Energy infrastructure transactions, ranging from project financing to the acquisition of energy assets, are typically easily bankable, as evidenced by the sheer number of lenders piling in to the market and the downward pressure on margins.
Energy infrastructure in Europe is attracting substantial interest not only from traditional banks, but also from institutional investors such as insurance and pensions funds, dedicated infrastructure funds and sovereign wealth funds on a global scale. A key consideration to address early on is which of these players are prepared to take which risks. There is a marked and increasing interest from international senior, sub-senior and mezzanine lenders that are looking closely at the European energy infrastructure market, willing to lend long money. The forms of financing and the tenors offered by these institutions could offer very attractive and secure long-term debt to sponsors, project promoters and developers. In addition, the current market is not segmented as it used to be. It is dynamic in the sense that structures contain financing features that were typically seen only in project finance, acquisition finance or asset finance, respectively. It is important to structure the financing so as to maximise flexibility.
Holdco financing is currently used and discussed in a variety of contexts as if it were something new. The concept, however, is not new. Before the credit crunch in 2007, which preceded the global financial crisis, neither PIK financing at a deeply structurally subordinated level nor ‘covenant lite’ features were unusual in leveraged finance transactions. It is now back, but with a different application and a different name.
The concept is quite straight-forward in its pure form. Rather than lending to the operating company or at the asset level, lenders are providing debt at a higher level in a structure. The proceeds of the loan can be utilised to refinance debt of existing project finance banks lower down in the structure, recycle equity investments, fund acquisitions, finance operations or a combination thereof. Holdco financing is close to corporate debt but with more risk, relying on guaranteed/regulated cash flow, allowing the sponsor to replace expensive, locked in equity with cheaper, often long-term, debt.
A holdco borrower has no operations and therefore no independent cash flow. Holdco lenders are not directly secured by the underlying assets but depend on (a share of) operational cash flow being distributed up the structure to the sponsor, the holdco lenders shaving such distributions and in some instances blocking them. All debt service is thus dependent on distributions coming up the structure. This affects non-payment default mechanisms, equity cure provisions and account structures and drives capitalisation of interest.
It is therefore key to understand that the lenders’ recourse is not only limited upwards in the structure, in that there is no parent guarantee or other comfort, but it is also limited downwards in the structure, so that the typical holdco financing security package is limited to the shares in the borrower and its bank accounts.
Norton Rose Fulbright has extensive experience advising clients on all aspects of energy infrastructure projects across Europe. We would welcome the opportunity to discuss this with you in more detail.