The global supply chain disruption wrought by Covid-19—the flu-like virus originating in Wuhan, China—is taking its toll on project finance activity and reminding bankers that construction risk is still real, even if it is not reflected in loan pricing.

As governments and companies seek to contain the spread of the epidemic and ensure the wellbeing of citizens and employees, travel plans for client meetings and conferences are being canceled.

While travel restrictions may have an impact on business development, there is nothing to prevent deals being executed entirely remotely, says a head of project finance in New York.

But the impact on supply chains—such as delays to the delivery of solar modules, wind turbines or other equipment—is more concrete and could result in some deals being restructured.

“It would be hard to imagine there won’t be disruption on some deals, especially those with tight deadlines,” says the project finance banker.

Reasonable expectations

Developers began to receive claims of force majeure from suppliers in late January, prompting market participants to begin working through the implications of late delivery, especially for tax equity investments in the U.S. (PFR, 1/31).

For the purposes of qualifying for tax credits, attorneys advise developers to gather evidence to show that they had a reasonable expectation that the equipment would have been delivered in time.

Wind projects on which construction started in 2016 must be completed in 2021 to qualify for production tax credits, unless the developer can prove that “continuous efforts” have been made over the four year period.

That will be easier for wind projects that aimed to qualify on the basis of incurring 5% of their total costs in 2016, versus those that qualified on the basis of physical work done on site, says a project finance attorney.

However, some tax equity investors are taking a more cautious approach, insisting on actual delivery within the time frame stipulated by Internal Revenue Service guidance.

“Imagine you are working on a deal and you get a notice from turbine supplier saying we have a force majeure claim," says the project finance head. "There are a lot of deals going through credit committees right now. It will be interesting to see what that means in terms of timeline for approval."

Risk reassessment

The disruption comes after years of margin compression on construction loans, which bankers say implies virtually no premium for construction risk.

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"...highlighting the importance of good hygiene and robust credit policies."
Pricing on wind construction loans dipped into double figures in 2018 (PFR, 3/15/18) and has continued to creep down since then. At the end of last year, Pattern Energy Group priced a one-year construction loan for a wind repowering project in Texas at 75 basis points over Libor (PFR, 3/2/20), which deal watchers say is not atypical these days.

Lenders will be "as accommodating as possible" if complications arise around conditions precedent for funding signed deals, says the project finance attorney.

But if the Covid-19 epidemic turns out to be a painful experience for lenders, it is possible that banks will reappraise the risk/reward trade-off.

“People will realize that construction risk is risk, whereas the pricing in construction loans suggested that things were not risky at all,” says the head of project finance. “You just need one horror story to change things dramatically in terms of construction risk.”

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