example sponsor development risk assessment report

XXXXXX ProjectSponsor Development Risk Assessment Report

Efforts to develop solar projects in the United States require the accomplishment of a number of critical milestones which define the development process and eventually lead to a successful project. Efforts to achieve these milestones face a number of obstacles that require careful planning, risk assessment and mitigation efforts in order for the project sponsor to achieve success. A broad categorization of these critical milestones and phases in project development are as follows:

Land Lease and Leasehold Matters

Project Approvals and Permits

Interconnection and Transmission Feasibility

Power Purchase Agreement

EPC and Construction

Sponsor Financial Exposure prior to Financial Closing

Project Financing and Financial Closing

Each of these phases of project development has unique risks associated with them. A successful development of the XXXXX Project (the “Project”) requires an assessment of these risks and plans on how to mitigate them.

Risk assessment and mitigation typically occurs in two stages. The first stage is the initial identification of risks in the development plan which is the purpose of this report. The second stage is more of an ongoing process of risk assessment as the Project progresses through the development process and changes are made to the Business Execution Plan (BEP) and or new business opportunities or alternatives present themselves for consideration.

One thing is certain in project development: there will be surprises, some good and some bad. When a bad surprise happens the key for handling it is to have as many alternatives and options available as possible to deal with it coupled with an understanding of what the long term implications are of each of these alternatives and options on the overall development of the Project.

XXXXXX PROJECTSPONSOR DEVELOPMENT RISK ASSESSMENT REPORT

XXXXX current risk management strategy is to assess risks in each of the respective phases of development outlined above and to develop strategies to address, mitigate or abate those risks.

1. Land lease and Leasehold Matters.Risks in the land lease and property matters reside in four areas:

Risks of the City’s or XXXXX default under the terms and conditions of the lease, resulting in the loss of the beneficial use of the land to XXXXX. This risk can be controlled and mitigated by monitoring the Parties compliance with the essential terms and conditions of the Lease and maintaining on-going dialogue with the City not only through the development cycle of the plant but continuing on into the operation phase of the Project.

The risk that XXXXX will be unable to secure clear lessee’s title to the Leasehold, thereby rendering the project non-financeable. Obtaining lessee property title insurance from a reputable title insurance company will mitigate this risk. As of the publication of this report XXXXX has secured an American Land Title Insurance (ALTA) policy for the Property.

The risk is that there are hazardous materials on the Leasehold that would render it unusable for the construction and operation of a utility scale solar facility. XXXX has secured a Phase 1 Environmental Site Assessment for the Leasehold and no evidence of recognized environmental conditions that would prohibit the development or financing of the proposed Project were found.

The risk that there are biological (desert tortoise as an example) or archeological (Native American cultural remnants) finds on the Project property or along its proposed transmission ROW that could cause a delay, a lengthy and expensive remediation plan, or even worse, a shutdown of the site or a re-routing of a ROW. To date XXXXX, through its subcontractors, has conducted biological and archeological surveys of the Project site and the ROW to the XXXX substation with no material or significant findings. A biological survey still needs to be completed for the XXXXX transmission ROW but it is not expected to have any material or significant findings given the numerous surveys that have already been conducted throughout the XXXXX. This biological survey is expected to be completed in the spring of 2013.

The risk that the costs of property and other use taxes will render the Project economically unfeasible.

Pre-Operation: XXXXX was previously in a dispute with the XXXX County Tax Assessor regarding tax assessment of the Project’s land prior to commercial operation. XXXX and XXXX with the assistance of counsel, XXXXX, were able to reduce the current assessment of property value to a more reasonable valuation that reflects the pre-operational value of the land for property tax assessment purposes.

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Operation Phase: The next stage of property tax assessment during the operational life of the Project will be of particular importance since this future assessment will take into account the value of personal property (building and structure) that is installed on the site during construction. The amount of personal property that will be established on the site during the construction of the Project will significantly increase the property tax basis of the Project and hence the amount of property tax the Project will be required to pay. A careful interpretation and application of the property tax law for solar projects in XXXX will be of great importance since the property tax assessment will end up being one of the largest on-going expenses of the Project during its operational life.

2. Project Approvals and Permits.There are several risks associated with the permits and approvals for the proposed Project. These risks are generally associated with the costs and time required to apply for, process and receive approval for the permits with the various federal, state and local agencies involved in granting permits and approvals for the Project. However, given that:

The Project is located on land owned in fee by the City of XXXXX.

The other solar developments in the XXXXX are also located on City owned land and none of them have had a problem to date with permitting or environmental issues.

All exiting and proposed EHV transmission in the XXXXX crosses land claimed by the BLM, a federal agency. The BLM requires crossing permits for all ROWs across claimed federal lands. These crossing permits must be granted in conformance with the National Environmental Policy Act (NEPA).

