Use of Low-Interest, Subordinated Debt to Finance a Wind Project in Pennsylvania

Four Pennsylvania funds have teamed up to offer $3.6 million in low-interest, subordinated debt to a 9 MW wind project. This offering represents the first use of low-cost debt by a state clean energy fund to support a large-scale wind project in the U.S., and marks a significant departure from standard grant-based project support. This case describes the structure of the incentive and how it has impacted the project, and identifies several caveats to keep in mind. Innovative Features Several innovative features of this investment deserve note:

• The subordinated debt reportedly provided a similar amount of value to the project as would have a production incentive that had previously been offered in Pennsylvania. Unlike production incentives, however, subordinated debt allows the Pennsylvania funds to recoup their collective investment (and earn a 5% return) over 10 years.
• Because the debt is subordinate to any senior financing, it does not interfere with the project owner's ability to arrange senior financing. Existence of a senior lender experienced in project finance will provide considerable cost savings to the Pennsylvania funds, which intend to piggyback on the senior lender's due diligence and mimic the structure of the senior loan agreement.
• The syndication of Pennsylvania funds allowed each fund to participate at a level with which it is comfortable, while drawing on the financial expertise of the syndicate leader and the senior lender.

Results

• The project came on line in 2001, but has yet to tap into the subordinated debt. This is because the project does not yet have a permanent owner, and the current owners (the development team) have sufficient cash reserves to own and operate the project without financing in the interim.
• It is clear, however, that the existence of the financing played a positive role in the negotiation of a 20-year power purchase agreement with Exelon (the wholesale buyer).
• While these promising early results seem to indicate that the use of subordinated debt to finance large-scale projects could be a model worth emulating, several factors, including implications for the federal production tax credit, must also be considered.