Former director of structured finance division at the U.S. Export-Import Bank shares what not to do when seeking loans for an organics recycling infrastructure project.
BioCycle May 2016
My experience as a lender in the project and structured finance space was that fewer than 10 percent of all projects presented for finance were sufficiently developed and ready for prime time consideration when they were brought to the bank’s attention. I usually needed only about 10 minutes to review and kick back the deal to the project developer for additional work that may have been tantamount to rejection. This often left me frustrated, as project developer teams were for the most part earnest, hard-working, and well-intentioned.
More often than not, the borrower was a renewable energy developer, a sector attracting project teams that are relatively inexperienced in project finance. Borrowers were attempting to seize opportunities to develop clean energy projects — which would include anaerobic digestion biogas facilities — in emerging markets. While disheartening, I knew misleading developers would only hurt them in the long run. They would just keep making the same mistakes.
This repeated saga inspired me to deliver a speech at a renewable energy financing conference in Long Beach, California entitled “How to Lose a Banker in Ten Minutes.” I listed the key faux pas committed time and time again and scripted a “what-not-to-do” speech, inspired by the Kate Hudson and Matthew McConaughey movie “How To Lose a Guy in Ten Days.” Kate Hudson’s character, Andie, uses Matthew’s character, Ben, as a guinea pig in an article about all the things women do to lose guys.
The speech was a big success, eliciting lots of chatter, laughs and agreement — and I thought learning — on what not do when presenting an infrastructure deal to a bank.
That was until, at the evening cocktail reception, someone congratulated me on the speech and introduced a project. Within one minute — not even 10 minutes — he did all the things that I had just told the group not to do. So below is my attempt — again — to teach professionals operating in the clean energy project finance arena. Remember, this is HOW to lose a banker. Do the opposite to keep things moving.
1 Lead With Your High-Level Contacts
Demonstrate how these relationships are the key to your success. I cannot count how many times I heard about high-level contacts and relationships. The higher the level, the better, most thought. Bankers think something else. Deals that arise because of key relationships are either not real or are highly vulnerable, and are around only long enough for the next developer to come around to the contact and request a meeting. At worst, the high-level contact can conjure up concerns of bribery or corruption. Serious developers and borrowers have contracts, sales track records, or both. Anyone touting a high-level political contact as an opener is labeled as not serious and lacking substance.
2 Tout The High Rate of Return
Most people cannot understand why a high projected rate of return is bad, and that is why this mistake is so common. Why are high returns bad? First, bankers do not really care what the rate of return is. Banks care about “debt coverage” — how much cash margin or coverage there is to pay debt, or about “debt leverage” — the ratio of debt and equity in a deal. Terms with the word “debt” in them — get it? Return is an equity concern; better projects deliver more return to equity holders. Debt just gets paid, hopefully on schedule. If anything, high returns only serves to remind banks that they should sweep cash, i.e., to have some debt prepaid so that equity is not returned before the debt is. This is something developers don’t want. Banks are also unimpressed with high projected returns because those returns are just projections loaded with assumptions. The higher the return, the less credible the deal. Want to be certain to lose your banker? I suggest a 40% IRR.
For these reasons, sophisticated large company sponsors of projects go to great lengths to conceal returns. While transparency is best, I would give brownie points to developers who at least tried to keep profits under wraps.
3 Use A Hotmail Address
An AOL account or a gmail address will do, but most of the really questionable deals all seemed to use hotmail addresses. Small parties just starting out or just forming a special-vehicle company may not have a website or a proper email address at first, but it is not really that hard to get a domain name. Somehow, parties came to the bank seeking serious finance without a serious email address. This put an immediate black mark on the borrower. Once a borrower has a real email address, and a business card and company materials to confirm, it is a whole new world. Want to lose the banker fast — hotmail it is.
4 Make A Technology Pitch
Take up valuable time trying to sell the project technology and products to the banker. How can that be bad? Aren’t the project’s technology and the products it makes what makes money to pay back debt? They are, but that does not matter, because — here’s the big mystery — the banker is not the one buying the products! Even if the banker is totally wowed by the technology, it does not matter. Banks want to see long-term contracts with strong terms to sell products to credit-worthy buyers, or at least a deep market with a strong track record where competing projects have higher costs. If you really want to lose your banker, then go on and on about what a revolutionary breakthrough the project represents. That way, the banker may become worried that he is being asked to take new technology risk, i.e., the risk of developing and commercializing a brand new technology, a risk that most banks will not assume.
5 Assume Success
There are lots of easily available competitive advantages you can assume, such as access to a fuel source or a short-term market failure that will make a new project a big success. Developers of biomass projects using agricultural products or waste-to-energy deals using municipal waste to generate power or produce fuel seem to specialize in this tactic. The key to success for these projects was always their ready access to agricultural or municipal waste within a specified radius of a project. To make their point, developers would draw circles around the project and identify how much agricultural or municipal waste was produced and discarded within each circle. Developers would claim that there was so much available within the project area that, even without supply contracts, the project will earn large profits from a consistent supply stream.
Assuming your own success is a great tactic for losing a banker because challenging assumptions only takes a few minutes. What could go wrong with easy access to free waste materials within a few miles of a project? To start with, agency and other lenders typically give credit to what is contractually committed and sure to be available. Second, so many things can and will go wrong with a supply of agricultural and municipal waste. Bad weather can intervene, or problems with collection and processing mechanisms for waste. Digging deeper, relying on a large number of contracts from farmers or municipalities means lots of short-term agreements with parties with uncertain credit.
Ultimately, the whole premise for assuming one’s own success is just wrong. If there is a magic bullet such as a reliable stream of waste for power, then the nasty old free market always catches up with you. Other projects pop up and increase demand for the same material, thus driving up costs. Remember when corn prices rose to such high levels? The culprit was a large number of ethanol projects that used corn; most of those projects went bust when corn feedstock prices rose.
6 A Great Unmet Need
Highlight a great unmet need as a selling point. There are, quite sadly, millions of people in Africa and other parts of the world who lack access to electricity. There is a dearth of refining capacity throughout many parts of Latin America and Asia. In spite of economic growth, many places throughout the developing world lack access to basic products. A banker will see this lack of development as a sign of credit weakness, before believing economic growth signals credit strength. Power in Africa is scarce mostly because there is too little income to pay for it, or because regulatory and political systems are too weak or corrupt so that there is no money to pay for power. Bankers first look for the money that will ultimately repay the debt; they are funny that way.
7 Go Really Big or Small
One last pointer is go big or go home — and you will really go home. You can also go small and go home. Make the project really big with layers of infrastructure so that it is complicated with huge loan exposures. My favorite was a wind farm that was placed on ships and then connected to a new electricity grid that powered a refinery and petrochemical project. The project cost billions of dollars. The presentation had the predictable effect of scaring several banks. Banks prefer reasonable exposures that can be managed within the boundaries of the sources of credit.
A very small project is better than an enormous project, but can also create problems, especially for project finance. It can cost as much, or more, money to finance a small deal than a big one. Banks would prefer that smaller deals have bank guarantees or other structures, but to lose the banker’s attention, insist that the small deal be financed through project finance.
These are the basics and most apply to new developers, but a surprisingly large group of experienced borrowers will continue to make these mistakes. If you think you or your deal is different, think again. Once you have really learned these lessons, there are still more subtle ways to lose a banker.
John Schuster is a Principal with the 32 Advisors Project & Structured Finance practice and advises U.S. and international clients on structured and project finance transactions. Before joining 32 Advisors in 2014, Schuster was head of the structured finance division of the US Export-Import Bank.