Finance | 8 Min Read
We are, by every measure, in the greatest moment of crisis the world has faced since World War II. In the United States, we are confronting three generational crises at the same time - the coronavirus pandemic; economic collapse; and the social justice movement which taken together are shaking the nation’s confidence to its core. The resulting sadness and anxiety are at levels not experienced since 1974. The negative mood permeates every aspect of life creating despair, anger and frustration leaving people exhausted and hopeless.
The personal angst of the times is also being felt in the private equity and private lending markets. Perceived risk levels on investments are increasing as result of doubt over the rate and extent of the economic recovery. Many deals that would have received approval six months ago from a private equity firm or private lender are now being passed on because of the analytical increase in risk failure over the near term.
The U.S. Federal Reserve is taking the most aggressive actions in its history to support the economy and has indicated that its efforts are open-ended and unconstrained in amount. The actions being taken by the Federal Reserve include:
The program will allow companies access to credit so they are better able to maintain business operations and capacity during the period of dislocation related to the pandemic. This facility is open to investment grade companies and will provide bridge financing of four years. The Federal Reserve will finance a special purpose vehicle (SPV) to make loans from the PMCCF to companies. The Treasury, using the ESF, will make an equity investment in the SPV.
Additionally, the program will purchase in the secondary market corporate bonds issued by investment grade U.S. companies and U.S.-listed exchange-traded funds whose investment objective is to provide broad exposure to the market for U.S. investment grade corporate bonds. Treasury, using the ESF, will make an equity investment in the SPV established by the Federal Reserve for this facility.
The Federal Reserve’s focus on supporting the liquidity of the private investment and private lending sector is a direct recognition that a lack of confidence could result in a freeze in the secondary markets eliminating access to capital. The result of a freeze in capital would turn a crisis into a catastrophe. However, there is an essential component to the Federal Reserve’s actions that points the private capital markets in a certain direction. It is the requirement that the companies accessing capital be investment grade.
Investment grade refers to the quality of a company’s credit and its ability to repay its issued debt. The rating must be BBB or higher by Standard and Poor’s or Moody’s.
There is, in any crisis, enormous opportunity to take advantage of investment opportunities especially when the parameters of capital access with required risk levels are so clearly defined. Whether you are the executive leading a company raising capital or the fund investing private equity or making a private loan, the requisite mitigation of risk and credit enhancement is now easy to understand, accessible and an economically viable cost baked into the transaction.
What I am talking about is Performance Guarantee Insurance (“PGI”) structured through Critical Mission Consulting, LLC out of Denver, Colorado. PGI protects businesses, and their capital providers, from non-payment of their commercial debt or failure to achieve an expected rate of return or projected value on a private equity investment. It makes sure loans are paid and investors are secure in their investments and allows all parties to reliably manage the economic, commercial and political risks of trade that are beyond their control. Additionally, PGI is an accessible and economically viable path to achieving a BBB credit rating, opening up the opportunity for companies or the funds that invest in them, to sell their bonds into the Federal Reserve backed secondary market.
A case study of a current client is the best way to understand the power of PGI and its potential to open access to the greatest opportunity in a generation.
Green Hydrogen Client (“GHC”), using its proprietary technology, produces green hydrogen from various types of waste. Through its mass production of green hydrogen, the company’s mission is to decarbonize the world by solving two crucial global crises: climate change and waste pollution.
1. Raise $80M
2. Obtain enhanced bankability with a strategy to mitigate risk of downside loss due to default and a credit enhancement facility based on client’s green hydrogen technology and the asset of the commercial facility.
3. Obtain a BBB credit rating or better.
Barriers to Obtaining Capital
Due to inherent technology risk and the perceived economic risk related to the current crisis, lenders could suffer significant losses if the technology does not perform as expected; therefore, lenders were reluctant to fund client’s project.
Barrier 1: Inherent Technology Risk
As is the case with any venture involving new technology, lenders were initially reluctant to fund GHC’s project. Based on uncertainty surrounding inherent technology risks, lenders were wary to provide financial support.
Barrier 2: Overall Project Risk
In addition to the inherent risks surrounding their breakthrough technology, GHC also faced project risks that accompany many first-time commercial projects now exacerbated by the current trifecta of crises. Although the technology had been validated by several global institutions, in addition to having been demonstrated at a full-scale test site for seven years, concern around production capacity still existed .
Solution: Cover the trade with PGI:
The offering includes PGI backed by an S&P AA-rated insurance provider. This deal component reduced the pre-revenue cost of debt from 12.5% to 5% (15-year term).
The premium to provide the private the lender with a default guarantee that covers the principal, interest and penalties for the 15-year term of the private loan is a 6% one-time premium of the total loan amount.
Solution 1: Bespoke Insurance Policy
Backed by an S&P AA-rated insurance company, we facilitated the structuring of a bespoke PGI policy, with a total value of $80M, that mitigated project risks stemming from the green hydrogen technology. By partnering in the risk assessment process, we identified potential risks and recommended a PGI solution that would effectively mitigate them. GHC obtained a financial backstop that will ease the concerns of potential investors at a cost of 6% of the lender facility.
Solution 2: Basket of traditional and specialty coverages
In addition to structuring the PGI policy, we evaluated the entire GHC project from a commercial-risk standpoint. Relying on insurance expertise, we not only placed standard P&C coverages necessary for the project, but also arranged a basket of specialty coverages which further mitigated project risk in several key areas.
Result 1: Insured projected revenues
By structuring an insurance policy that transferred technology risk from the lender to the insurance company, GHC has effectively guaranteed projected revenues which in turn protects GHC’s debt obligations to its investors and lenders.
Result 2: Guaranteed production levels
As a result of the additional specialty insurance coverages, the project was further risk mitigated from a commercial standpoint. By placing coverages for technical, production and facility risks, GHC obtained a guarantee of the project’s minimum output. GHC was able to proceed confidently without having to worry about the fallout of potential production failures.
Result 3: Enhanced bankability
Through the combination of results #1 and #2, GHC achieved enhanced bankability and attractiveness to investors. By guaranteeing projected revenues and minimum output levels, the coverages structured under the PGI and additional coverages provide the project with a needed level of predictability that appeals to investors and lenders. Said guarantees effectively risk mitigate GHC’s project and allows them to approach the market, confident that they will secure required capital.
Result 4: Investment Grade Credit Rating
The combination of guarantees and risk mitigation backed by S&P AA rated companies allows GHC to apply for their own BBB credit rating. The private lender can also support the achievement of the investment grade rating if it is their desire to sell the bond in the secondary market to the Federal Reserve.
The brightest people in the financial sector I’ve been working with immediately recognize what Performance Guarantee Insurance brings to the table in terms of opening access to more transactions and capital. There is a recognition that more capital can be deployed at lower risk while preserving the potential upside. There is also a “light bulb moment” for private equity fund managers and private lender fund managers who realize that their companies may be able to obtain a BBB credit rating making their bond issuances marketable through the Federal Reserve program.
Now is the time to take advantage of the investment opportunities with Performance Guarantee Insurance’s powerful risk mitigation and credit enhancement results. Whether you are the executive leading a company raising capital or the fund investing private equity or making a private loan, the requisite mitigation of risk and credit enhancement is now easy to understand, accessible and an economically viable cost to the funding of your transaction.