Bonds are issued to finance major expansions or to refinance existing debt.
|
Traditionally, energy project developers have obtained the majority of financing through their balance sheet or traditional bank debt. However, in response to heightened political and economic instability, energy companies, including traditional sectors such as upstream oil and gas as well as less established renewable energy technologies, have had to consider diversifying their sources of funding.
Show
The global financial crisis has resulted in stricter regulations on banks and higher capital requirements, leading to pressure on banks to reduce their loan books, particularly in relation to longer-term liabilities. This has meant, among other things, that energy projects can no longer rely on traditional debt alone for financing, leading to a gradual shift from bank-led financing to non-bank and capital markets-based funding. As a result, more innovative ways of funding, such as high yield bonds, are being considered and implemented. What are high yield bonds?As the name suggests, a high yield bond is a type of corporate bond that offers a higher rate of return because of its higher risk profile. High yield bonds offer an opportunity for institutional investors to participate in energy-related projects through listed, tradable securities that can offer superior risk-adjusted returns due to their access to a deep and liquid market. High yield bonds are securities that can be issued in public markets or placed privately. Publicly listed bonds tap into a very large investor pool, require regular financial reporting and offer the benefits of daily liquidity, pricing and higher levels of transparency. A private placement is the method of placing debt with a small number of selected, sophisticated investors, which debt may be listed or unlisted. Often, though not exclusively, such investors are non-bank institutions. Most bonds are issued in the public bond market, although the private placement market also provides an important liquidity source. The attraction of private placement derives from the limited amount of disclosure, flexibility on maturity and greater certainty around execution. A material distinction between high yield bonds and other forms of traditional energy project financings is that high yield bonds have incurrence (instead of maintenance) covenants. Such "incurrence covenants" control the issuer's ability to incur a non-ordinary course liability, based on a financial ratio, and are only tested when the issuer chooses to incur debt or take other relevant actions. Whereas the more pertinent maintenance covenants used in reserve-based lending (RBL) and other traditional funding require the borrower to maintain certain financial ratios on an ongoing basis. Therefore, energy projects exposed to political or economic volatility would benefit more from high yield incurrence covenants. When issuing in the international bond markets, companies can choose between the Regulation S disclosure standard, which limits them to investors outside the United States, and the Rule 144A standard, which gives them access to US institutional investors. Complying with the Rule 144A standard is more demanding because of the broad anti-fraud provisions of US securities laws. New investorsEnergy project finance has proved to be an attractive new asset class for alternative investors, such as insurance companies and pension funds, which are facing pressures (for example, under Solvency II and other regulatory regimes) to diversify and ensure the profitability of their portfolios and to match investments to their long-term liabilities, while often subject to a relatively conservative risk appetite. Within the past five years, non-bank investors have significantly increased their commitments and exposure to energy financing, given the long-term nature of the liabilities for many types of institutional investors and their corresponding need for suitable long-term assets, coupled with significant policy support for clean energy. This is particularly true for established renewable energy technologies, where the risks are relatively well understood and government subsidies are encouraging investment. As a result, there have been increases over the last few years – particularly across Europe – in investment from non-bank lenders, in both the public bond markets and private placements, and most large energy businesses are now funded at least in part through corporate bonds (high yield or investment grade, depending on the rating of the issuer). Historically, high yield bonds have been widely used in the construction, refinancing or expansion financing of large LNG, pipeline and petrochemical projects. However, there is also a growing potential for the high yield capital market to provide further support to the independent oil and gas sector as well as to renewable energy projects. Independent oil and gas companies are the largest users of RBL facilities. These players typically use RBL structures for development financing and general corporate purposes. However, the cheaper price of public bonds and the covenant-light nature of alternative funding sources is shifting companies towards non-traditional sources of finance and away from the bank markets. Bond markets are increasingly being accessed to finance new development opportunities within the mid-cap exploration and production sector. For example, Hellenic Petroleum, DEA Finance and Seven Energy took out their RBL facilities with senior high yield bonds, while each of Aker, Ithaca and Tullow Oil placed high yield bonds alongside their existing RBL facilities. More recently, high yield bonds have also been successfully used to finance alternative energy projects. Among examples of the alternative energy projects financed with high yield bonds are multiple iterations