To date, the five completed projects have been granted ROWs by the BLM and the four projects in the permitting process have all moved forward with the support of the BLM and related federal and state agencies.

An issue did arise in the 1st quarter of 2013 regarding a ROW request into the XXXXX and XXXXX substations down the western side of the XXXXX. This is a route that XXXX, XXXX and XXXX have all requested to connect their project development sites with the two mentioned substations. It turns out that a large wind developer in Wyoming, XXXXX , had previously applied for this ROW and claimed that they control the rights to the whole corridor and asked the BLM not to grant any further ROWs in this corridor. XXXX ROW request to the BLM went without notice to XXXXX, XXXX request for the same path was opposed by XXXXX who claimed they had pre-existing rights to the whole corridor based on an earlier application. It is my understanding that a deal was worked out with XXXXX regarding this ROW, although it is not known if XXXXX will be allowed to utilize this same path or will be forced to choose an alternative path.

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XXXX has now decided that its first choice of substation interconnect will be the XXXX Substation which requires a ROW far from the XXXX ROW which is more closely connected with the ROW to get into XXXX or XXXXX substations so this has now become a moot point for XXXX. If in the future a ROW is contemplated by XXXX into either the XXXX or XXXX substation an issue with the ROW connecting the Project’s site to these two substations would be likely under the original ROW XXXXX had proposed.

Given that XXXX preferred transmission route is to XXXX, the assessed risks to permitting and approvals for this ROW is low. Continuing with the execution of the Project’s plan for compliance with the BLM policies and procedures in regards to its 299 application, which includes the completion of the biological survey in spring 2013, will hopefully precede a Finding of No Significance (FONSI) and subsequent NEPA approval and approval under Public Utilities Commission XXX Utility Environmental Protection Act. The FONSI and NEPA/ PUXXXPA are considered likely by early summer of 2013. These series of approvals will be the completion of a major milestone for the XXXXX Project.

3. Interconnection and Transmission Feasibility, Costs and Timing.The XXXXXX is considered one of the most attractive transmission corridors for energy projects in the Western United States. There are currently five major substations (XXXX, XXXXX, XXXXX, XXXXX and XXXXX) and over 30 extra high voltage transmission lines entering and exiting the XXXX. Virtually every state and regional balancing authority and IOU and POU in the Rocky Mountain and Pacific Coast region own, all or in part, and operate transmission lines and substations in the XXXXX. There are, however, concerns regarding the availability of bays in the various substations, transmission capacity, and the costs and timing of network upgrades and improvement plans.

The primary strategy for risk mitigation in the areas of interconnect and transmission was to file separate interconnection applications and proceed with the requisite system impact studies (SIS) and/or facility studies with the California Independent System Operator (CAISO) for interconnect at the XXXX substation, XXXX for interconnect at the XXXX substation, and the Los Angeles Department of Water and Power (LADWP) for interconnect at the XXXXX substation. Although the extra cost of applying for three different transmission options was unfortunate, by doing so XXXXX gave itself the maximum flexibility to have options available in the case that transmission costs at one or two substations would have economically unfeasible or that capacity improvement schedules precluded timely commencement of power delivery to a power purchaser.

XXXXX received very good news in the 1st quarter of 2013 in regards to the interconnection at the XXXX substation which is the nearest to the XXXXX project of the four substations in the XXXX. The SIS XXXX received at the end of January 2013 from XXXX indicated a very reasonable interconnect cost of XXXXX. Additionally, XXXX indicated that they could establish interconnection with the Project within two years (2015).

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Further discussion with XXXX in February and March of 2013 has yielded even better news regarding the on-going facilities charge that will apply to the XXXXX project. The on-going facilities charge is expected to be in the neighborhood of XXXXX a year. Initial feedback in January 2013 from XXXX was that the facilities usage charge would be similar to that of a capacity usage charge versus a wheeling charge. The initial estimate was over XXXXX a year for the Project if it were to use the XXXXX substation as its interconnection point. At the end of March 2013 XXXX administrators reported to XXXX that the on-going facility usage charge (facility maintenance charge) will likely be XXXXX per annum. This is a significant cost reduction and makes the XXXX substation by far the most attractive alternative for XXXXX in terms of total cost as well as the ability to serve multiple off-takers out of this point of interconnect.

While given this very positive news from XXXX, the issue remaining is that the XXXX process is not over and the process still requires a phase 2 Facility Study as well as the actual interconnect agreement with XXXX needs to be documented and approved by legal counsel for its completeness and ability to provide uninterrupted and economically predictable service to energy off taker(s).

