit the proper amortization of such projects).
11. Only the Treasury’s Federal Finance Bank offers better terms, at interest rates of 22-75 basis points over Treasuries (or approximately 4%) and tenures of 20-30 years, available solely for the DOE Section 1703 Loan Guarantee Program (for certain new and unique technologies) and only when DOE agrees to 100% coverage of up to 80% of total project costs.
12. The program is designed to work under the USDA’s section 9003 program, or the DOE’s 1703 program under many circumstances, the DOE’s 1705 program, or the USDA’s B&I or REAP programs. A good comparative for all these programs is this comprehensive presentation from Mark Riedy of Mintz Levin.
Why Bonds?
1. Bond financing is much more flexible than commercial debt. It does not run into many of the problems/regulatory restrictions facing lenders who will agree to look at and participate in these loan guarantee programs at the USDA and the DOE.
2. It also permits the trustee bank to participate with very little risk.
3. Further, if additional costs or CAPEX-bearing applications/equipment/build-out must be considered in the project, the project company would not need to increase an existing loan or locate an additional loan, rather it merely must place additional bonds to secure additional proceeds.
More on the DOE 1703 Loan Guarantees
1. Section 1703 of Title XVII of EPACT, as expanded by EISA, authorizes loan guarantees for renewable energy and certain other projects that employ “new or significantly improved” technologies.
2. Section 1703 authorizes loan guarantees for renewable energy and certain other projects.
3. Eligible projects must “avoid, reduce or sequester air pollutants” and “employ new or significantly improved technologies” rather than commercial technologies.
4. A principal goal of Section 1703 is to encourage early commercial use in the United States of new or significantly improved technologies
5. Section 1703 does not specify a deadline by which projects must be constructed.
6. Section 1703 authorizes loan guarantees only for projects that avoid, reduce or sequester air pollutants or greenhouse gases and employ new or significantly improved technologies.
7. Eligible projects include alternative fuel vehicles; efficient electricity transmission; distribution and storage; energy efficiency projects; solar, wind, biomass, hydro and geothermal power technologies; and advanced biofuels production facilities.
8. “New or significantly improved technology” is defined as not more than two substantially similar technologies in commercial operation in the U.S. in the past five years.
9. Private borrowers and project sponsors are applicants, not private lenders.
More on the USDA Section 9003 loan guarantee program
1. On November 19, 2008, the USDA issued a competitive FOA requesting applications for loan guarantees under the Biorefinery Assistance Program (Farm Act 2008, Title IX (amending Farm Act 2002), Section 9003–Biorefinery Assistance Program), authorized by the Food, Conservation, and Energy Act of 2008, (“Farm Act 2008”).
2. This was the Program’s last major funding announcement, and another is expected soon.
3. The Program is funded through FY 2012.
4. The Biorefinery Assistance Program is designed to promote the development of new and emerging technologies for the production of advanced biofuels. It provides loan guarantees for the development, construction and retrofitting of viable commercial-scale biorefineries producing advanced biofuels.
5. The maximum permitted loan guarantee is $250 million per project, and may cover up to 80% of the project debt, subject to the availability of Congressionally-appropriated funds. This coverage shortly may be increased to a limit of 90%, and other changes could occur, through an anticipated USDA proposed rule.
6. Preference will be given to projects where first-of-a-kind technology will be deployed on a commercial scale.
7. Advanced biofuels are defined as fuels that do not rely on corn kernel starch as the feedstock. For example, cellulosic ethanol may be produced from switchgrass, corn stover, forest waste, animal waste, food waste, yard waste, fast-growing trees, woodchips, canola, algae and other plant material rather than from the edible portion of crops such as corn. It also will include butanol or other alcohol fuels and biogas (e.g., from landfills, sewage) manufactured by converting organic renewable biomass, biogas, and green diesel and green gasoline produced from renewable biomass.
More on the subject
For an excellent overview of the compete array of bioenergy (and renewables) credits, grants, loan guarantees and mandates, Mark Riedy of Mintz Levin gave this excellent overview in March.
Key contacts for the program
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