A look at 12 key points that explain the current state of the U.S. waste-to-energy sector.
There is a renewed interest in waste-to-energy throughout the world, but such projects have unique and stringent financing requirements. Many budding developers, particularly those from a wind, solar or real estate background, underestimate the operating and technological risk, and seek financing on conventional terms. About half the projects we see cannot be financed on any terms.
• Waste to energy and recycling projects have a high failure rate. This has an enormous influence on the reception by lenders and third-party equity providers.
• A technology provider is not enough. The project needs an EPC with the financial capacity to offer performance guarantees. The operator must be able to demonstrate ongoing operating capability.
• A technology is “proven” when it can operate on a commercial scale. Feasibility studies and white papers have no value in the financing market. Pilot plants offer some validation, but are not proof of concept. They too frequently fail at scale up.
• Most conventional project finance is real estate or asset-based, which offers a high investment recovery rate if the project should fail. Waste-to-energy projects have little or no marketable assets or real estate. A failed project is virtually a complete write-off.
• Generally speaking, lenders are not comfortable with waste to energy on a project finance basis. Smaller lenders do not understand them; larger lenders understand them, but are only interested in larger (greater than $50-$75 million) projects from larger clients with established or desirable relationships.
• Highly leveraged projects, in the current market, are a myth. We are frequently contacted by budding developers seeking high leveraged loans, and investment tax credits for the entire equity contribution. And unfortunately, some investment banks promote such nonsense.
• Eligibility for tax-exempt bond financing does not alter the loan underwriting criteria. Mutual funds and bond investors are not dumb money.
• We have seen a number of investment banks issuing term sheets for such projects. Investment banks are financial intermediaries. A term sheet from an intermediary is not only useless, it is deceitful. Only a term sheet from a direct lending or equity source that has the actual capability to write a check, has relevance.
• Many private equity firms in alternative energy state that they are interested in waste-to-energy; but what they really want is wind and solar, which they (think) they understand and is considered risk-free. Few financial investors understand the technology and operating risks behind WTE, and are ultimately willing to close.
• Developers must generally have their own early stage pre-development money.
• Viable projects require long-term feedstock and offtake agreements. Merchant facilities are exponentially more difficult to finance.
• Unlevered project IRR of high teens to mid-twenties is necessary to attract private equity.
• While investment tax credits are generally available for larger wind and solar projects, waste-to-energy is often considered too risky. Investment tax credit providers want equity returns with debt security. Their terms and conditions often conflict with and are incompatible with debt.
Kapolei, Hawaii: ?Six months ago, Island Pacific Academy was like many start-up independent schools. Even though it had enrolled 650 students PK-11 in four years of existence, it struggled to meet the debt service on a $20 million bond issue amidst rising costs and the stagnant enrollment of the current recession.? Today, the School has cash reserves and completed the purchase of its property. The debt remains, but the debt service is more manageable, given the school?s comparatively low tuition and enrollment.? How did they do it?
“Bond math 101”, says Nick Prassas, financial advisor to the School.? ?Two years ago, the School sold a bond issue at par, at a low fixed interest rate.? When the credit crisis hit, interest rates spiked higher.? Higher interest rates, lower bond prices.? The School was able to negotiate the repurchase of its bond issue from bond holders at a substantial discount.?
Of course, the School still needed a source of funds to buy back their discounted bonds.? That source:? federal stimulus dollars from the United States Department of Agriculture.
“We were at the right place at the right time,” says Stuart Hirstein, Associate Headmaster and Chief Operating Officer.?? ?The USDA, which provides rural community facilities financing, became one of the conduits for disbursing federal stimulus funds. The agency, having guaranteed a loan for the School several years ago, was already familiar with our financial profile.? We made our request just as stimulus funds were being allocated.?
The USDA funds came in the form of a direct loan, and a loan guarantee.?? The direct loan carries an interest rate of 4.5%, repayable over forty years, instead of the customary thirty.
“It sounds straightforward, now that we’ve closed the transaction,” says Dan White, Headmaster of the School. “The USDA program is designed to support new community initiatives.? Fortunately, IPA had received a five-year grant from the Hawaii Community Foundation in their Schools of the Future program. The Schools of the Future process will, in fact, transform our school and represent a genuinely new initiative. Putting the deal together, though, required long hours and hard work by several knowledgeable people.?
The notion of a school capitalizing on the USDA stimulus program to buy back their own bonds at a discount, just one year after selling them, is novel.
?Obviously the recession provided fertile ground for thinking outside the norms of independent school finance,? added Prassas. ?Everything we hear, though, about independent schools in the post-recession world would suggest that the old norms are not likely to return.?
?The schools of the future?15 to 20 years down the road?might well look very different than today.? Why wouldn?t school financing evolve in a similar fashion?? asked White.?We still need to make enrollment targets,? continued White. ?The debt service is still a huge chunk each month.? We continue to be frugal; we have to be. But we have a huge asset?our land?that we did not have before, and there is great security for the school in that fact.?