While XXXX will undoubtedly decide to go forward with the XXXX interconnection at Mead, as indicated in the previous paragraph, the XXXX interconnection agreement still has several steps to go through before it becomes official. Therefore, in an abundance of caution one could argue that it would be prudent to continue with a Phase 2 CAISO study assuming XXXX as the primary point of interconnect. Doing this would give the Project a second option if for whatever reason unforeseen problems came up with XXXX.

The primary arguments against this strategy are two-fold: 1) if the XXXX interconnection does not work out the project would be faced with considerably higher interconnect expenses by interconnecting at either XXXX or XXXX. It is not certain at this point that the Project would be competitive in the market for a PPA if it was forced to go to these other substations, and 2) In the case for the CAISO interconnect at XXXX, having an immediately available second option for the Project might not matter given that the three major investor owned utilities in California are not looking for renewable energy until the end of the present decade (2018 – 2020). This extended time horizon would give XXXX time to reapply to CAISO in this worst case scenario.

Given the economic costs of continuing on with the interconnect applications for XXXX and XXXX and: 1) the higher interconnect costs if XXXX was forced to go to either of these sites in the near term, and 2) the lack of sense of urgency for a PPA with the CA IOUs, it is advisable that XXXX cease with the interconnection application for these two interconnect points. Doing so will save XXXX from putting at risk a XXXX deposit or LOC for the 2nd phase of SIS for the XXXX application and an additional XXXX for an interconnect study for XXXX with LADWP. Worst case for XXXX would be to reapply CAISO and/or LADWP for interconnection studies if XXXX was unable to acquire an interconnect agreement with XXXX.

Lastly, there is another issue regarding the potential scenario where the interconnect agreement is ready to be signed before the PPA is ready. The potential risk under this

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scenario is that XXXX would be put into a position to sign and commit capital to the substation upgrades before knowing if they have a signed PPA with an off-taker. This is a common problem faced by developers who are trying to get a PPA and an interconnect agreement done at the same time, which is prudent project development.

According to legal counsel (XXXX) this problem is usually resolved through effective communication with the Interconnect/ Transmission Authority, XXXX. Legal counsel believes that XXXX would very likely give XXXX an additional few months to ensure they have a PPA before they would be required to commit to the upgrades required at the XXXX substation. The key to this strategy is communicating early and clearly with XXXX about the intentions and time schedule of XXXX.

4. Power Purchase Agreement.

The risks associated with the PPA fall into two broad categories:

(1) XXXX will be unable to enter into an agreement to sell the power as the market for energy from renewable will be phased out, or

(2) Terms and conditions for the purchase and sale of energy from the Project will be such that it will render the Project uneconomical.

The first risk appears to be unlikely to materialize. The demand for power in the western US and in particular California, and most of the states in the American Southwest are expected to resume a positive growth rate as these economies emerge from the severe recession of 2007 – 2010. Further all of the states in the American Southwest have RPS goals to meet by 2020 – 2025, with California’s RPS requirements dwarfing that of all other states.

Additionally, both IOUs and POUs are beginning the process of closing down and decommissioning coal and nuclear power plants, resulting in the loss of large blocks of base load generating capacity in the later years of this decade and into the next. What this likely means is that natural gas and renewable energy will play an increasingly important role for utilities well into the foreseeable future.

The second risk, being unable to structure a PPA that is economically beneficial to XXXX, is more problematic. Over the last several years utilities have liberally signed hundreds of PPAs, many of these have been with thinly capitalized and ill prepared developers which have resulted in the widespread failure of proposed projects with PPAs from ever delivering energy to the grid. This trend has also resulted in a “race to the bottom” for PPA prices where each year small developers have bid into the utility RFPs with very aggressive PPA prices hoping to get a PPA with a utility. As mentioned, many of these PPAs will never materialize into an operating project, but the problem it creates is that it drives down prices to unrealistic levels.

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It is well documented that from 2008 until now over 70% of the total MWs that have been signed under PPAs have never achieved operational status. The reasons for this widespread systemic failure come from: i) lack of development capital, ii) poor planning and site selection of the project (particularly as it relates to permitting and interconnection), and iii) inability to raise project financing.

While the IOUS in California are claiming that they do not need to enter into new PPAs with renewable energy projects given their large backlog of signed PPAs, given the high attrition rate of projects, most knowledgeable industry participants believe that California IOUs and other utilities in the Western U.S. will need to continue to sign new PPAs for the remainder of the decade to replace projects that have fallen out and to meet 2020 RPS requirements, particularly after 2016 when utilities ability to use “bucket 2” and “bucket 3” power to meet RPS requirements is cut in half.