of the Abengoa and Areva transactions, which tend to issue high yield bonds typically on an annual basis, as well as the more recent UK examples of Melton (MEIF) and Drax (both of which issued bonds to finance biomass fuel projects). Financing at Various Stages of the ProjectIn general, large energy projects can be divided into three phases: the planning phase, the construction phase and the operational phase. The most commonly used types of financings for each of the phases are listed in figure 1. Figure 1 - Principal sources of energy project funding through the different stages of developmentPlanning (pre-development, including Project balance sheet Reserve based lending High yield bonds (public or private placement) Private equity High yield bonds (public or private placement) Bank loans IPO Retail bonds Cash flow from operations Bank loans Project finance Infrastructure funds Project finance Multilateral development banks Proceeds from divestments Mezzanine finance Increased predictability of cash flows and business maturity Due to the lack of cash flows to service debt, resulting in negative carry, and high risk of non-completion during the planning stage, high yield bond issuance is not one of the common sources of energy project funding during this stage. It is often observed that the capital markets are unlikely to be available to support development projects with no track record. Instead, bonds have focused on the refinancing of existing indebtedness once a project is operational (and thus generating sufficient revenues), rather than financing prior to project completion. Recently, institutional investors have been seen to take construction risks on properly structured greenfield projects where what is key is (i) meeting the rating agency requirements and (ii) providing appropriate credit enhancement in the structure through, for example, shareholder or parent guarantees, equity backstop or government support. Note for example Abengoa Greenfield Euro- and USD-denominated bonds due 2019. Additionally, ContourGlobal, KCA Deutag, International Power and Puma each had a number of greenfield projects in their portfolios and were contemplating launching several more at the time they issued their senior notes (though each of them already did have a number of revenue-generating assets - either operational or development phase projects - in their portfolios at the time). Bond financing is making even greater inroads in the construction phase, where there is more certainty around the project completion timeline and predictability of future cash flows. An increasing number of energy projects are refinanced with high yield bonds during the construction stage, and this is where the new frontier lies for energy related bonds – see for example the Greenko bond transaction highlighted in figure 2. Figure 2: Spotlight - green bonds Green bonds are corporate bonds, project bonds, and sub-sovereign bonds that finance investment in green infrastructure assets such as clean energy. From a financial markets perspective, green bonds are not different from other bonds. However, green bonds are worth a separate mention in this context due to their role in financing clean energy. Corporates in Western countries and in developing countries alike are looking at green bonds.These offerings add to the supply of bonds available to project developers who previously had to focus on financings from development banks and equity. UN Environment estimates that the number of policy measures to "green" the financial system has more than doubled to over 200 measures across 60 countries. These policies translate into the rapid growth of green finance in the marketplace. Financial centers including London, Hong Kong, Paris and Casablanca have set out plans to seize the green finance opportunity. Climate Bonds Initiative, an international organisation working on mobilising the bond market for climate change solutions, reported that there was a record-breaking issuance of US$81 billion of climate-aligned bonds in 2016, with the largest number of new issuers and the largest single month of issuance to date. The issuance of the RMB 30 billion (US$4.3 billion) green bond by Bank of Communications in China in November 2016 is recognized as the largest single green bond issued to date. Green bond case study: A leading hydro, wind and thermal power Indian green bond offering – late brownfield phase and beyond Greenko Group is one of the largest clean energy independent power producers in India, with more than 1 GW of projects across hydro, wind and thermal energy. The Group's portfolio includes operational run-of-river hydropower projects and wind projects, as well as two run-of-river hydropower projects that at the time of the initial bond issuance were under construction and near operational. Greenko Investment Company's issuance of US$500 million of senior notes due 2023 at 4.875 per cent enabled the company to access the international capital markets for a competitive source of financing to address the ongoing need for green energy for India. The high yield notes are guaranteed on a senior basis by Greenko Energy Holdings and represent an innovative structure that addressed the company's financing needs during the construction/early stages of operations of its portfolio assets (which have subsequently been refinanced with an upsized high yield bond issuance). Ashurst advised the joint bookrunners and lead managers as well as the lead green structuring agent in this transaction, which was India's first high yield green bond issuance (and Asia's largest dollar green bond offering). This transaction won High Yield Deal of the Year by Asian Mena Counsel 2016 and was shortlisted for High Yield Deal of the Year by IFLR Asia Awards 2017. For coverage of our Historically, however, high yield bonds were most often used during the operational phase of an asset, which is the time period after construction risk has ended and the asset begins to generate positive cash flow and the initial bank loans are being refinanced. With stable underlying cash flows in the operational phase, energy projects are akin to fixed income securities and therefore bond financing is a natural and economically appropriate financing instrument. Nonetheless, the above dichotomy is somewhat artificial, and capital structures of varying degrees of complexity may make sense to energy companies at different stages of development, based on a number of factors such as the number, types and geographies of projects under development within the portfolio and the interested investor pools. Some of the energy-related financing structures incorporating high yield bonds include the following:
