In the energy sector, projects that don't fall under utility-scale or residential categories are typically classified under the catch-all segment of commercial and industrial (C&I). This broad classification can obscure the nuanced differences within the segment. In prior blog posts, we explore the shift to "true C&I" and the various challenges in financing these projects. Developers must collaborate with financing partners who understand the nuances of C&I. Rigid underwriting in C&I financing overlooks the unique aspects of each project, often disregarding potential revenue streams and resulting in sub-optimal financing terms for sponsors.
Financiers determine how much to lend based on the Cash Flow Available for Debt Service (CFADS) after a project has covered all relevant operating expenses and senior investors, like tax equity. They apply a Debt Service Coverage Ratio (DSCR) to decide the amount to advance against expected CFADS, a process often referred to as "Debt Sizing."
Determining CFADS & Debt Service Payments | Key Inputs to Determine Total Proceeds |
---|---|
Inputs:
Formula (annual figures):CFADS = sum(revenue) minus sum(expenses)
Debt Service = CFADS / DSCR |
|
*In the event the Term is shorter than the Amortization Period, this is typically called a “Mini-Perm” structure where a balloon payment would become due.
When determining a project’s expected CFADS, financiers have discretion over what qualifies as "eligible revenue." For example, some lenders may exclude revenue from storage assets due to concerns about battery performance risks. This practice reduces the revenue a sponsor can use to repay debt, limiting total proceeds. Additionally, debt proceeds are impacted by financing terms. Some lenders arbitrarily limit amortization periods, meaning contracted revenue sources may not be fully accounted for, regardless of their contracted term.
Consider a project that includes installing electric vehicle (EV) charging stations. Traditional lenders might disregard cash flows from these charging stations as repayment sources because they lack long-term contracts. However, the rising demand for EVs and increased usage of charging stations indicate significant revenue potential over time. If financiers were to credit even a small portion of this revenue stream — using a Debt Service Coverage Ratio (DSCR) of 2.0x, for example — it could substantially boost the proceeds available to the project sponsor. This additional credit could be the deciding factor between the project's success or failure due to insufficient funds.
Standard underwriting for C&I solar projects often follows a checklist approach with predetermined values or assumptions for the inputs above. Rigid underwriting reduces debt proceeds by not considering each project's unique aspects, leading to suboptimal financing outcomes due to a lack of risk-adjusted flexibility and a one-size-fits-all approach that overlooks specific project variables.
To illustrate this, let's consider Donnie the Developer, who is working on a project that includes solar, storage, and EV charging. While the solar and battery assets are fully contracted for 20 years, the EV charging revenue is not contracted. The financing parties, constrained by their underwriting manual, set amortization at "the lesser of 15 years or 80% of the contract term," which arbitrarily results in a 15-year amortization period. Additionally, the lender excludes any revenue from EV charging.
Donnie’s proceeds are significantly limited by these rigid practices. Adopting a more nuanced approach would substantially increases his proceeds. First, amortization could be allowed for the full contracted term, considering that the useful life of these assets exceeds 20 years. Additionally, financing parties could apply a more conservative DSCR of, say, 2.0x specifically for EV charging revenues, providing some credit for this cash flow. As a result, Donnie could see a significant increase in total debt, potentially by 10% or more.
This flexibility enhances financial outcomes for Donnie by increasing project feasibility and attracting broader access to capital. By tailoring financing terms to the unique aspects of each project, Energetic Capital ensures developers like Donnie can optimize their projects, secure necessary funding, and contribute to the growth of sustainable energy solutions.
Comments