In our last post, we explored how the corporate power purchase agreement (PPA) market is evolving, with the rise of off-balance-sheet structures and increased demand for credit-enhancement tools.
Today, we’ll dive deeper into how these tools are applied, offering insights into their benefits and costs through real-world examples.
Why Credit Enhancement Matters More Than Ever
Whether to address credit risk concerns or to free up balance sheet capacity, credit enhancement tools are becoming essential for corporate PPAs. Here’s how they are reshaping the landscape:
Offtaker Insurance to Backstop Revenue: These policies guarantee revenue streams, protecting projects against unforeseen shortfalls.
Mark-to-Market Insolvency Coverage: Insurance can cover damages owed if a counterparty defaults, ensuring project viability.
Applications in Sponsor and Lender Scenarios
Sponsor Cases
Sponsors are leveraging credit enhancement in several ways to stay competitive:
Reducing or Eliminating Credit Support Requirements: By offering credit insurance, sponsors can reduce or eliminate the need for credit support. However, having some level of credit support significantly impacts the policy premium. In this scenario, costs are typically passed along to the offtaker in the form of a higher rate—offering a trade-off of no posting requirements for the offtaker.
Supplementing Internal Credit Requirements: Sponsors often require 100% of their offtake to be investment-grade (IG). Credit insurance can help meet these internal credit benchmarks, though it’s not always the easiest sell. In many cases, sponsors absorb the cost of the policy.
Customized Solutions: Specific cases often present unique permutations of these strategies, offering tailored flexibility based on project and participant needs.
Lender Cases
For lenders working with sub-investment-grade or unrated offtakers, credit enhancement plays a vital role:
Revenue Sizing for Debt: Lenders set revenue expectations for the project based on a "minimum merchant rate," calculated as the difference between:
(A): The discounted sum of contracted revenue at the VPPA/Strike price.
(B): The discounted sum of contracted revenue at the "minimum merchant rate."
Credit Support Gaps: When Buyer Credit Support in the PPA isn’t sufficient to cover this gap, lenders may reduce loan sizing or refuse to move forward.
Credit Insurance as a Solution: A credit insurance policy can fill this gap by covering the difference between expected revenue (Covered Periodic Payment or CPP) and actual revenue during defined billing periods following offtaker default.
The CPP is usually set at 1.0x coverage of P99 revenue, ensuring all obligations of the project are covered.
The policy limit is calculated as the total credit support required, less existing Buyer Credit Support.
This approach allows lenders to provide more proceeds to borrowers, offering a capital-efficient alternative to requiring sponsors to post collateral. While obtaining additional Buyer Credit Support is another option, it’s typically less feasible.
What Are the Benefits?
Off-Balance-Sheet Flexibility: Companies can reduce reliance on letters of credit (LCs) or cash collateral, freeing up liquidity for growth.
Broader Offtaker Access: A wider pool of eligible participants often translates into more competitive pricing for PPAs.
Enhanced Financing Confidence: Credit enhancements reassure project stakeholders, from lenders to tax equity investors.
The Cost-Benefit Analysis
While these solutions come with associated costs, the savings in opportunity cost often outweigh the expense. Companies can maintain commercial terms while unlocking capital previously tied up in guarantees or collateral.
For example, in sponsor cases, passing costs to the offtaker can provide immediate liquidity benefits without requiring a posting requirement. For lenders, credit insurance enables greater debt sizing, ensuring project viability and long-term success.
Strategic Necessity for the Future
As the corporate PPA market continues to mature, credit enhancement is no longer an optional tool—it’s a strategic necessity. By enabling broader participation, mitigating risk, and enhancing financing options, these tools are helping shape the renewable energy landscape.
How is your organization leveraging these innovations to stay competitive in the renewable energy landscape?
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