Your Project Finance Should Be a Fat Bear

Your Project Finance Should Be a Fat Bear: Loan Life Coverage Ratio and Why It Matters

By Matt Lucas, PhD; NER's Managing Director, Business Development

 

I’m a huge fan of the US Park Service’s Fat Bear Week, which features some huge bears. The bears have been fattening up all summer and fall for their long winter hibernation. This is the opposite of fat shaming—fatter is better. But truth be told, if they get too fat it’s harder for them to do, well, bear things.

You may not have jumped to the same analog as me, but hear me out: Debt is to project finance as fat is to bears. When you’re building a new facility, as many of New Energy Risk’s clients are, you’ll want some debt. Quite a lot in fact. But too much debt makes the project unwieldy. An over-leveraged project won’t be nearly as healthy looking to your cap table as the fattest of the fat bears.

We know that raising money is hard. Raising equity is especially challenging: equity is in the most junior position to receive cash flows, and equity fundraising is a more linear, incremental process than raising debt. In contrast, raising debt via a public bond offering can raise vastly more capital with similar effort.  And maybe most importantly, debt has a lower cost of capital! It’s no wonder that project developers try to minimize the equity they have to raise in order to accelerate their execution timeline and improve financial returns for their existing equity investors. However, this approach can lead to projects that have too much debt instead. So how do you know what’s the right amount of debt? (You want a fat bear, not a fat bear that can’t climb!) The answer is in your loan life coverage ratio.

 

What’s a Loan Life Coverage Ratio (LLCR)?

An LLCR is a metric that relates available cash to debt service to the cost of the debt service. A higher number is more favorable and means your project can get fatter on debt without drawbacks, reducing the amount of equity otherwise required. A handy equation:

LLCR = [ (net present value of cash available for debt services over the life of the debt) + reserves] divided by (present value of debt)

  • Cash available for debt service (CFADS) is your revenue minus operating expenses (including taxes but not including depreciation).
  • The denominator of the LLCR is the present value of your debt.
  • The interest rate of your debt is the discount rate used for calculating the net present value in the numerator.

A project with a LLCR equal to 1.0 is break-even: all its free cash pays its debt service. A ratio higher than 1.0 means there’s more than enough free cash flow to meet debt service.

You might have heard about a related metric, the debt service coverage ratio (DSCR). The DSCR is similar to the LLCR but is calculated on a quarterly or annual basis, so it’s a snapshot in time. In contrast, the LLCR is an average over the lifetime of the debt. For projects with lumpy free cash flows due to seasonality or infrequent-but-expensive maintenance costs, the LLCR is a more generous metric because it smooths out the cash flows.

 

Why the LLCR Matters

Debt lenders will use the LLCR to gauge the riskiness of your project. Of course, merely breaking even is not a compelling financial result, so the LLCR needs to significantly exceed 1.0.  Below are some typical minimum LLCRs used by lenders for different projects in various industries:

Example of Debt Lending Situation Typical Minimum LLCR
Infrastructure backed by investment-grade rated government entity 1.25
Power plant whose offtake buyer is creditworthy 1.4
Oil & gas industry 1.4
Metal & mining industry 1.4
Infrastructure with merchant risk 1.75
Power plant selling on merchant market 2.0
New Energy Risk’s experience of projects that get funded and reach financial close 1.7

The table makes it clear that projects with merchant risk—those that lack contracts to sell their production to a creditworthy entity—require significantly higher LLCRs.

At New Energy Risk, our experience is that deals with LLCRs of at least 1.7 are those that get investment. That higher ratio gives the debt lender confidence that even if the project technologically under-performs, or the value of the production decreases, the project will still be able to pay its debt service and make it through the long winter (whether hibernating or not).

 

What Can I Do If My Project’s LLCR Is Too Low?

Uh oh, your bear of a project got too fat on debt! What can you do to restore your photogenic and investment-worthy proportions?