Another trend that bodes well for the future of solar projects is the continuing improvement in solar panel efficiencies and the rapid decline in unit costs. Solar panel prices have fallen significantly since the mid-2000s to a point where true grid parity with base load energy is not as far off as many thought only a few years ago. Utilities tracking the costs of solar and alternative energy developments are likely negotiating PPAs in anticipation of these trends continuing through the balance of the decade.

Mitigation of the risks outlined above is well within XXXX s capability.

First, XXXX needs to continue to carefully monitor and assess all aspects of Project costs and expenses. Given the competition in the market for new PPAs and the rapidly declining cost of utility scale solar PV projects, it is imperative for XXXX as a developer to ensure that its costs and project layout maximizes economic value for the XXXX Project site. This focus on maximizing economic value is ingrained in XXXX, XXXX’ s corporate parent’s culture.

Given the recent positive developments with XXXX as a point of interconnect the Project will probably remain very competitive in the market place on a pure cost basis with almost any project in the market. This coupled with XXXX’s agnostic approach to using the best equipment and XXXX’s development and utility experience and investment grade rating should clearly give the Project a competitive advantage over most projects competing in the market for a PPA.

Second, if at all possible, XXXX should try to open PPA discussions on multiple fronts to avoid becoming hostage to any one customer for the sale of the Project’s power. Ideally if the Project’s energy output can be marketed to multiple buyers then XXXX and its advisors will gain a much better appreciation of the terms in the market which will allow them to realize the best possible PPA for the Project. The Project’s point of interconnect at XXXX greatly enhances this opportunity. Often a project relies heavily on a single power purchaser or group (CA IOUs) which restricts a developer’s capacity to negotiate the best PPA for purchase and sale of a project’s energy. The existence of

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alternative paths provide incentive to power purchasers to agree to reasonable, market rate terms and conditions for the Project’s PPA.

Third, and perhaps most importantly, XXXX needs to increase its visibility to all of the potential energy off-takers under consideration for the Project. One of XXXX s greatest strengths is that it is a fully owned subsidiary of XXXX and through XXXX, part of the XXXX family. Unlike many of its competitors, XXXX has the corporate experience, financial strength and relationships with advisors, consulting, legal and engineering firms and EPCs to plan, develop, finance and provide O&M to utility scale power generation projects. XXXX’s sponsorship is a significant advantage for the Project.

A detailed and coordinated approach to promoting XXXX and the Project needs to be conducted. This is often a “grass roots” effort, in that the marketing of XXXX and the project needs to be conducted person by person in numerous organizations in a systematic effort. Further, once XXXX and the project are introduced to individuals in various organizations follow up correspondence needs to be maintained.

As part of its development plan XXXX and XXXX have agreed that a well connected law firm and/or a PPA advisor (perhaps the same organization) would be critical in assisting in a marketing of the project. Major law firms specializing in independent energy and project finance typically have strong relationships with numerous utilities. It is also very important that the law firm and/or the PPA advisor have good connections and an abundance of experience in the local market where XXXX is hoping to get a PPA. As an example, East Coast based lawyers and law firms may not have the local experience needed to effectively direct a marketing campaign to promote XXXX and the Project.

Securing an economically viable PPA is the cornerstone of a viable Project. Following each of the above risk mitigation measures will ensure that the Project achieves this objective.

5. EPC and Construction Risk

Construction risk, as is the case with most independent power projects, will be one of the larger risks associated with the Project and therefore will need to be carefully reviewed and structured around to minimize the impact to the Project, the capital providers to the Project, and to the Sponsors themselves.

Often the greatest period of risk in financing a renewable power project is during the construction and start up phase of the project. Construction lenders in a non-recourse transaction will not take this construction risk without a combination of “completion guarantee” and/or other support mechanisms from the Sponsor(s) and/or the EPC Contractor and/or other related parties, such as Equipment Suppliers (Solar Panel Manufacturer).

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Typically a completion guarantee is essentially a guarantee limited in time, since it guarantees the project will be completed in a certain time frame and will perform at a certain rate of efficiency. It expires not on completion of construction but after the expiration of a period of time sufficient to ensure that the project will in fact perform as represented. If the construction lender is otherwise satisfied with the projected cash flows and the economics of the transaction, the completion guarantee may eliminate the necessity for any other source of long term direct guarantee.

Construction risk is used in this context to mean the risk associated with the Project achieving commercial operation by a date certain, with no cost overruns and meeting certain performance measurements over a defined period of time after construction is completed. While there are other risks that may delay the completion of the project or adversely impact it, such as political risk, casualty risk, and acts of God, these risks are not directly assumed by the Sponsor/ EPC Contractor and will typically be covered under third party insurance for such occurrences.

