Insights on Surety Bonds from CEBA Members
Part 3 of the Energy Customer Investment-Grade Credit Support Blog Series
Surety bonds are an increasingly popular method of credit enhancement for non-investment grade offtakers looking to do clean energy deals. CEBI spoke to two long-standing CEBA members who have successfully leveraged them. Equinix and Iron Mountain Data Centers used surety bonds to negotiate power purchase agreements (PPAs) in 2015 and 2017, respectively. At the time they did these deals, both companies were sub-investment grade, though Equinix has since become investment grade. In a recent interview, Bruce Frandsen, Director of Global Renewable Energy and Cleantech at Equinix, and Chris Pennington, Director of Energy and Sustainability at Iron Mountain, shared advice on using surety bonds as a credit support mechanism for clean energy procurement:
Leverage consultants and advisors: Both Pennington and Frandsen highlighted their reliance on consultants from the very beginning of their PPA process. A good consultant ensures that credit status and possible mitigation strategies are raised early. Consultants also help place offtakers in conversations with developers who are willing to consider surety bonds.
Include your Treasury and Risk departments in strategic discussions from the very beginning: While setting sustainability goals can seem like a process that does not require heavy input from Treasury or Risk, both Frandsen and Pennington wish they had involved these teams earlier. Both companies used letters of credit (LCs) for their first PPA deals, but their Treasury departments immediately suggested surety bonds once they realized how many deals both companies aimed to pursue. LCs pull on a company’s line of credit, which may be fine on occasion but is not ideal for multiple deals. Had Treasury been involved in strategic planning, they may have aimed to avoid LCs altogether. In addition, since the Risk team is likely to be the team actually working with banks and insurers to underwrite agreements, it is helpful to also loop them in.
Address your credit status and willingness to do surety bonds up front: Pennington noted “It’s super easy to… not have [the discussion about credit support and surety bonds] up front because you get so excited about talking about this solar project or wind project… But when the time comes, it’s like, oh, that’s a really hard barrier that can completely stop progress.” Frandsen agreed, suggesting that companies include this information in their requests for proposals (RFPs) or solicitation requests. In fact, Equinix still references surety bonds as a credit support mechanism in their RFPs, even though they are now investment grade, as a proactive measure to address the risk that their status may drop.
Provide a surety bond that mirrors an LC’s callability and provide it up front: Offtakers might prefer surety bonds because they don’t impact their lines of credit. However, other deal chain stakeholders often prefer LCs because they are “immediately callable,” meaning that developers can more easily demand payment and when they do, the offtaker’s lender typically has only about 48 hours to pay. While surety bonds traditionally are not written that way, both Frandsen and Pennington recommend writing your agreement to mirror this functionality, with Frandsen stating, “that [lack of immediate draw capability] seems to be the main component that scares the financial institutions away from looking at this as a viable option.” Pennington recommends having the actual bond form ready during the terms sheet phase of PPA negotiation. Negotiating the bond form can take anywhere between a few weeks to a few months, so it is critical to ensure that all parties — financiers, developers, and offtakers — are comfortable with this as soon as possible.
Be willing to accept surety bonds in return: Developers have stated that a barrier for their acceptance of surety bonds is that while offtakers ask to use it for themselves, they are not often willing to accept them from developers in return. Especially in a more constrained buyers’ market, being willing to accept similar terms from a developer may be key.
Be willing to accept an LC as a Plan B: While both companies were able to use surety bonds successfully, Frandsen and Pennington agree that the first attempts can involve trial and error. Be committed enough to the PPA negotiation that you are willing to consider other options if conditions change. In fact, Pennington mentioned that Iron Mountain recently had to switch from a surety bond to an LC at the last minute because while they had informally agreed on a surety bond, the project’s financier was unable to get comfortable with it after seeing the bond form. Pennington noted “…there has to be a strong enough commitment to what this contract achieves in the first place… it can’t entirely hinge on whether or not you have a surety bond in place.”
If you are interested in leveraging surety bonds or have done so and would like to share insight, please reach out to firstname.lastname@example.org.