Q&A: Ralph Cho and Michael Pantelogianis, Investec – Part II
Ralph Cho and Michael Pantelogianis started as co-heads of power in North America at Investec earlier this year. The duo sat down with Senior Reporter Nicholas Stone to discuss competition, trends in pricing and innovation in deal structure. The hot B loan market was a common thread throughout the conversation. “The fundamental issue driving competition currently for us is the activity level in the B loan market,” Pantelogianis said. The first part of the conversation ran last week.
What kinds of transactions will you do that could set you apart? MP: By virtue of our global footprint and the bank’s openness to taking development risk, we are willing to look at late stage-development funding. However, access to this type of capital comes with a price and is limited to conventional or proven technology. We are comfortable with a range of technologies, including conventional thermal generation, biomass, hydro, geothermal, wind, solar, concentrated solar, waste heat and landfill gas. We funded the startup of a waste heat development outfit a year ago called GenAlta Power up in Canada, which has had a lot of success. We originally invested in a 7 MW portfolio and now it has grown in just one year to over 50 MW around waste heat.
RC: When you start talking about equity bridge, preferred equity positions, late stage development loans and super holdco loans, there is just not enough capital out there willing to do this. So we see this as something that sets us apart. Our global team is comprised of bankers with roots out of industry and finance. We can turn to our resources internally and quickly understand the guts of a deal.
Do you think the market is trending to more collaborative work?
MP: We don’t find our discussions with our competition to be competitive in the way it used to be in the past. Our conversations today revolve around how we can work together on projects. We certainly can’t be viewed by any of the commercial banks as competition, unless they are doing merchant risk or taking subordinate levels of project cash flows. The receptivity has been pretty strong. RC: There is a more constructive tone to our conversations. We are also seeing that with the mezzanine players, in general, their appetite on a per- transaction basis is limited. We could potentially club up and do larger transactions, the way private equity or senior lenders do club deals. Investec is not the type of investor that needs to take down an entire transaction. Mike and I are totally open to bringing in others and working on transactions.
Is it competitive out there?
MP: The fundamental issue driving competition currently for us is the activity level in the B loan market. For example, if we dial back a couple of years, the big question was always, “how are these merchant generators going to refinance the mini-perm debt that they did when gas prices were $8-12 per MMBtu?” Guess what? With a nice dosage of QE3 and investors seeking yield, merchant generators have gotten another reprieve enabling them to take care of these financings with the same investor base, the B loan market. If it wasn’t for factors like QE3, maybe you wouldn’t see the liquidity that is driving the leverage market to provide the ability for a merchant generator to obtain financing. About a year and-a-half ago, we would have been poised to see a lot of that activity, as would many of our other friendly competitors. I think this is validated by all of the mezzanine funds that emerged; Energy Capital Partners, Ares Capital Management, Carlyle. RC: Yes. I agree that one of the biggest competitors that we have today is the institutional loan market. But I will tell you how we differ from the B loan market. First, deal size is important. I think the market has gotten hot enough that you could pull off a transaction as small as $150 million, but no less. That is a pretty good mark, because the B loan buyers need to have some liquidity in order for it to trade actively. Second, you need to obtain credit ratings by Standard & Poor’s and/or Moody’s Investors Service. The ultimate rating will be a significant driver of price. Third, you also need to have a bank or a broker-dealer that creates a market for an underlying credit. Fourth, the credit should be relatively straightforward. The more complex you make it, the harder it becomes to sell -the last thing institutional lenders want to hear about are constructions risks, sale leaseback structures, partnership flips, etc. Fifth, cash sweeps are virtually certain to be at or near 100% of distributable cash flow. And sixth, there is no delayed draws of loans. Institutional buyers expect their loan to be fully funded at closing which makes construction deals difficult.
MP: Our value-add is based on several things including delayed draw loans, structuring flexibility, dealing with complex stories and providing certainty of underwriting for a significant piece of a loan.
What sort of trends are you seeing with pricing, tenor and structures in project finance?