As stated above, in non-recourse project financings, construction lenders will require the Sponsor and/or EPC Contractor to provide a completion guarantee or some other form of support or some combination of the two. The combination of support and guarantees from the Sponsor(s), EPC Contractor and other Equipment Suppliers can be as diverse as there are projects in the market.

As an example, the support from the Sponsor could be in the form of a completion guarantee in lieu of the EPC Contractor supplying a completion guarantee and/or a date certain for funding some portion of the Project. Sometimes this is more acceptable to a Sponsor then negotiating a completion guarantee with the EPC Contractor who may be unwilling or unable to provide for such a guarantee. Given the relatively low-tech nature of the Project, it seems more than reasonable that such completion guarantees will be available from most large EPC Contractors. Where this could be potentially problematic is with the choice of the panel manufacturer or equipment supplier that has limited market presence and the EPC Contractor is asked to “wrap” (see below) the solar panel performance risk.

The requirements of the construction lenders will be based on many different factors, including, but not limited to: i) the reputation and credit worthiness of the EPC Contractor, ii) the reputation and credit worthiness of the Sponsor(s), iii) the experience of both the Sponsors and the EPC Contractor in building and operating a power plant similar to the one that is being project financed, iv) the amount of installed equipment of the panel manufacturer, v) the economics of the Project and the amount of projected coverage assumed in cash flow projections.

In many project financings the EPC Contractor is asked to provide for a completion guarantee that is limited to a specific period of time and a capped amount. Since the EPC Contractor is often the project party that has the most understanding and control of managing construction and performance risk, the EPC Contractor will often be the

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project participant that is asked to assume this risk. If the EPC Contractor is the party supplying the completion guarantee then the lenders will usually ask that the EPC Contractor “wrap” the risk of all subcontractors including the panel manufacturer so that the EPC contractor becomes the focal point of responsibility for the performance of the project. Therefore it is typically important that the EPC Contractor accepts the warranties and performance guarantees of the panel manufacturer and makes these warranties and performance guarantees their own.

As an example, a EPC Contractor will provide a “wrap” of the construction of the Project that will cover i) completion, ii) performance, iii) cost over runs, and iv) delays. This wrap of the Project will fall off after a period of time following COD (90 days as an example). After the completion guarantee falls off the lenders and equity participants will typically rely on the reps and warranties provided by the various equipment suppliers such as the panel manufacturer.

The form of the completion guarantee will need to be acceptable to the construction lenders. For large, well know and highly rated EPC Contractors a corporate guarantee may suffice, but often EPC Contractors will provide a completion guarantee (also sometimes called a performance bond) that will be backed by a “standby” letter of credit (LOC) for the amount that the EPC Contractor is at-risk. Another arrangement that is sometimes used in conjunction with a LOC is for the construction lenders to hold back the full amount of the EPC Contract until a period of time following COD to ensure that the project is operating according to agreed upon specifications.

If construction lenders are not comfortable with the “wrap” of the Project by the EPC Contractor or the EPC Contractor is unwilling or unable to provide for such a guarantee then the construction lenders will look to the Sponsors to provide such credit support.

As to the amount of the Completion guarantee that a construction lender will seek from an EPC Contractor, as noted above this amount can vary depending on a number of different factors, including but not limited to, the technology employed, the track record of the EPC Contractor and the Sponsor(s), as well as the robustness in the economics of the project. For planning purposes, a 30% liquidated damages cap can be assumed, assuming the application of well known technology, well known EPC Contractor and Sponsors. If less well known technology is used the amount of liquidated damages can approach 100%. Bottom line is that since the amount of guarantee sought by the construction lender can be based on so many factors it is best that the dialogue with a construction lender is established early on in the process regarding what they would require with any combination of equipment, EPC Contractor and Sponsor(s) so as to eliminate unpleasant surprises.

While it is perhaps somewhat misleading to suggest a specific amount of completion guarantee that lenders will seek without us knowing the details of the Project, a typical term sheet of these concepts can illustrate what lenders would typically find acceptable:

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Project Construction Loan Amount: $400,000,000 – This would represent 100% financing during the construction phase of the Project and typically include a 10% contingency in the budget that is over and above the Liquidated Damages offered by the EPC Contractor. Project cash flow model and assumed debt service coverage amounts would assume the full $400 million construction price which incorporates a 10% cost over-run contingency.

Completion Guarantee: EPC Contractor will provide Completion Guarantee with liquidated damages capped at 30% of the total construction amount for: i) completion of the Project with specific performance requirements over a defined period of time that is deemed by Lender’s Engineer to be acceptable in assuring long term performance of the Project, ii) cost-over runs over the budgeted amount of the Project, and iii) a date certain for completion of the Project.

