At Corality we work with clients to achieve their goals faster and with increased certainty. Commonly our work evolves around financial model development for project finance transactions in the wind and solar energy sectors, and in this post I would like to share some considerations which may assist you in your own situation.
How good does a financial model need to be for a renewable energy project finance transaction?
There is no official benchmark outlining the required functionality for a project finance model in the renewable energy industry, and I doubt that we will ever get there. There is however a fairly streamlined list of expectations from project finance banks in relation to what they will expect from a model and this is commonly drastically different from the project developers’ check-lists for functionality.
Our job is to help our clients get more project finance deals done quicker by making the financial model development process transparent and efficient while adding new insights along the way. Our experience is based on the review of hundreds of financial models for project finance, and the unpleasant reality is that many models do not fill the absolute minimum requirement for a project finance credit risk committee.
We can help you raise the bar in the world of financial modelling
One of Corality’s foundation principles is that we are aiming to ‘raise the bar in financial modelling’ for all involved parties, and we do this in a number of different ways. Firstly, for financial modelling enthusiasts starting out in there career we provide tutorials in SMART Campus (or our most popular tutorials here), which are effectively samples from our financial modelling courses, secondly we run courses all over the world focusing on areas including project finance modelling, renewable energy, infrastructure/PPP/P3 and other related fields. Finally, we engage with project developers, financiers and consortia to develop custom build financial models for specific transaction objectives, using SMART financial modelling.
Maintaining a bad model or building a new financial model fit for purpose?
Now we get it – not everyone is an expert at everything. We could no sooner expect solar and wind developers – who need to understand engineering principles and stakeholder relationships – to understand best practice financial modeling than you could expect a financial modeler to understand cars. That’s my point though: I use a car mechanic to ensure the wheels of my car don’t fall off when I drive out of my driveway. In the same way, developers need to understand their shortcomings when it comes to financial model development and either train their staff in this specific area, or engage a specialist to guide them through it. This has been common practice in Europe and Asia-pacific for the last 10 years, but we have noted that this in not even nearly as common in the United Stated and Canada. We would be proud if you wanted to select Corality for this but we recommend you to search the market and find a specialist firm that is aligned with your culture, modelling philosophy, industry focus and regional representation before you make a call on this.
“The model? Whatshisname took care of that back in ’09…”
We also understand how we all got here. One guy in the organization was assigned the task of updating the model many years ago. He’s long since left. But through hundreds of deals and thousands of iterations, no one can really understand how that guy’s model works anymore. And no one wants to rock the boat by trying. No big deal though, right? We’ll just copy and paste over the old deal and resize the page to print for the boss…
Project finance debt pricing: Pay now or pay later.
Unfortunately no, you can’t just keep copying and pasting over that old model. Why? Because if you’re sending that model to a bank for financing, I almost guarantee you’re leaving money on the table. In other words, your project finance banker’s credit committee has added (likely more than) a few basis points to the rate they’ve assessed your project due to model risk. In other words, the bank knows it’s going to take more time to diligence the risks associated with your project and so they’ve priced the deal accordingly.
Further, if you’re sending that model to an equity partner, chances are high that you’re burning unnecessary development capital in the process. Equity guys need to get deals approved by committee and those committees generally ask even MORE questions than the banks. Sensitivities, additional cases, and even more additional questions are hard enough to manage when you’ve got a model that produces transparent results in a digestible format. If you’re still copying and pasting over that last deal, well, the cash you laid out for that engineering study is going to take even more time to get paid back.
We’re not blind to the reality that development budgets are tight. But paying for a clean and clear model once can actually SAVE you money in the long run. Lower interest rates and quicker equity checks mean more deals. More deals means lower return requirements, which means even more deals. And that’s why we’re all here in the first place, right?
Financial models are like cars – they need to be maintained
And just like conducting maintenance on your car, to be sure the asset you rely on to drive a deal successfully is working efficiently; you should ensure that you have a clear plan around a ‘maintenance program’ for your financial models. This could be as simple as scheduling 6 monthly clean-out-the-redundant-areas sessions, or better, ensure an internal peer review by a senior person with regular intervals. Often old models contain dirty secrets of times that have passed – represented by model errors, waste time and confusion.
Corality’s new course Financial Modelling for Renewable Energy Projects is aimed at project developers, sponsors, financiers and investors looking to improve their skills set in financial modelling to ensure robust, efficient and transparent analysis.
Tax equity, partnership flips, pre-tax and after-tax IRR requirements, maintenance reserve accounts, sculpted amortization profiles – These concepts aren’t supposed to be straightforward. Through our course programs, we can bring clarity to these subjects and give you full confidence in your own analysis.