Page 1 July 2014 Capacity Building of Banks/FIs For EE Project Financing Capacity Building of Banks...

July 2014Capacity Building of Banks/FIsFor EE Project Financing

Capacity Building of Banks and Financial Institutionsfor Energy Efficiency Project Financing

Module 4 Project Appraisal

Partnership to Advance Clean Energy-Deployment (PACE-D)Technical Assistance Program

September 2014


• Introduction

• Project Appraisal

• Loan Security Considerations

• Developing Financial Products

• Risk Assessment and Mitigation

• Establishing an Energy Efficiency Business Unit

Presentation Outline


• Strengthening technical competencies - Feasibility, knowledge gaps, credibility

• Evolving technical appraisal techniques for EE Projects – Minimum technical safeguards to ensure servicing of debt

• Adopting the cash flow approach for financing - Departing from asset-based financing models

• Adapting financing mechanisms to EE business models - Different business situations and business strategy

• Leveraging existing customer relationships – Incorporating EE financing in corporate lending

• Devising sound Payment and Security Structures - Financial mechanisms for improving credit rating

• Standardizing Energy Services Agreements - Overcoming contracting problems, evolving Contract Template for EE Project

Increasing EE Project Lending – Key Considerations


• Who is the borrower – project host or ESCO?

• What is the structure of payment obligation? Fixed, pre-established Variable, performance-based

• If performance-based, what is the method for measuring/calculating performance/savings? Measurement & verification procedures Changes to the “Baseline” Energy price risks

Other factors influencing savings

• What are the major risks?

Considerations in Project Appraisal


• Promoter appraisal

• Technical appraisal

• Economic and financial appraisal

• Environmental and legal appraisal

• ESCO appraisal

• Risk identification, assessment and mitigation

General Framework - Project Appraisal


• Banks have their own unique appraisal schemes

• Sample checklist of required information will be provided in Guidelines

• Topics included:

General information on the organization

Financial and operational details

Promoter background

Management and organizational set-up

Promoter Appraisal


• Key questions Are the technologies/products proven? Who has developed the savings estimates? Are the savings estimates realistic? Are there any factors that may impact the savings?

• Technical appraisal should include: Evaluation of the products and technologies Assessment of savings calculation procedures Consideration of risks and uncertainties in the savings estimates

and project implementation plan

Technical Appraisal


• Includes assessment of: Project development costs Project capital costs Operating and maintenance costs Energy cost savings Other cost savings Escalation factors Financial structure Promoter or ESCO equity investment Sharing of savings between host & ESCO

Economic and Financial Appraisal


• Procedures for appraisal similar to other investment projects

• Environmental: Assessment of possible environmental impacts Determination of need for permits/clearances Obtaining needed permits/clearances

• Legal: Statutory approvals Legal documentation

Environmental and Legal Appraisal


• Basic ESCO Assessment Firm structure and organizational information Qualifications and experience; BEE accreditation Financial and operational information Past track record with performance contracting

• Client references Project completion on time Project costs – estimated vs. actual Guaranteed vs. achieved savings Client satisfaction

ESCO Appraisal

Loan Security Considerations


• Most EE equipment has low collateral value Equipment typically 60-65% total project cost Equipment generally uneconomic to remove & use elsewhere Finance security needs to be based mainly on end-user credit, not

equipment asset value

• Positive Credit Features of EE Projects Equipment represents “essential use”, increases willingness to pay EE projects reduce operating costs, increase ability to pay EE projects generate savings and improve bottom line

EE Project Equipment as Collateral


• First security interest in project/equipment

• Full faith & credit obligation of end-user Preferred drawing right on end-user account Assignment of key end-user revenue stream

• Real estate Mortgage where project is installed

• Vendor Recourse equipment repurchase or remarketing commitment direct guarantee, cash reserves

• Additional collateral from end-user/borrower

Loan Security – End-User as Borrower


• First security interest in project/equipment

• Assignment of Energy Services Agreement (ESA)

• Must examine end-user credit

• Structure ESA to include fixed payment for debt service

• Escrow of end-user payments (TRA account)

•Recourse to ESCO & ESCO parent company

• Cross-default provisions for project portfolio

• Cash Reserves for debt service, repairs, etc.

Loan Security - ESCO as Borrower


• Are they well-capitalized?• Do they have parental company support or private equity/external

investors on board?• Do they have well-defined cash inflow sources?• What is their financial capacity to meet time delays and cost overruns?• Is the financial plan adequate to address both project and working

capital needs?• How can the lender minimize recourse to non-project assets &

personal guarantees?