Liquidated Damages are usually further broken down into categories for cost overruns, performance and delays, collectively the Liquidated Damages associated with these two main sections will collectively total 30%. As an example only, cost overruns may be 10% of the LDs, performance related issues may represent 10% of the LDs and construction delays may represent 10% of the LDs, paid out in a daily penalty to be paid for every day that the Project fails to meet completion by a specified date. Often when there are complications associated with construction of a project all three categories are often tripped.

Sponsors: Sponsor(s) will agree to fund its portion of the equity in the project at a Date Certain or when Lender’s engineer deems project has achieved successful completion, whichever occurs first. Lenders will require that the Sponsor’s commitment to fund the Project be established at the financial closing of the construction loan. This commitment is often met by the Sponsor’s posting a LOC or posting a corporate guarantee that the Lenders find acceptable. The other alternative is for the Sponsors to fund their equity in the project pari-passu with the Lenders during the construction

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phase. Typically the Sponsors would rather post a LOC for their commitment so as not to employ their capital during the non-cash generating construction phase due to the higher cost of equity capital.

Tax Equity: Tax Equity will also be looked upon to fund on the

earlier of a Date Certain or when the Project meets its completion milestones.

With that said, typically Tax Equity Investors will not assume construction risk. They will only fund once the project has met its completion milestones.

Take Out Funding Requirement: What is certain is that Lenders to the Project will require a take-out funding of the construction loan to be contractually agreed upon prior to the closing of the construction loan. Typically this will include the senior lenders assuming a percentage of the construction loan as the long term loan, and an agreement among the Tax Equity Investor(s) as well as the Sponsor(s) as to the amount of capital that they will fund.

Over the last several years Lenders have given full credit for the 1603 credit (30% of the project cost) as a portion of the guaranteed amount due from Sponsor(s) and Tax Equity Investor(s). Giving full credit to the 1603 credit significantly reduced the “take-out” amount that the Sponsors would need to guarantee since tax equity investors would not assume construction risk. With the expiration of the 1603 credit in December 2011, the last of the 1603 deals were done in 2012.

In 2013 there have been few data points in the market to determine with certainty how Lenders will respond in giving credit or even partial credit to the Investment Tax Credit (ITC) that is also equal to 30% of the project cost. With the tax equity investor not committing to COD this may have the effect of increasing the amount of the “take-out” guarantee that the Sponsor(s) will need to guarantee during the construction period.

This scenario and ways to mitigate the amount of the “take-out” guarantee will need to be further explored with our, to be named, financial advisor and legal counsel. The other item of consideration is how this guarantee would be measured and accounted for by the Sponsor(s) on their own balance sheet. Clearly the guarantee for the take-out equity funding requirement is a conditional or contingent one, in that the EPC Contractor will likely be offering a guarantee for the on time completion and performance of the Project, and the Tax Equity Investor will offer a guarantee that they will fund if the completion milestones of the Project are met. Given those two guarantees by the EPC Contractor and the Tax Equity Investor the way the guarantee will be characterized and accounted

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for by the Sponsor will not be the same as if they offered an unconditional guarantee with no counter guarantees in place.

6. Sponsor Financial Exposure Prior to Financial Closing.

Sponsors typically take on additional financial risks during the development cycle of the project by providing a capital bridge that is required for providing a LOC, cash deposit or corporate guarantee for performance under the PPA and Interconnect Agreement, ordering equipment, and mobilizing legal, financial and engineering personnel whom require payment prior to financial closing of the construction and permanent financing. It can be thought of as a capital bridge since the financial guarantees and expenses will be reimbursable to the developer at the closing of the construction and long term financing.

Unfortunately the risk of providing this capital bridge on a deal that is not 100% certain to achieve financial closing is hard to avoid given that the PPA and Interconnect Agreements are required to be signed before financial closing, the long lead times expected for certain types of equipment (which require ordering sometimes a year in advance) and the significant amount of professional services that are required to move a project through financial closing.

One of the ways to minimize this risk is to wait until there is a high degree of certainty that the project will achieve financial closing. Typically this means that a developer will wait until a PPA and Interconnect Agreement is signed or in advance stages of documentation before ordering equipment or spending heavily on legal, financial and engineering services.

When ordering equipment, often a down payment will be required by the manufacturer when the order is placed to cover the working capital requirements of the order. It is important that this down payment is properly negotiated with the manufacturer and reviewed by XXXX’s legal counsel to ensure maximum protection for XXX of a down payment being made to a financially weak manufacturer. XXXX will likely want to ask for some protection from default by the equipment manufacturer by asking for collateral. Often this collateral for the down payment will be a first lien on the raw materials and unfinished goods that the project developer has ordered. In addition to this collateral assignment, more protection may be needed, depending on the state of the manufacturer, in the form of covenants and a guarantee, similar to what would be found in a loan agreement, which is essentially what a series of down payments on an equipment order becomes.

