Refinancing Canadian renewables projects post PPAs

Chatham’s involvement in renewable power development in Canada coincided with the creation of the Ontario Feed-in-Tariff (FIT) program. FIT was instituted to encourage development of onshore wind, solar and other renewable projects. At the time, the Independent Electricity System Operator (IESO) offered 20-30 year fixed priced Power Purchase Agreements (PPAs) to developers. Investors were attracted by the long-dated income streams from these projects, their superior IRRs relative to bonds and low correlation with publicly traded equity returns.

By 2016, the IESO ceased to accept PPA applications, and combined with a newly elected Ontario government, new long dated PPAs were no longer issued. Not surprisingly, since then existing renewable projects have become “bid” in secondary, especially those projects that reached operating phase around two or three years post construction. With fixed revenue streams and funding locked in for an equivalent term via bank floating rate swapped to fixed rate, infrastructure funds and pension funds have been purchasing these assets at IRRs that are, while still superior to traditional fixed income alternatives, below those internal rates of return (IRRs) realised by developers. Typically, investors refinance by either, reducing bank loan credit spreads and extending the term of the loan or accessing the now well-developed market for Canadian dollar fixed rate project finance bonds. In either case these investors have succeeded in reducing their long dated funding costs and increased their IRR.

Since 2016, Chatham has advised on over $4.5B of successful renewable power refinancing’s with numerous infrastructure sponsors in Canada. As our case studies below demonstrate, these restructurings typically fall into two broad categories:

1. Bank loan refinancings of existing floating rate bank debt with legacy interest rate swaps

Chatham was mandated to assist a Canadian infrastructure sponsor in increasing a $650M bank facility by $350M (to $1B) and to extend the term by three years. Our engagement involved:

• Novating existing swaps (with a significant mark to market (MTM) outstanding) from four exiting banks to eight remaining banks. To achieve best pricing for our client, we performed extensive x-value adjustment (XVA) analysis to ensure the swap credit spread charged by the remaining banks to accept novation was consistent with Basel 3/XVA “market” pricing.
• Extending the Mandatory Early Termination (MET) date of the existing swaps to match the amended loan maturity date. As above, Chatham ensured that the client was not a ‘price taker’, since the extended swap exposure profile provided the banks with an opportunity to inflate pricing due to the non-transparent nature of XVA modelling.
• Managing the execution of new hedges due to the upsizing of the bank credit facility. Chatham selected the most appropriate bank to execute the hedges (execution bank) and negotiated swap credit spreads with the remaining assignee banks.

2. Bond refinancing of existing floating rate bank debt with legacy interest rate swaps

In the past four years a market has developed in Canada for long dated fixed rate project finance bonds. This is typically accessed as a funding vehicle once a project is well into its operational phase and is generating consistent revenues.

In a recent transaction, a Canadian sponsor was refinancing a $450M floating rate bank loan with a fixed rate bond issue. Interest rate swaps were in place with a remaining term of 18 years and a MTM liability of $90M. Due to the Additional Termination Events (ATE) in the ISDA the swap liability would need to be repaid simultaneous with loan repayment, therefore the bond issue raise was $540M. Chatham achieved an optimal solution for the settlement of the MTM liability that arose as part of the fixed rate bond issue.

The sponsor faced the following problems, which should be kept in mind by other sponsors looking to achieve a similar refinancing:

• Appointment of a bank as Reverse Swap Syndication Agent, to ensure that the government of Canada (GoC) yields used to calculate the swap termination amounts were consistent with the GoC yields used to price the new bond issue.
• Running a benchmarking exercise with each exiting bank to ensure termination values were based on appropriate bilateral credit support annex (CSA) adjustments.
• Challenging the exiting banks on provisions in the 2002 ISDA Agreement related to any benefit that a bank may receive in the event of swap termination and amounts owed by a less credit worth counterparty (see ISDA Close Out Protocol).

Often, financial sponsors don’t have the in-house derivative execution and XVA modelling capabilities to verify bank pricing. Chatham has this expertise together with the experience and technology to ensure pricing is ‘on market’.

We forecast continued robust refinancing activity in the Canadian renewables sector as infrastructure sponsors pursue a lift in IRR from their existing projects.