Mike Garland, ceo of Pattern Development and president and ceo of its yield company, Pattern Energy Group (PEGI), discusses the latest trends in project finance and gives his view on the state of yieldco equities in the second part of this exclusive interview with Richard Metcalf, editor of PFR.
PFR: We have been hearing from market participants that pricing on project loans has increased slightly this year, in part as a result of increased costs of funds for commercial banks, especially those in Europe. Have you noticed this and has it had an impact?
Yeah, we feel like it’s ticked up a little bit. They’re using Basel as an excuse. We think it’s baloney for the most part. In years past, we’ve always seen this cycle of margins expanding and contracting for project financings by banks and I think we’re just seeing a little resistance right now with banks wanting to maintain the margins, because they’ve been coming down over the last couple of years. Up until this last six months, we’ve been seeing really excellent spreads and there has been a little bit of pushback on spreads in the last three to six months. But some banks are—I think it’s a little bit about which banks—some banks are still moving the margins down a little bit and other banks are trying to push back and blame the regulators for their cost of capital.
PFR: Are you able to give a numerical figure to put that in perspective?
We’re not talking about much. We’re talking about 10, 15 basis points.
PFR: That’s the pushback in the last three to six months?
Correct.
PFR: And what about tenors on term loans, or back leverage if tax equity is involved? Bankers tell me you can still get 18-year term loans for projects with 20-year contracts, but they also say sponsors are comfortable with mini-perms and the refinancing risk associated with that.
We’re seeing some banks going out 18, even 20 years, depending, as you say, on the PPA term. There are some who can get out there even longer than 20 years. The majority of them though are under 20 years, and a one to two year tail before the PPA expires on the term of the debt.
The bond market is still pretty good if you have a longer-term PPA. We’re seeing a little bit more of the combined bond-and-debt combinations to get out longer. And we’ve also done a number of mini-perms. We’re not afraid of mini-perms. In Canada, for example, it’s very popular to do mini-perms, so we’ve tended to do mini-perms in Canada. We did last year do a bond for one of our Canadian projects at just under 4%, so the market’s still good. I think in some ways the tenors going out longer or staying out longer is more important than 10 to 15 bps in margin difference. It’s very helpful to have the banks playing longer-term.
PFR: That’s interesting. You say longer than 20 years? Can you name any deals like that specifically?
I’d rather not. Right now, we’ve had conversations with a couple of banks about going past 20 years. We probably won’t, because our projects tend to be a little bigger and so you have to have a club of banks and so you have a little bit of a balancing act between tenors. A few of them have talked about going longer.
PFR: Can you say which banks?
No.
PFR: Also on the subject of project debt, we’ve seen NRG Yield finance a drop-down a couple of months ago by raising additional project-level debt (PFR, 9/15). Moving onto the yield company side of things, is that also an option for Pattern Energy?
It is. We have done that, in essence, like the bond deal we did last year for example. A lot of our projects have very high debt service coverage ratios, when you look at the P50, like 1.7 coverage. So we have very strong, I think higher than most banks require and higher than most in the industry have in terms of our debt service coverage ratios. So that would imply that we are underleveraged at the project level.
We think that’s pretty good, in the sense that it’s always good to have a little extra room to play with. We’re not big leverage guys, we don’t like high leverage, and so we’re a little bit cautious about trying to go out and have maximum project level debt. But it is something we look at all the time and we’ll decide whether we want to go there or not. If we want to add some debt it’s always a little easier to add at the holdco level, but we’re always looking at how to optimize the project debt.
For us, the size of the debt, meaning increasing the amount of debt, in some cases is less important than extending the tenors and optimizing the amortization of our projects, as opposed to just raising more capital and just leveraging our assets more.
PFR: Looking at the stock prices of the yieldcos, it doesn’t look like they’ve performed particularly well in the last three months. How does that affect the prospects for drop-down acquisitions?
We’ve said we’ve got capital currently to do potentially another drop or two. So one of the things we’ve learned in the public markets is you’ve got to be patient. When times are good, you’ve got to take advantage of it, and when times are lean, you’ve got to relax and not overreact to it.