Engineering and Design personnel (XXXX) need to be cognizant of this risk window and recognize when developing a critical path for engineering and construction of the Project that ordering of equipment and advanced negotiation with an EPC Contractor will not

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likely be done in earnest until after a PPA and Interconnection Agreement is signed or at least in very advanced stages to minimize risk to the developer.

As explained in the section discussing interconnect issues, often a developer will be in the predicament where an interconnect agreement is completed before the PPA or vice versa. In either of these situations the developer is faced with a risk of committing capital to the upgrades required on interconnection or committing capital to performance under the PPA before knowing with certainty that the other agreement is going to get done. This is a common problem because developers try to get both documents completed at or near the same time. In order to avoid making such commitments without knowing if the other agreement will be completed the developer can typically buy themselves some time by effectively communicating their situation to the utility or interconnect authority they are dealing with. Typically if the developer communicates their position they will be allowed time before they need to commit capital required under the agreement. During this time they will be able to get the other agreement signed.

Once these documents (PPA and Interconnect Agreement) are both signed the developer will need to commit to a rather large performance guarantee under both contracts. This performance guarantee (under a PPA it is a performance guarantee that the project will deliver power as defined in the contract for the interconnect agreement it is typically a financial guarantee that the Project will cover the expense of system upgrades required for transmission of the power unto the grid) is made before financial closing and therefore will add to the developers at risk capital until financial closing occurs.

As for legal and financial services the developer needs to exercise caution with professional service providers until the PPA and interconnect are either completed or very near completion. While law firms and banks may defer the actual billing of services to the back end of the deal, this deferral, if it is offered, does not eliminate the cost and liability of professional service providers which can grow quite large as the Project nears financial closing.

7. Project Financing. Failure to achieve a successful project financing is typically related to: i) the lack of a suitable PPA, ii) a PPA that produces a low return on invested capital, iii) a weak and thinly capitalized sponsor, iv) poor planning and understanding of the project finance market, v) use of equipment that is lacking historical field experience combined with an inadequate performance warranty or a balance sheet not able to back up the warranty, and vi) a project that is missing a critical contract or permit or has a contract or permit that is discovered to be flawed and deemed not suitable for non-recourse financing.

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Assuming that XXXX is successful in acquiring all the required permits and contracts as well as an economically viable PPA, the one risk that remains and is difficult to manage is the cost of capital in the market.

The cost of capital is among the most significant costs for a project and unfortunately is often a function of the supply and demand forces in the financial markets, and to a large extent outside the control of XXXX. One thing to keep in mind is that when the supply of capital becomes scarce, capital will flow to the best projects first. Also some sub sectors of the financial market will be more active than other sectors, for instance the commercial bank market may be retrenching but the institutional market (life insurance companies) may be expanding. It is important that all sectors of the market are understood and explored as financing alternatives. Financial consultants need to have a broad understanding of the market and alternative options.

Therefore one of the ways to best manage the risk of changes in the financial markets is to ensure that the project compares favorably with others in the market and that XXXX and its advisors thoroughly understand what the various sub market are looking for in a project and make sure that the XXXX Project has these same attributes and marketed accordingly.

Additionally, it is important that a methodical, systematic and timely approach is taken in approaching the market. Approaching the market in this manner with personnel and advisors that are well versed in project finance and with a thorough understanding of market conditions in all sub-markets will make a material difference and lead to a successfully financed project.

XXXX has already taken many steps in the right direction for the successful financing of the XXXX Project. XXXX has a solid understanding of the economics in the Project, developed a comprehensive financial model, will have explored a number of financial market alternatives prior to entering into the market, and their financing plan assumes the naming of a financial advisor as soon as it is practical, likely soon after the signing of a PPA.

To recap, the path to a successful project financing for the XXXX Project will likely look very similar to the following schedule of activities, the one caveat being if XXXX hires a Financial Advisor late in the PPA process. If a Financial Advisor is hired they will likely follow a similar path that is shown below.

Path to Financial Closing:

1. Financial Modeling of the Project – The financial modeling of the Project will certainly be an ongoing process up until financial closing and even beyond to the commercial operation date as the project emerges from construction and goes on-line. Hopefully, the changes to the financial model of the Project will be more fine tuning (small changes in equipment prices or small changes to energy output due to changes in site layout and configuration) than anything else.

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The important financial modeling exercises will likely be in the early stages of development (August 2012 – late 2013) when project configuration and equipment choices are being matched to a power purchase agreement and an interconnect agreement.

2. Financial Modeling of the Special Purpose Company – Similar to the financial modeling of the Project, the financial modeling of the Special Purpose Company will be an ongoing process that will likely continue right up until financial closing as financial terms and conditions are agreed to as a normal part of the negotiations that occur in project financing.