  1. Consider New Energy Risk: We can help! New Energy Risk’s insurance products can enable debt funding where it was not previously possible or reduce the cost of debt. In both cases, NER’s help with coverage reduces your cost of debt and increases your LLCR.
  2. Reduce your cost of debt by financing in a major currency: Debt is typically cheaper when it’s denominated in major currencies, so if your project is capitalized in a minor currency, you could try denominating your project’s feedstock and production in a major currency instead.
  3. Reduce your cost of debt with government assistance: In the US, the federal government will provide loan guarantees for certain types of innovative capital projects. At New Energy Risk, we have worked with projects pursuing such guarantees from the US Department of Energy and US Department of Agriculture.
  4. Adjust your cap table to increase the relative percentage of equity: If the total project cost remains fixed, then reducing the portion of the cost capitalized as debt will reduce your debt service and increase your LLCR.
  5. Reduce project capital costs: If you can simplify your project to reduce its capital cost without reducing revenue, that will raise your LLCR. For example, you might find that a captive, on-site system for over-the-fence procurement can shift costs from capital to operating expenses and save money on a levelized basis.
  6. Reduce operating expenses: If you can reduce operating expenses while holding revenues constant, that will increase free cash flow and increase your LLCR. Maybe the project can be situated in a lower-cost location. Maybe automation can reduce on-site labor costs. You might also try to contract your feedstock costs for a fixed or capped price to reduce the risk of escalating operating expenses.
  7. Contract your revenues: Lenders will discount your revenue if they feel it’s uncertain. Selling your production to an investment-grade entity for a fixed price or on a take-or-pay basis will help assure you get more fully credited for all your revenues.

 

So fatten your bear of a project with debt, but not too much; keep the LLCR in mind! Have questions about your own LLCR or project finance? Reach out to us at contact@newenergyrisk.com. We’re here and happy to help. (Although we don’t accept salmon for payment, sorry.)

 

 


Interview: Jay Schabel, President of Brightmark Energy Plastics Division

We are inspired by people who are passionate about technology that solves pressing global challenges. Scaling and commercializing those solutions requires serious knowledge, courage, support, and perseverance. In this interview series, our chief actuary, Sherry Huang, talks with friends of NER who demonstrate these qualities professionally and personally, and whose journeys will inspire you, too.

 

A Conversation with Jay Schabel, president of Brightmark Energy Plastics Division, formerly CEO of RES Polyflow

NER worked closely with RES Polyflow to ensure the cost-effective capitalization of its plastics waste-to-value facility in Ashland, IN, USA. Brightmark Energy acquired a majority stake in RES Polyflow in November 2018. This interview has been lightly edited for length and clarity.

 

By Sherry Huang, Chief Actuary

Jay is a calm, wise, and thoughtful business leader and technology entrepreneur. Before we first met, I joined a conference call for which I hadn’t yet received background information. Although he was leading the discussion and I had not initially been invited, unprompted, Jay sent me the files that I needed to get up to speed. It was a small act of kindness, which made an everlasting impression, and I knew then that RES Polyflow was in good hands.

Jay Schabel
Jay Schabel [Photo credit: Brightmark Energy]

Jay, let’s start with how you got to where you are today. You have vast engineering and construction management experience. Tell us about how you started your own businesses and how that took you to Brightmark Energy today?

I always knew I would start my own business. My father owned a successful trucking company, and I wanted the same experience of creating something. I launched my first start-up on January 1, 2000: a technology company that makes metal injection molding machines. That company is still operating and profitable today! I sold it when I bought another company in the automobile industry with some friends. In the next eight years, I bought and sold various companies, building up to an organization with $300M in revenue before selling my interest to my partners in 2008. This process of buying, building, and selling businesses provided great training for my work with RES Polyflow. I started on the plastic conversion technology in 2008. It was originally known as Polyflow until we added ‘Renewable Energy Solutions.’ Since our acquisition, we are Brightmark Energy Plastics Division, and we are still thinking of a name for the core technology.

Brightmark Energy Plastics Division is providing an important technology solution that turns post-use plastic into valuable products, and this reduces the amount of waste that would otherwise end up in a landfill or the ocean. Looking forward five to 10 years, what is your vision for this technology?

We want to divert 8M tons of plastic waste from landfill and waterways by 2025 and are already working on initiatives to support this goal. (Editor’s note: The Ocean Conservancy estimates that 275M tons of plastic waste is produced every year, of which 8M tons enter the oceans annually.)

What are some trends you are seeing in your industry? How do you see your industry changing and evolving?

The goal of our industry is to figure out how we can help divert as much plastic waste as possible from landfill and waterways. Recyclers are struggling to figure out what to do since China and southeast Asian countries stopped accepting used plastic from foreign countries. We want to use our disruptive technology to help manage this change and solve this plastic waste pollution problem.

Others have been working on this issue for a while, too. For example, Dow Chemical along with its partners have tested two “Hefty Energy Bag” programs in Omaha, Nebraska and Citrus Heights, California. They collected previously non-recycled plastics and converted them into valuable products, demonstrating that recovery of non-recycled plastics is a viable municipal process.