RC: For senior debt, pricing is declining. We are seeing plain-vanilla credits floating at, or a little bit above, LIBOR plus 200 basis points. Tenors are lengthening again and we are not just talking about Japanese banks offering this. We are seeing construction plus 18-year deals in the renewable space once again. I think that is as aggressive as we’ve seen and it continues to persist due to a lack of supply. Banks are also willing to hold large amounts by underwriting and holding between 25% to 50% of a transaction. In some cases, we have seen banks commit up to $400 million on one transaction.
In terms of any innovations in the market, what kind of structures are people trying? How do you see the bank/bond hybrid transactions?
RC: People are marketing that as an innovation, but that financing approach has been around since the QF days. As more banks are willing to step up and go long tenor, it will make fixed-rate deals less competitive. Bonds have make-whole payments and negative arbitrage issues.
MP: In terms of innovations on an industry basis, the things we are seeing of interest are out of the guys in California who are building out large residential solar portfolios –such as SolarCity, SunRun, Sungevity. We hear that the same commercial banks that have done project finance historically are providing working capital to help build out these portfolios. At commercial operations, traditional tax equity players are doing tax equity deals around such portfolios and some banks are providing partnership flip back leverage. As we look at newer areas of activity, the residential solar space is definitely a burgeoning trend we are interested in.
Will you look at merchant financings? How do you see that space playing out?
MP: We are open to merchant financings. We’ll look at them. I think we want to use our experience and do it judiciously. We have seen it done successfully in the market, we’ve done it successfully as an institution and we’ve done it successfully in our past lives at WestLB and at our predecessor institutions.
RC: Specific opportunities that are floating around in the market include some quasi-merchant facilities in the PJM region and there are several of them. There are also several merchant wind farm financings that are out there. In general, it is a difficult sell to get many banks on board with that. Merchant gas power is easier in my view, but some banks have expressed more comfort in lending to merchant wind. I think it varies by institution.
MP: Reduced deal flow out of the renewable energy sector has provided some momentum for financing merchant power. If we think about the era post-crisis that we sat and indulged in, the majority of action for the banks was around renewable energy. With wind development having tapered off due to a lack of legislation, overall deal flow has decreased and you see it in the volume.
Is that market only going to grow more?
MP: I think it will be episodic. I think the B loan market will be there for these types of assets long term. It has been there, since the merchant meltdown post-Enron, where banks got hurt with write downs. The B loan market was there helping guys like Riverstone and other private equity firms buy out all these distressed assets. I think banks will be there on a relationship basis as they have traditionally been there. If renewables get hot again, then what is the motivation for people to go down the risk spectrum?
When do you expect to book your first deal?
MP: I think we will be closing on several deals this summer. There is a natural life cycle to these deals. It starts with pitching in our case, not following. We are looking to originate for the bank. The bank takes a very traditional approach to originating and offering products. It doesn’t want to be positioned as a portfolio manager in the U.S.
RC: Mike and I have been doing this for a long time. We have worked together for nine years. You know us from our WestLB days. We did big-name deals together, like Caithness Shepherds Flat in Oregon and several deals for Edison Mission. We’ll run this business togethe and live and die together on this business. We complement each other’s skill set very well. In looking at a transaction from start to finish, we are seamlessly integrated.
MP: We are very optimistic on the business that we are building here. We’re pretty excited to be here. That’s key. This is just an incredible market to be a part of. The energy space is constantly evolving. We’ve got massive spending going on in our energy space. We’ve got natural gas, midstream infrastructure and renewables that have continued to proliferate and carve out their piece of the energy pie. Then there will be financing activity from the traditional thermal generation that is needed for reliability and consistency and that needs our capital. Even though we get frustrated that there is a lot of competition or limited deal flow, I think this position compensates us nicely by virtue of the flexibility it gives us to augment the deal flow, by being able to play in different areas of the capital spectrum. We are not seeing any shortage of deals at this stage.