As with the financial modeling of the project, much of the financial modeling of the Special Purpose Company (SPC) will take place concurrently with the financial modeling of the Project with the intent that XXXX will have a solid understanding of the best financial vehicle for the SPC prior to launching the RFP to lenders and tax equity investors. Feedback from XXXX’s Financial Advisor and RFP respondents will provide input on the pricing and terms and conditions for their investment in the Project and will further refine the modeling of the SPC prior to financial closing.

3. Prepare Comprehensive Project Financial Feasibility Report – This report will be written with recommendations as to which financial structure for the SPC and the Sponsors will maximize their respective financial goals and objectives (as an example: IRR, NPV, minimize equity investment, etc.). This report will also be a comprehensive survey of the financial markets and provide likely pricing and terms and conditions of the various capital providers to the Project. It is currently assumed that this report will be done by me and prior to the hiring of a financial advisor.

4. Prepare Information Memorandum for Project – This report will be prepared to provide potential financial investors (debt and equity providers) with a comprehensive view of the Project, complete with a detailed summary of all of the material contracts, permits and licenses. The information memorandum will provide a complete economic analysis of the project, typically with an economic model for investor review and analysis. The Information Memorandum and all of its exhibits will become the primary document that will be used by investors to determine whether or not they have an interest in investing in the Project. A well written, informative and comprehensive document will be instrumental in attracting investors’ attention to the Project. As a rule of thumb, the more investors that are interested in the Project the better terms and conditions the Sponsors will be able to negotiate and the lower the cost of capital they will be able to employ in the Project.

5. Distribute Information Memorandum to Project Capital Providers – The timing of this event will very much depend on when and how far along negotiations are with a utility on the Project’s power purchase agreement. Most financial institutions will not want to begin work on preparing a bid on a project financial proposal until they are confident that a power purchase agreement is going to be signed. The date that the Information memorandum is distributed should roughly coincide with the end of negotiations with the

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utility on the power purchase agreement. The distribution of the Information Memorandum in many respects represents the beginning of the project financing process.

The distribution of the Information Memorandum will be done with a person to person meeting of various financial institutions. It is anticipated that the distribution of the Information Memorandum will coincide with an approximate week-long visit to financial institutions in New York to introduce the Project in person.

6. Receive Feedback and Choose Lead Capital Providers – The Sponsors will decide during this time on lead capital providers who will be chosen to represent the banks and tax equity investors. It may be that a sub-debt provider will also be chosen if that is a viable financial structure alternative. During this time period, financial institutions will be given time to analyze the project, prepare bid submittals of which the Sponsors will chose on which proposals best match the financial objectives they desire.

7. Negotiate Preliminary Terms and Conditions with Capital Providers – This process will provide Sponsors and Capital Providers Terms and Conditions of their financing proposals of which they will take to their respective investment committees for final approval.

8. Lead Capital Providers conduct due diligence and finalize terms – This period is provided for Capital Providers to complete all of their due diligence and seek approval from their respective investment committees. By the end of this process the lead Capital Providers will have provided binding commitments to the Sponsors for the XXXX Project, subject to changes that may occur during the financial documentation closing process or any other material change to a contract or permit or license.

9. Negotiate Inter-creditor Agreement – The Inter-creditor Agreement can be a difficult agreement to negotiate since it governs the relationship between each class of the capital providers in the Project. Often the lenders, tax equity investors and the Sponsors will all want and expect certain rights and privileges to protect their investment in the Project. Often these demands and expectations of each class of investor are in conflict with one another. The Inter-Creditor Agreement is the document that will govern over these conflicts and make them cohesive with one another. It is not anticipated that an Inter-Creditor Agreement will be finalized at the end of this period but at a minimum a general framework will be agreed upon prior to bank market syndication.

10. Syndication of the Bank Deal – The lead banks selected and/or the Financial Arranger will syndicate the senior construction loan and senior term loan to a wider market of interested financial institutions. Often banks that bid to be a lead bank will be interested in being a member of the syndicated bank group. During this process the bank market will receive the deal in the form of the Information Memorandum and a bank meeting (often in New York to get the most banks interested and involved) and take the bank deal that has been largely formulated by the lead bank(s) to their respective investment committees for approval to participate in the debt financing.

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11. Lender and Tax Equity Documentation Completed. This is typically a two to three month process between bank approvals and completing all documentation on behalf of lenders and tax equity. Tax equity will provide a conditional commit to fund based upon the Project achieving COD at the end of the construction period.

12. All Conditions Precedent for Financial Closing Completed.

13. Project Financial Closing.

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example sponsor development risk assessment report

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