What advice do you have for technology entrepreneurs who are trying to start or scale their business?

Be honest with yourself. At RES Polyflow, we determined that we needed a significant level of scale in order to be economically viable, but that created a difficult financing task. The insurance solution from NER and AXA XL was critical in completing the debt financing. The required level of financing was a big pill to swallow, but at the end it was beneficial. Make the tough decision early and stick with it.

Lastly, I understand you used to own and operate a winery, which is almost as exciting as reducing waste and pollution for planet Earth! Outside of Brightmark Energy, what are you up to now?

Yes, my wife and I used to own three acres of grapes. We made our own wine and operated a winery, but it became too much while I traveled a lot for RES Polyflow so we sold it a while ago. Now we are building our dream home. We are having the time of our lives!

Thank you, Jay! 

 

About the Plastics Renewal Facility in Ashley, Indiana

Brightmark Energy’s plastics-to-fuel pyrolysis process sustainably recycles plastic waste directly into useful products like fuels and wax. The plastics renewal facility, now under construction, will convert 100K tons of plastic into 18M gallons of fuel and 6M gallons of wax annually. To finance this deployment, RES Polyflow and Brightmark Energy raised an aggregate $260M including $185M in Indiana green bonds, underwritten by Goldman Sachs & Co.


New Energy Risk Welcomes Strategic Hires to Drive Growth & Streamline Client Experience

SAN FRANCISCOSept. 26, 2019 /PRNewswire/ -- New Energy Risk, an affiliate of global insurer AXA XL, announced the appointments of Dr. Matt Lucas as Managing Director, Business Development and Dvorit Mausner as Director of Execution. The strategic additions of Dr. Lucas and Ms. Mausner come at an exciting time in New Energy Risk's evolution, as the company surpassed $1.99B in aggregate transactional value supported by its technology performance insurance solutions.

Tom Dickson, CEO of New Energy Risk, remarked that "as we look toward the future, New Energy Risk seeks to expand its business and associated benefits to novel technologies across new sectors and geographies, and provide support for a greater variety and size of projects.   Matt and Dvorit joining our team is a pivotal moment for New Energy Risk as we expand into new technology sectors.

"As the renewable energy sector continues to explode, technology providers are increasingly looking to New Energy Risk to help take revolutionary technologies from development to deployment and commercial scale," Mr. Dickson added. "By bringing on Matt to lead business development and Dvorit to streamline operations, we expect to better serve an increasing number of clients with a more efficient process."

In his new role, Dr. Lucas will lead New Energy Risk's expansion into new technology sectors, geographies, and products. He brings both technical and commercial experience at large corporates and startups to New Energy Risk. He was previously a technology scout for a large corporation, then had operating experience in multiple hardtech university spinoffs, and exposure to public policy advising in the nonprofit sector. Dr. Lucas received his PhD from UC Berkeley in Mechanical Engineering.

Ms. Mausner will support the streamlining and management of the entire client experience. She brings experience scaling six previous operations across the for-profit, academic, and non-profit sectors. She has previously directed engagement for international fundraising and behavior-change campaigns and revitalized a 6,000 sq ft science makerspace. Ms. Mausner is also co-founder and partner of Temescal Brewing in Oakland. Most recently, she designed a pre-seed carbontech startup accelerator. Ms. Mausner studied at the University of Pennsylvania, where she earned a business certification from the Wharton School, a Master's in Philanthropy and Social Justice, and a Bachelor's in the Biological Basis of Behavior.

New Energy Risk has also promoted other personnel. Sherry Huang is now Chief Actuary, and Brentan Alexander assumes the role of Chief Commercial Officer in addition to his existing role of Chief Science Officer.

Visit the www.newenergyrisk.com/team to learn more about Dr. Lucas and Ms. Mausner, and to connect with New Energy Risk via contact@newenergyrisk.com.

About New Energy Risk
New Energy Risk is a leading provider of performance risk solutions for breakthrough energy technologies and a pioneer in the development of large-scale technology performance insurance. The company was founded in 2010 to provide complex risk assessment and serve as a bridge between technology innovators and insurers. Since then, New Energy Risk has supported project finance transactions in aggregate value of over $1.99 billion for renewable energy and new technology deployments. New Energy Risk is an affiliate company of AXA XL. To learn more, visit www.newenergyrisk.com.

About AXA XL
AXA XL provides insurance and risk management products and services for mid-sized companies through to large multinationals, and reinsurance solutions to insurance companies globally. We partner with those who move the world forward. To learn more, visit www.axaxl.com

 

##