Key features of high yield bonds in the context of energy project financeA side-by-side comparison of the most salient features of a typical high yield bond and the typical terms of project finance is set out in figure 3. Figure 3 - High yield vs project finance – features and considerations
Several of these features merit a more detailed discussion, as outlined below. Economics Cash drawdown High yield bonds are structured to have one closing upon which the whole amount is drawn down, with no subsequent drawdowns (versus committed funding and drawdowns when required in project finance or a bank revolving credit facility). Without staged drawdown to match capital investment needs, surplus funds received under the bond financing at financial close will need to be held in a bank account or otherwise invested until required. Given the current low interest rate environment, the yield on the bank account will almost certainly be well below the interest rate of the financing, leading to what is known as "negative carry". In contrast, traditional bank loans can be disbursed to the project company according to a predetermined schedule, although banks do charge commitment fees (a percentage of the margin) on available, but undrawn, facilities. The counterbalancing factor is that the bond financing is generally cheaper (due to the depth of the bond market). An "all in funding cost" should be calculated (which will take into consideration the cost of carry on bond proceeds) when determining the most appropriate type of financing. Another factor in the cost calculation is the normally longer maturity of bond financing relative to bank financing, which may increase the equity returns and decrease the risks and costs of refinancing. Note also that there has been some discussion among practitioners of structuring a staged drawdown bond, though we are not aware of any such instruments currently in the market – this is a space to watch. Redemption High yield bonds ordinarily carry early redemption costs (non-call periods of up to half of the tenor of the bonds, which means during this period voluntary redemption of the bonds may not be permitted or permitted only with the payment of a "make-whole" amount, which is rather expensive). The make-whole amount is calculated so as to guarantee a certain rate of long-term minimum returns to the investor on the basis of the amount which the prepaid investor would need to invest at a risk-free or low-risk rate (such as the Bund rate or the UK Gilt rate plus a premium) to achieve the same return as the bond, over what would have been the life of the bond. In contrast, project financing carries limited or no prepayment penalties. However, in the context of construction/early stages of operation of an energy project, it is highly unlikely that the project will start generating excess cash and thus drive an early prepayment during the first few years after the financing is put in place. It is worth noting that high yield bonds contain a change of control set at 101 per cent of the principal amount so that, if the project changes ownership, the bonds may be redeemed in whole or in part (which may or may not make economic sense to the investors depending on the price at which the bonds are trading at such time). ConclusionWhile energy projects have traditionally been financed through banks, the implementation of Basel III regulations, requiring stricter monitoring and disclosure, ultimately leading to higher costs and higher capital requirements, has opened the door to high yield bonds as an alternative source of finance. By accessing the institutional bond market, companies are able to reduce their project funding cost. As a result, high yield bond financing is now being used during the construction and operational stages of energy projects, and occasionally even during the planning stage, and we believe this trend will continue. What is a bond quizlet?A bond is a long or short term debt instrument (a loan) issued by corporations and municipal, state and federal agencies. A bond is a contract; it's an IOU. Principal, Face Value, Maturity Value, and Par Value. The amount of money the firm borrows and promises to repay at some future date, usually at the maturity date.
What bonds are retired when the bondholder exchanges them for the issuing company's stock?Convertible bonds are corporate bonds that can be exchanged for common stock in the issuing company. Companies issue convertible bonds to lower the coupon rate on debt and to delay dilution.
What type of risk is intentional failure by management to accurately disclose violations of debt covenants?What type of risk is intentional failure by management to accurately disclose violations of debt covenants? d. Detection risk.
Who is responsible for the determination of the existence of misstatements in the financial statements?02 of AS 1001, Responsibilities and Functions of the Independent Auditor, states, "The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.
|