Right now, we’ve positioned ourselves to be able to continue to do some dropdowns if we choose to do that. We have recently dropped a project, Armow (PFR, 8/17), and we have a new big project coming on, Broadview, in the coming months, so we’re still expanding at PEGI our projects without having to raise more capital, and we’ll just see how the capital markets work. There are other ways to raise capital as well that could complement and extend out the capital raising we have to do.
So while the stock, we believe, is still way undervalued, as you can imagine, it still seems to be driven less around the performance of our stock and other peer companies’ stock than it is by bigger macroeconomic drivers. They are really moving the stock value more than our performance.
We have performed exceedingly well, I think, in light of some tough wind over the past couple of years with El Niño, and we have offset that and managed that, meeting our [cash available for distribution growth target]. If you look at our growth, we’ve continued to grow even in light of that.
We would love to see the market be better so that we can raise more capital easily and do more dropdowns that are accretive. We’re patient, but we also like to figure out other ways of doing things to improve our stock value for our shareholders.
Our assets are performing well and we have to give credit that this is still a fairly nascent industry. It’s only three years old and we’ve had some really turbulent times to work through. There has been—in addition to the whole energy markets bouncing around—in our industry, some of our peers have created uncertainty for us, and I think investors are starting to understand who are the long-term players, who are the more predictable players, and I think that the industry will benefit from that over the long run. But in the short run, you’ll have periods of time when it’s a little tighter than we would like to see.
PFR: You mentioned possible other ways to raise capital. PEGI issued a convertible bond last year and some of your peers have also issued straight debt in the capital markets at the corporate, yieldco level. Are those the sorts of things you had in mind? Maybe even a ‘green’ bond?
Yeah, the debt markets are certainly available to us, we could refinance some of our debt, like I said. At the corporate level, we could raise additional debt if we wanted to and extend it out, which would obviously increase our cashflows. There are other ways to extend our debt or capital. Like I said, we have some excess capital that we can use to reinvest in the business, and we could do a dropdown and do it with a partner as opposed to 100% ourselves, so that we can expand the amount of capital we have available to us to multiple projects. There are a variety of tools that we have available to us to help meet our dropdown requirements.
PFR: When you say your dropdown requirements—obviously you’ve got a development company that has a pipeline of projects that will be getting financed and entering construction and being completed—if you’re being patient, does that mean you would hold the projects in the devco for longer?
Well, we did that last year, so certainly our devco has been co-operative in helping ride through these waves of the public markets, and so I think we demonstrated that very strongly last year for the over a year we did not go to the public markets and we kept developing and building projects.
Armow was in operation before we dropped it down to PEGI and so that is always a possibility. There are other possibilities. We could potentially jointly finance it with a partner with what funds PEGI does have and reinvest capital out of our cashflows. Or maybe we’d look to what I call high-grading our assets: We could sell an asset and invest [the proceeds] into a higher accretive project. So there’s a lot of ways to use your capital to improve shareholder value. We’re looking at all of those, but we need to be patient because we think these are cycles less driven by the quality of our assets and our business than bigger-picture issues, and what we want to do is be able to continue demonstrating to the market that we will do what we said we were going to do. And I think the market is starting to get more confidence.
We have a great relationship between the devco and PEGI and so it allows us some other unique opportunities. We think it’s an advantage to have a private company as a development partner because they don’t have the same public balance sheet concerns about keeping things on their balance sheet that a public company would. So they can be a little more flexible than a public company on the parent side.
It allows us to seek alternative financing over there as well. We’re not big on warehouse facilities, but there are ways to do simple financing that allows us to carry projects—even just additional debt. When you have operating assets at the development company, you now can raise debt. For years, at the devco, we did not raise debt. There was no reason to, and it was more of an equity business, but if we have to keep construction and operating assets on our balance sheet at the devco, then you can raise project debt or portfolio debt against those assets and still have capital available to reinvest in your development business. And so, all those tools are available to use right now if the markets don’t improve.
But I’m optimistic they’re going to improve. If you look around at some of these returns, these yields, they’re just too good to pass up. The quality of the assets, particularly that we have, and the yield we’re providing is really pretty extraordinary for the times right now, when you think about the money market and other funds, the risk in our business relative to a money market, and the spreads are just huge right now.
Click here to go to the first part of this interview, in which Garland gave his view on trends in the availability and pricing of power purchase agreements, the competitiveness of offshore wind and the latest developments in the tax equity market.