The role that federal credit programs play in financing commercial activities continues to grow. According to the Congressional Budget Office (CBO), approximately $2.2 trillion in federal credit assistance is projected for 2023 of which direct loans and loan guarantees for commercial activities are estimated to total $173 billion, up 20% from $144 billion in 2022. About $85 billion of that amount is expected to be obligated by credit programs that fund medium to large scale commercial projects. In addition to those amounts, the Inflation Reduction Act of 2022 includes funds to support potentially hundreds of billions in loans for purposes such as clean energy technology commercialization, advanced technology vehicle manufacture, rural and tribal clean energy development, and energy infrastructure and transmission enhancement. Programs involved in project-finance activities are primarily housed within the Department of Agriculture (USDA), Department of Energy (DOE), Department of Transportation (USDOT), Environmental Protection Agency (EPA), US International Development Finance Corporation (DFC), and the Export Import Bank of the United States (EXIM Bank).
The value of government credit programs is in their ability to offer larger loan amounts at below market interest rate and for relatively longer tenors than available in the commercial markets. Success in obtaining funding support for commercial scale construction projects requires applicants to have a compelling business case and a thorough understanding of the requirements, application processes, and risk appetites of the various credit programs. For instance, under its Title XVII program, the DOE’s Loan Programs Office will accept a relatively high level of technology risk. However, the program’s tolerance for other credit risks is largely commensurate with that of other credit entities, public and private. Translated, this means that while LPO may, in its underwriting, accept a higher risk of technological failures associated with scaling up a plant deploying new or innovative technology to commercial capacity, it may not be willing to accept the same higher level of management, liquidity, offtake, feedstock, and operational risk.
Grant Thornton has experience at most of the federal agencies and departments responsible for administering credit programs and seeks to help private sector entities identify and successfully apply for and receive funding for their projects. This article reports on the general, financial, technical, and operational attributes that make for a strong structured corporate or project finance application. Following the advice below will help to ensure not only expediate responses from program offices but also financing approval.
- Solid well-conceived business plan: Applicants for federal credit program assistance must demonstrate a reasonable prospect to reasonable assurance of repayment, a higher risk threshold than private sector financial institutions. Nevertheless, these programs still seek reliable estimates of project future cash flows. Consequently, business plans submitted must be well conceived and supported by reasonable assumptions.
- Completion of feasibility study, front end engineering and design (FEED), and approved environmental assessment: Applicants will do well to ensure that they have developed a preliminary finance plan structure prior to engaging federal lenders. It is therefore advisable for project sponsor(s) to engage financial, engineering, and legal consultants.
- Experienced and financially stable project counterparties: Federal lenders seek confirmation that project sponsor(s) and other counterparties have the experience and financial capacity to execute on their contractual obligations to the applicant/project company. Federal lenders view favorably projects that have experienced engineering, construction, and construction (EPC) contractors, creditworthy offtakers (if applicable), feedstock suppliers with adequate capacity over the term of the loan, and operations and management (O&M) operators with strong track record operating plants of a similar nature and size. Federal lenders also have a preference for maintenance agreement(s) with the original equipment manufacturers as it helps to confirm quality and duration of warranty periods.
As to tenor of contractual arrangements, the longer the better, preferably equal to or longer than requested loan/loan guarantee tenor. While fully executed contracts are not expected and not advised at the time of application, it is important for applicants to understand terms that are potentially unacceptable to federal lenders and therefore deal killers. Applicants would benefit from providing draft agreements to programs for review prior to finalizing. Applications, under a project finance structure, that do not include any third-party supply or off-take agreements may be compared unfavorably to applications that include such agreements.
- Strong engineering, procurement, and construction (EPC) contract: Strong and effective EPC contracts are necessary for project success and therefore viewed positively. The presence of liquidated damages (LDs) and performance guarantees by the contractor (preferably a large, established, creditworthy counterparty), are indicators of a strong EPC contract. LDs mitigate adverse revenue impact of late construction completion by requiring that a specified amount be payable by the EPC contractor to the project company for each day project construction completion is delayed. Most federal lenders seek a Date Certain EPC or construction contract with sufficient liquidated damages to ensure both a commercial operations start date and sufficient funds to service debt and meet other contractual financing commitments in the event the project is delayed. For that reason, “completion” must be unambiguously defined in the EPC contract as it will have a large impact on the credit program’s assessment of construction risk.
Federal lenders will also want to ensure that completion requires the plant be in a condition sufficient to merit release of contingencies and release of the construction contractor from delay LD liability. The EPC contract must therefore set out clear and objectively measurable criteria on completion. This typically involves technical testing by independent experts, or by standard measures/tests with clearly ascertainable results to demonstrate technical reliability and performance capacity before completion is deemed to have been achieved. While an EPC contract with all these elements may not be feasible in its entirety for every project, applications that lack an EPC contract do not provide insight into key EPC terms, or which include contracts presenting highly variable costs, may be deemed weaker than comparable applications that include EPC contracts.
- Detailed construction budget: The cost of completing construction is fundamental to financial viability of any project given that project financial assumptions and model ratio outputs are all dependent on assumed cost of construction. Consequently, providing federal lenders detailed construction budgets strengthen applications, particularly for innovative projects that may face increased risk of cost overruns. The more cost detail provided by the applicant, the easier it is for programs to identify potential future challenges and develop appropriate mitigation strategies. Absence of such detail increases lender apprehension. Applications that do not provide sufficient detail in their construction budgets may fail to provide for reserves or contingencies, among other omissions. These omissions can weaken a project’s perceived financial and credit risk profile.