Reviewing Financial Capacity of Borrowers


• Earmark, securitize or escrow cash inflows to service debt

• Ensure suitable tri-partite contractual protection for performance and payments through ESAs

• Structure cash collaterals (e.g. deposits) or over-collateralize (e.g. escrow more than needed for servicing)

• Follow best practices from equivalent bank asset products (e.g. rental securitization, power projects)

• Take protection from partial risk guarantee facilities such as BEE’s PRGFEE

Devising Payment and Security Structures


• Structuring contracts to protect interests of borrowers & lenders against payment defaults

• Adhering to specific protocols vs. standard contract template

• Ensuring clear-cut measurement and verification (M&V) and payment procedures

• Mitigate causes for disputes & litigation

• Protecting lenders interests directly in the ESA itself

• Identifying and assigning risks

Standardizing Energy Services Agreements

Risk Assessment and Mitigation


Project Risks


• Confirm that the products, equipment and/or technologies are well established and proven; review benchmarks

• Review and assess prior experience of the implementing organizations with the technologies, equipment and products being proposed

• Verify credentials of the energy auditors• Assure that project meets the appropriate design standards

specifications • Obtain client references, where appropriate, for similar project

implementations• Use of contractors that guarantee their performance and offer fixed

prices

Assessing and Mitigating Technical Risk


• Assess creditworthiness of both the host and the ESCO

• Examine the ESA and assure that it has adequate assurance for cash flows that will be used to repay the loan

• Establish payment security mechanism such as escrow account or TRA

• Develop customized financial products

• Implement schemes to adequately collateralize project assets

Assessing and Mitigating Financial Risk


• Verify experience of project management and construction management organizations and individuals

• Assure that sufficient time has been allocated for permits and licenses

• Verify ESCO’s track record in implementing projects on time

• Use lump-sum contracts with penalty clauses for failure to meet committed deadlines

Assessing and Mitigating Construction Risk


• Assure that ESA contains performance guarantees (given by both the ESCO and the equipment suppliers) are measurable

• Review structure of performance guarantees

• Assure that an adequate M&V plan is in place

• Confirm that a baseline has been established for M&V

• Use third party M&V agent

Assessing and Mitigating Performance Risk

Ramasamy, Sujata

Establishing an Energy Efficiency Business Unit


• Identify the target market characteristics

• Define typical project characteristics

• Develop innovative financial products for the market

• Facilitate the development of a pipeline of attractive projects with creditworthy customers

• Design and implement a plan for marketing, project investment preparation, & market aggregation

• Develop project appraisal guidelines and procedures

• Organize and provide technical assistance to loan officers

Functions of an EE Business Unit


• Technical characteristics

• Project economics

• Typical size of individual projects

• Typical credit characteristics of end-users & borrower(s)

• Credit structure of financings

• Credit enhancement strategies

• Collateral/asset value of EE equipment

• Projects risks and plan for assessment, allocation & management/mitigation

• Financial structuring

Defining Project Characteristics


• Based on target market characteristics credit characteristics typical deal size & attractive economics Ability to assemble acceptable security package

• Define loan offer(s) term, pricing required security structure, with guarantee economic parameters: e.g., size, % own funds documentation requirements

• Prepare marketing plan, identify/do initial deals, train branch staff network

Developing Financial Products


• Waste heat recovery and cogeneration

• Lighting, cooling and controls for buildings (particularly hotels, hospitals and shopping malls)

• Motors, pumps etc. in industrial facilities

• Streetlighting

• Municipal pumping

• Off-grid renewable energy projects

• Fuel substitution in industry

• Chauffage or outsourced energy management

Customizing Financial Products to EE Projects


• Establish relationships with qualified ESCOs and equipment vendors

• Assess capabilities and experience

services/products offered; business methods

target end-user market & customer profile

reference projects & current pipeline

financing needs, capital demand estimate

• Select initial companies & projects to prepare for investment: provide finance structuring assistance

• Structure multi-project finance facilities to reduce transaction costs

Working with Energy Service Providers


• Establish relationship with equipment vendor or manufacturer

Vendor offers deal pipeline to lender/lessor

Financing can be marketed at point of equipment sale

Standard origination documents, end-user credit screening & analysis processes & criteria

Vendor can help process loan/lease transaction & absorb some transaction costs

Simplifies transaction from customer perspective

• Vendor may act as lessor & match primary lease with assignment or sale/lease back with bank

Vendor Finance Programs


• Credit facility for financing current and future projects

• Revolving credit line based on signed contracts with customers

• Drawdown conditions based on expected project costs and cash flows

• Specification of project economic parameters such as project size, debt/equity ratio, debt service coverage, sharing of savings, etc.

• Security could be combination of ESCO balance sheet, parent organization, and project cash flows

Establishing Credit Line with ESCOs


• Master Loan Terms Standard origination

procedures Lender evaluates and

approves end-user credit Standard sub-loan

documentation Recourse to ESCO & to

ESCO parent (if applicable) Construction finance;

disbursement procedures Pricing, fees

• Security Requirements Assignment of project

assets, contract rights, revenues

Project flow of funds; escrow account; priority of pmts

Debt service reserve considerations

Other recourse & collateral; end-user credit standards

Cross default provisions between projects

Establishing Credit Line with ESCOs

Thank you

Dilip R. LimayeFinance Team Leader

USAID PACE-D Technical Assistance Program

[email protected]

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