In last week’s article “Banks of Mainland China Make Jack Ma Lose Sleep. Banks of Taiwan Make Offshore Windpower…?”, We have discussed the kind of “David and Goliath” scenario involved – a financial tool which uses future value in exchange for today’s cash. As for project finance, it usually involves a new startup in a burgeoning industry (remember previous example of “Startup A”, the green energy company?) wants to borrow a huge sum of money from the bank, where the loan bear with higher risks than normal corporate loans, much longer tenor, and relies heavily on future cash flow as the key repayment source and primary debt protection. Banks are major financial institutions providing funding to project finance, and in fact, they are also the highest risk takers. Given this coupled with the fact that offshore wind power (OWP) is an industry that most of them are unfamiliar with, local banks have to rely on the assistance of experts from those fields including legal, finance, insurance, construction, technology, environmental impact assessment and energy.
So what kind of risks would project finance for OWP actually encounter with so many experts working together to assist in evaluation? In the article “Why Do Investors Choose to Invest into Renewable Projects?” we got acquainted with different type of risks, and different level of risk tolerance from a variety of financial institutions. Obviously, banks have the lowest risk tolerance, which is much less than that of venture capital companies.
Banks Must Determine the Structure of Their Risk Boundaries. Otherwise, They Would Only Scare Themselves
We do have past experience in development projects in private power plants, incinerators, High Speed Rail, and Kaohsiung Rapid Transit System. Risk exist across the board including but not limited to legal, finance, insurance, taxation, construction, technology, environmental impact assessment, IT security, transportation, grid connection, etc. Therefore, to accurately evaluate the viability of OWP project financing, one must conduct a comprehensive review, discuss risk allocation mechanism or find out solutions to implement risks mitigation for those identifiable risks as stated below:
- Competence of management team/shareholders at the startup company: e.g. Financial and/or operational projection is too optimistic? Could major shareholders honor further equity injection commitment?
- Risk from changes in laws and regulations
- Failure or delay in implementing actions as promised by the public authority
- Bankruptcy of developer/fixed price turnkey contractor/equipment suppliers
- Construction & technology risks: e.g. seabed piling
- Marine safety
- Risks related to fluctuations in weather, tides, wind speed, wind direction, soil liquefaction, salt damages, and seabed geology
- Impact upon environment, fish harvesting, and ecosystem
- Losses caused by fires, typhoons, and earthquakes
- Working environment, medical care, and safety measures
- Project completion risk
- Project delay risk: e.g. grid-connection with Taipower
- Cost overrun risk
- Foreign exchange risk
- Interest rate risk
- Operation and maintenance risk
- IT security risk
- Technology transfer risk
- Testing and authentication risk
- Perfection of security interest risk
- Other events arising from force majeure
Banks Need to Upgrade Their Own Capabilities. Otherwise, They Risk Hurting Themselves
Just like starting one’s own business, even if the founder is able to evaluate all possible risks, the business is destined to fall apart if the founder does not possess necessary capabilities. The risk management system of Taiwan local banks is extremely outdated and rigid, while their lending philosophy and operational workflow remain stay in old-fashioned style of “asset-based lending” (lending relies primarily on liquidating the pledged assets as key repayment source). Lending officers will determine the size of lending purely based on a discounted percentage of the pledged assets’ assessed mortgage value. They fail to truly understand the concept of “cash flow lending” (lending relies primarily on cash flow as key repayment source) and are unfamiliar on how to utilize it effectively. If you ask a bank to play the role of either Mandated Lead Arranger or a Participating Bank in a loan syndication involving OWP companies, there are still significant room for further improvements in areas such as flexibility in decision-making, quality of bank personnel, industry knowledge, risk assessment, financial products, hedging strategies, syndication strategies, post-facto loan management, legal and tax knowledge, etc.
However, local banks find themselves sitting with plenty of idle cash nowadays. No doubt they are interested to explore new ways and long term solutions to grow the bank and the fund usage, rather than having their staff making daily phone calls and begging you to borrow money. As a result, as long as the project involves experienced and strong shareholders, comprehensive and professional financing structure, reasonable risk allocation mechanism, and Administrative Agent’s highly-regarded track record in post-facto loan management, banks will be definitely motivated to consider participation in the syndicated loans.
When someone with inadequate capabilities has the motivation to learn, the best approach will be to learn from someone who is the Ace in the field. Foreign banks – especially European banks – stand in an advantageous position in many areas in terms of experience, talents and financial products. In addition, they are highly interested to take part in the development of Taiwan’s OWP industry. Besides vying for the opportunity to become Financial Advisor for local banks, they may also serve as the Mandated Lead Banks or Participating Banks as long as the return of project finance properly and reasonably reflect the degree of risks involved and, at the same time, the project structure and relevant contracts are professionally and comprehensively fine-tuned in line with the standards of international best practices.
One side is willing to learn while the other side is willing to share experience, we would therefore suggest the finance structure of OWP projects could possibly be divided into two major parts:
- Commercial Banks Tranche
The role of Coordinating Lead Bank (including the role of Participating Bank) should be assumed by one European bank, which must have abundant OWF project finance experience. Other Participating Banks may include both local and foreign banks
- Export Credit Agency (ECA) Tranche
International export credit agencies such as EKF, EIB, and foreign banks provide guarantees or loans to support the project
Nowadays, local banks seems to have a detrimental thought, that is, “Alright! Since the government wants us to throw in money, we will reluctantly agree to finance those projects as long as the developer agrees to pay slightly higher interest rate and handling fee.”
I believe the implementation of aforementioned structure may prevent local banks from being trapped by meager profits.
Once the structure is adopted, we can sit and observe. If the sums of foreign ECA and international banks which agree to provide guarantees and/or loans exceeds 50% of entire project borrowings, this indicates the specific non-recourse project financing may have higher degree of finance-ability. As such, local banks can feel more confidence at ease to consider participating in the financing. On the other hand, if the sum of foreign ECA’s and international banks’ guarantees and/or loans is less than 50% of entire project borrowings, this means the case may have very low degree of finance-ability. And local banks should not recklessly jump on the bandwagon to lend even if the developer is willing to pay higher fees. You should then turn around and ask the developer (aka. Major Shareholders of Green startup A) to either provide their own assets or other acceptable guarantees, and change the financing structure to either normal corporate loan or limited recourse project financing.
Furthermore, all of us can be benefitted by above signal and stand in a better position to judge whether the OWP industry in Taiwan is worthy of making investment. This will help us identify and grasp crucial factors in play – representing a much better strategy than establishing the selection process to demand so-and-so percentage for localization of supply chains.
But coming to think of it, does it really exist that one side is willing to learn and the other side is willing to share experience? In the next article, we will discuss the gigantic differences in lending strategy between local and foreign banks, how to resolve their cultural differences? And the developer’s responsive strategy when local banks become cleverer and refuse to be baited by meager profits.