- Clear source of equity capital: Applicant or sponsor skin-in-the-game is a requirement of all loan/loan guarantee programs. The federal government typically provides financing support for no more than 80% of eligible project cost. Consequently, applicants should clearly identify and substantiate all sources of equity capital. The strongest applications demonstrate equity capital that is readily available and provided directly by the project sponsor or a combination of the sponsor and committed creditworthy joint venture partners. Applications that rely on yet-to-be-raised equity, equity that is contingent on yet-to-be-generated revenue from earlier phases of the project, or upon successful raising of debt may be viewed as comparatively weak.
- Market and Competition: Strong applications will provide information on their markets and competition, including data to substantiate any claims made in the application. Useful information for such consideration includes average selling prices, segmentation (to the extent that it exists) and both historical and forward-looking market trends
- Identification of all resources necessary for the project to become fully operational: Failure, by applicants, to fully identify and account for all resources necessary for a project to become operational contributes to weakness in financial models. Financial models are designed to model the project company’s expected future realities. Therefore, where critical elements such as O&M requirements, liquidity backstops, and decommissioning, are unaccounted for, it may result in overly optimistic project timelines and financial projections that do not represent nor reflect possible future outcomes, both cashflow and operational performance (as evidenced by financial ratios).
- Control over the project site: Stronger applications identify and demonstrate control over a project site, or document steps taken to establish control. Site control can take the form of an Offer Letter from the owner, Letter of Intent to Sell, Option Agreement, or a Contract of Sale. Weaker applications do not identify host sites or are very early in the siting process
- Permitting and environmental review: All federal lenders require applicants fully comply with federal, state, and local permitting and environmental review requirements, particularly National Environmental Policy Act (NEPA). These can be time consuming processes. Applicants should seek guidance to ensure compliance.
- Intellectual property rights: Strong applications demonstrate clear rights to IPs necessary to implement the project. This is especially important in the case of new and/or innovative projects. Where proprietary technology is critical to the operation of a project, the willingness of an applicant to assign those IP rights to the federal lender as collateral in the event of a default strengthens the application.
- Working Financial Model: Applicants are required to deliver a detailed financial model outlining sources and uses of capital during construction, key assumptions, revenues and expenses during operations, and debt amortization with resulting coverage ratios. A working financial model allows for evaluation and validation of project prospects for profitability and capacity to service the requested debt capital. Strong working financial models should allow for sensitivity analysis and include: i) Assumptions underlying the model; and ii) Reserve accounts for future expenses (e.g., major maintenance, decommissioning).
- Ability to monetize tax/regulatory incentives: Strong applications demonstrate a clear strategy for monetizing state and federal tax incentives where there are tax credits and certificates that cannot be used by applicants. Appropriate monetization strategies could include off-take agreements for the sale of Renewable Energy Certificates or the confirmed participation of an equity provider with the tax capacity to make use of tax incentives.
- Shareholder Arrangement (where there is more than one sponsor): A binding shareholder arrangement removes ambiguity in terms of responsibilities among shareholders particularly during periods of project stress. Federal lenders look favorably at Shareholders Agreement that details the ownership structure and the terms and conditions on which the project company is to be owned and operated with established voting rights and requirements by the respective stakeholders; b) sponsor equity funding and committed injection of capital contributions, and obligations from each stakeholder(s); and c) resolution of disputes, disposal of shares, exit strategy and change of control (if applicable).
- Pilot/demonstration plant data: For programs that support new and/or innovative technology applications, there is a requirement for applicants to submit a specified minimum of hours of operating data from a demonstration facility that uses the same technology as proposed in the project application. For the DOE Loan Programs Office, that is between 1,000 to 2,000 hours. This is essential to determining potential future plan technical performance and therefore capability to support a loan. Applications are considered weak when only limited pilot or demonstration plant data is provided, or when the data provided is from a plant design that is materially different from the one proposed in the application.
- Engineering reports: Federal lenders require that applications should include project-specific engineering report. The reports should discuss the use of the technology in the context of the proposed project and not just the that discuss the general technology. Where the application supports the deployment of new and/or innovative technology, the report should discuss and highlight how the technology as proposed in the project constitutes a new or significant improvement over existing competing technologies in the U.S. commercial marketplace today (e.g., cost, greenhouse gas emissions avoidance or reductions). The report should also discuss how to mitigate technology risk. A few mitigation strategies include warranties, production or performance guarantees, corporate guarantees, letters of credit, and performance bonds.
- Management Capability and key staff: Strong applications include detailed information that demonstrates the capabilities of sponsor(s) and key personnel. Biographical information of key personnel is recommended and should include management’s experience, expertise, history, and organizational structure, as well as roles and responsibilities. Strong applications explain how the experience and skills of key employees will uniquely contribute to the success of the proposed project.
The application process differs from program to program. At the DOE’s Loan Programs Office, the Title XVII process is phased: Part I, an assessment of technical eligibility; and Part II, an assessment of project viability. Should the project receive a positive Part II outcome, the applicant is invited into Due Diligence, a comprehensive assessment of project bankability to determine the presence of a reasonable prospect of repayment. However, for the DOE’s Advanced Technology Vehicle Manufacturing (ATVM) program, the applicant submits a single application to determine basic eligibility and project viability. For the Tribal Energy Loan Guarantee Program (TELGP) at DOE, the tribal borrower engages with a commercial lender who applies for a loan guarantee on behalf of the borrower and project. Similar processes are used for the various other federal credit programs.
Grant Thornton has supported federal credit agencies in their underwriting of applications for loan support, conducted scans for private sector clients to identify programs for which they may be eligible, and conducted post-award compliance training. Our firm has a deep understanding and hands-on experience of the federal credit space from various angles and is available for consultations with commercial entities interested in exploring and successfully securing financing through these programs. Please feel free to reach out to any of the Grant Thornton professionals listed below for further information.