March 2, 2010
Illinois’ Green Energy Finance Initiative
A recent initiative from Illinois may serve as a model for other states that hope to attract green energy projects and stimulate economic development.
by Marnin Lebovits, Illinois Finance Authority
There are plenty of reasons to encourage and support the development of renewable energy projects. But in this down economy, the credit markets are typically discouraging. Here in Illinois, we’ve found a way to open new doors to financing renewable energy projects because we know they’re good business–and good for our state.
Like other states, Illinois recognizes the climate and environmental benefits from generating power from renewable energy sources. We know that developing these projects will reduce our region’s dependence on foreign oil.
Renewable energy will also help to meet state renewable portfolio standard (RPS) targets. Illinois established its targets in August 2009 and requires that by 2025 one-quarter of all of the power used annually in Illinois must be generated from renewable energy sources. Of this amount, 75 percent of the renewable power used must be generated from wind projects. This requirement has created a significant interest in renewable energy projects, especially wind projects. Also, like other states our state wants, to the extent possible, to provide incentives to help reduce the cost of power generation from these projects so that savings can be passed on to ratepayers.
Finally, renewable energy projects will spur economic development and provide a secure revenue stream for many farmers and other property owners struggling during this recession. The projects will create jobs–many in depressed, rural regions of the U.S., where municipalities will also benefit from the increased tax revenue sparked by such development.
Challenges for Project Finance
Despite these benefits, developers typically face serious obstacles when they attempt to finance renewable energy projects. Capital markets continue to face severe challenges, and the ability for developers to obtain traditional project financing is much more limited than in the past. Only a handful of financial institutions will provide loans for renewable energy projects, including wind farms. Even then, the terms and conditions for the loans are quite arduous.
Most recent transactions include loan terms of only 5 or 7 years, with a 20-year amortization period, generating significant refinance risk in most cases. Developers with the ability to raise capital in other forms, either on a portfolio basis or through a rated parent entity, are forced to prioritize projects in different stages of development across the U.S. market and even around the world.
To better compete, the Illinois legislature created new financing tools to aggressively attract renewable energy projects to our state. The state’s approach might serve as a model for others hoping to attract similar types of development
The Illinois Solution
The Illinois legislature recently passed a bill adding renewable energy projects to the portfolio of developments eligible for assistance through the Illinois Finance Authority (IFA), which provides expert, hands-on support to help businesses get the capital they need for growth.
The IFA’s assistance for renewable energy will come in the form of up to $3 billion of loan guarantees for project debt. This project finance can contain long-term tenors to fully repay the project debt, thereby eliminating the risk of refinancing. The loan guarantees will be secured by the state’s moral obligation. While moral obligation is not a full faith and credit guarantee, it is a model that has been used extensively in the municipal finance markets, and it’s used often in Illinois. As of September 2009, the State has outstanding debt (unrelated to this renewable energy finance initiative) of over $100 million using this model. Eight state agencies have the ability to issue moral obligation-supported debt totaling around $1.5 billion for local governments and economic development purposes. Clearly, this is an important funding tool.
These incentives will reduce a project’s financing costs by an estimated 100 to 175 basis points. Combined with other incentives offered by the state, such as grant funding available from the Department of Commerce and Economic Opportunity for renewable energy projects, Illinois’ incentive package is drawing attention from developers. In fact, the IFA late in 2009 was already reviewing a number of renewable energy projects for inclusion in this program in anticipation of the legislation’s effective date, January 1, 2010.
Private Sector Debt Loan Guarantees
Under the first of three IFA funding models, a developer can work with its traditional project finance lenders and add the IFA as a partner, providing a “loan guarantee” to private sector lenders. The private sector lender would also have the support of Illinois’ moral obligation pledge.
Lenders will need to first look to the renewable energy project revenues to cover the debt service. If the project doesn’t generate enough revenue, the lender (or lead arranger bank for a syndicated loan transaction) may call in the IFA. The addition of the state’s moral obligation may allow the private sector lenders to extend the term of their project debt, possibly even to fully amortize the debt (based upon the tenor of the power purchase agreement) and should help to reduce the cost of the private sector financing.
In a second financing model, the IFA would issue bonds secured by both project revenues and the state’s moral obligation support. The IFA would then loan the bond proceeds to the project developer to pay for project construction. Again, the first repayment source for the debt service on the bonds is project revenues. Illinois will be called upon by the Bond Trustee to fund any debt service deficiency on a moral obligation basis. In this instance, the tenor of the bonds could be set to correspond to a final term that will be near the PPA maturity, fully amortizing the project debt. The bond investors will assume the project risk. However, investors will also benefit from the security of the guarantee of the State of Illinois on a moral obligation basis. This additional security will reduce the project’s interest rate.
A Third Option
These two models can be combined with the private sector providing a loan for a shorter-term piece and bonds issued for a longer-term piece of the debt financing. For example, the IFA can provide a loan guarantee to private sector lenders on their shorter-term financing (also known as “Series A”) and the IFA can be the lender, on a pari-passu basis (in other words, without partiality) for a “Series B” financing that will represent the debt’s longer-term portion. The combination of the proceeds from the Series A and Series B financings will provide the total debt funding for the project, thereby reducing total debt service costs and eliminating the refinance risk of traditional private sector funding.
The U.S. Department of Energy (DOE) loan guarantee program for renewable energy projects requires a participating lender (either a financial institution or an economic development authority) to share risk with the DOE. Although the IFA intends to work with projects participating in the DOE program, it is not required.
To back its push for renewable energy projects the state created the Illinois Energy Team (IET) to help review environmental and technical aspects of renewable energy projects and help expedite project development. The IET includes specialists from the state university system, Argonne National Laboratory and state agencies such as the Illinois Finance Authority, the Illinois Power Agency, the Illinois EPA and the state Department of Commerce and Economic Opportunity. This panel reviews feasibility studies and reports, evaluates technology, and considers project siting, grid interconnection and environmental impact issues. The IET will also provide a forum for developers to work with various state agencies to help projects come to fruition.
The box presents a sample of the expected terms and conditions for the moral obligation support from the State of Illinois. These terms and conditions — subject to change — represent traditional project finance criteria.
The IFA has accepted program applications for three wind projects. Inquiries have come in from developers involved in virtually all renewable energy sectors, including wind, solar, clean coal, geothermal, biodiesel and biomass.
Marnin Lebovits joined the Illinois Finance Authority as a senior funding manager in August 2009 and helped create program guidelines and credit criteria. For the last 20 years prior to joining the IFA, he has been active in municipal and project finance, managing and actively participating in the municipal and project finance groups for both Sumitomo Bank and DEPFA BANK. Mr. Lebovits received his MBA from the Wharton School of the University of Pennsylvania and is a CPA.
For more information on this Illinois financing initiative, contact Mr. Lebovits at 312-651-1344 or firstname.lastname@example.org.