Teal blue graphic

Bank loans in the new era without subsidy need careful planning

A major challenge facing developers as government support for solar power disappears into the sunset is making their future projects attractive to lenders.

Many are already casting their minds beyond July 2017, when the financial help essentially finishes and the sector must fend for itself as a contributor to the National Grid. 

Solar projects are always highly scrutinised because there is not much value in the underlying tangible asset for a funder to sell if things go wrong. It is in that respect unlike lending to a business with a property or holding physical stock, say; or even to a householder who takes out a mortgage. 

The value of a Renewable Obligation Certificate is in part precisely because it allows investors, bankers included, to build a financial model based on a fixed income stream. Developers looking ahead must in their planning be sure to compensate for the absence of such security. They need to be aware that although funders are just as willing to lend they will expect proper preparation. It helps to understand relative appetites for risk, too, which is something often not taken into account.

Because they rely on future revenue of the project, funders are not just looking at whether a project can be built, but at all the contracts in place to underpin its revenue over perhaps a 25 year repayment term. That income is the nearest to security they have for their loan.

Fortune does not favour the brave to secure funding in this situation, it favours the diligent. Not surprisingly, there is often a tension between shareholders in a project, who might be putting up a small proportion of the development costs, and funders likely to be lending the bulk of it, because of the relative imbalance of risk.

As a result, lenders will always need to pore in minute detail over every single contract to protect their position. This means not just those dealing with the construction phase, including sometimes what components will be used, but those that cover planning permission, lease arrangements with landowners and connection agreements to a distribution network operator. 

They will also expect to have a direct contractual relationship with contractors appointed by the developer so that, in the event of a default, the funder has the right to step in to keep a project going.

Developers should also expect requirements for regular updates on how a project is proceeding and running subsequently. This will include amounts spent on maintenance and details of any insurance claims. 

And much of all that is before a lender even looks at the revenue from generation itself to make sure there is enough to meet repayment obligations.

The reason funders engage so closely is because the level of risk they are assuming is far higher relative to the return they can expect to receive than it is for shareholders. Funders only ever get their money repaid with interest and fee income, whereas a developer can look forward to a much greater return. This makes for different perceptions. 

Lenders will, in short, want to identify every single potential problem that they possibly can, however remote, and then to mitigate or minimise it before they agree a loan. One wind farm proposal foundered when it was discovered that a planned site was subject to ancient mining rights established hundreds of years ago and owned by a Lord of the Manor unconnected to the land ownership. The rights holder could, theoretically, have claimed his ability to exercise rights to mine was threatened by the structures proposed and tied the whole scheme into legal knots with claims for compensation. 

But developers who plan with detail and contractual certainties in mind will find plenty of interest from lenders. 

Projects need to be fully prepared

Advance preparation helps the due diligence process. Apart from anything, anticipating what a lender will want saves legal and accountancy fees.

The experienced developer can use contracts prepared for the process of a type the funder they are approaching has already approved. This also saves the time it will spend with lawyers on both sides. 

The process of due diligence generally favours larger projects. The deal costs associated with a £1 million proposal and those for a £10 million proposal are broadly similar in terms of assessing risk.

But size is not everything, and not every project comes from an experienced developer. Community schemes may not have a well of expertise from which to draw, but they can make hire professional advisers who do.

Whatever else the future holds for lending to solar, it is just likely to favour developers with a portfolio of working sites in terms of preparation. They can often take a ‘cookie cutter’ approach to the lending process: using essentially the same suite of documents to support their business case each time. These will also offer the same technologies and often the same contractors as used successfully by them before. A repeat portfolio is reassuring to a lender.

For others, the key to getting a project off the ground is securing legal and technical expertise early, and before approaching a lender. They should also make sure to contact the lender ahead of a formal approach to find out what their minimum requirements are for a loan. There is no point in presenting a case that omits something central from the funder’s perspective. 

Lack of preparation and of understanding that a lender is approaching a project from a different perspective to a developer can simply undo a proposal.

Funders essentially just want to know that a project is viable, which means making sure that the fundamentals to a project actually working are in place before approaching them. 

The first of these is local authority planning consent. The second is a grid connection offer from a distribution network operator, because the cost of a grid connection is a key determinant of whether a scheme is viewed as workable. And the third is land rights. They at least will expect to see that an option has been given by a landowner for an installation which can be exercised once funding is in place.

Lenders will scrutinise every detail

In addition to these basic requirements, a funder will also want to see construction contracts and a power purchase agreement that would start from completion. 

Developers need to be aware that funders will also assess the revenue stream of a project for the entire length of a loan. This loan life cover process is crucial to the decision they will reach, and will decide whether a loan is ultimately made. It is vital to get advice about passing the assessments that will be made by the funder using complex financial models.

Essentially, in addition to risk being squeezed out as far as possible, funders are looking for clear signs of efficiency. They always have done, of course, but this will become a more acute focus as the overall risk is perceived to be greater without the protection of subsidy guarantees.

But there is plenty to play for. It is not just energy generation projects that offer a bright future. Funders are increasingly open to investing in energy storage. The fundamentals will once again apply for securing a loan. Lenders will want to be sure that a battery storage scheme does not, for example, breach historic planning consents. There will also need to be careful scrutiny of arrangements with landowners and securing their express permission to allow storage units to be constructed.

The integration of storage units also raises many contractual issues, particularly with regard to purchase arrangements with the National Grid. There are also likely to be agreements with distributors affected by changes to the times that energy was carried and released.

But there is no doubt that the falling costs of battery storage, and signs of growing capacity, are going to change the way developments are assessed for funding, stimulating investment opportunities. Funders are keen to be involved with this, which makes it a good time to be seeking loans.

At the moment, working through storage issues resembles a Rubik’s Cube: All the sides are there, but getting them matched is proving difficult. This is largely thanks to an absence of precedent and the fact that most storage options are still more expensive than generating it in the first place. The difficulties will plainly be overcome, particularly as there are clearly potential revenue streams. Furthermore, incentive exists for storage to grow because it will allow for solar to play a bigger, more reliable role in balancing national supply and demand for energy. 

So the good news is that a well prepared solar project of any kind, presented to a bank in a way that it wants, will secure funding just as it has always done. There is no loss of lender appetite for solar, but there is going to be more scrutiny every step of the way from construction to delivery and revenue protection. He who prepares, wins.

First published by Solar UK on 17 November 2016.

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at November 2016. Specific advice should be sought for specific cases. For more information see our terms & conditions.

Insights & events View all