Infocast’s 2018 Solar Power Finance & Investment Summit Soundbites

Mayer Brown - Tax Equity Times
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Below are soundbites from panelists at Infocast’s Solar Power Finance & Investment Summit from March 19th to 22nd in Carlsbad, CA.  It was an extremely well-attended event and the mood of the participants was generally upbeat.  Many people observed that there was more capital for projects under development or to buy operating portfolios than there was such supply of projects available to meet that demand.

The soundbites are edited for clarity and are organized by topic, rather than in chronological order.  They were prepared without the benefit of a transcript or recording.

Impact of Tax Reform on the Tax Equity Market

Impact of the Corporate Tax Rate Reduction on the Supply of Tax Equity, Yields and the Capital Stack

“This year we can do $9 million in tax credits; before we could do $15 million.”  [The implication is that a 21 percent federal corporate tax rate is 40 percent less than a 35 percent corporate tax rate, so the tax appetite has declined by 40 percent.]  Vice President, Industrial Bank

“The [supply side of the] tax equity market has declined by 40 percent; some tax equity investors are taking a pause.”  Vice President, Regional Bank

“Our bank this year is slightly below the billion dollars of tax equity it originated last year for its own book.” Vice President, Midwestern Bank

Some “mainstream tax equity investors have taken a pause [from investing] to figure out what the 21 percent corporate tax rate means for them.  It is an investors’ market, but we nervously see a sponsors’ market ahead.”  Managing Director, Financial Advisory Firm

Traditionally, rates for tax equity have been a function of supply and demand, but now we are seeing real pressure on rates.”  Managing Director, Money Center Bank

[It is difficult to jibe this banker’s quote regarding pressure on tax equity rates with the quotes above regarding the supply of the tax equity market being smaller due to tax reform.  Possibly, tax equity investors are agreeing to share some of the yield detriment of the depreciation being less valuable and that has resulted in reduced after-tax yields.]

“Some utilities that had tax appetite no longer have tax appetite and need to raise tax equity for their projects.”  Director, Money Center Bank

“We are trying to get back to the same all-in return where we were before tax reform.”  [As the depreciation is less valuable at a 21 percent tax rate than it was at a 35 percent tax rate, this means either (i) contributing less for the same 99 percent allocation of the investment tax credit or (ii) contributing the same amount and requiring a distribution of a larger share of the cash.]  Vice President, Midwestern Bank

“Tax reform helped us because it means tax equity contributes less to the project, so it makes our loan product more necessary.” General Manager Renewable Energy Finance, Small Business Bank

“The debt market has come in and is filling the decline in tax equity.” Executive Director, Manufacturing Corporation

“The buyouts of [tax equity investors’ post-flip interests] are more valuable because of the lower tax rate.”  Partner, Big 4 Firm

“We see sponsors’ financial returns over a 35-year project life increase due to the tax rate reduction.”  ” Managing Director, Structuring Advisory Firm

Base Erosion Anti-Avoidance Tax (BEAT)[1]

“BEAT hasn’t had the impact the press predicted it would.  People have been able to structure around it.”  Managing Director, Financial Advisory Firm

“We have seen some of our syndication partners drop out of the tax equity market due to BEAT.”  Vice President, Midwestern Bank

“BEAT has had less impact on solar [than wind].” [This is because wind has a ten year production tax credit, so a wind investment requires a tax equity investor to forecast today whether it will be subject to BEAT over the next ten years; in contrast, the solar ITC arises all in the first year.]  Managing Director, Structuring Advisory Firm

100 Percent Bonus Depreciation

 “In a sale-leaseback, one hundred percent bonus depreciation does not fully offset the lower tax rate.”  Vice President, Regional Bank

“Expect to see tax equity partnerships elect out of 100 percent bonus depreciation due to capital account and DRO [(i.e., deficit restoration obligation)] issues .”[2]  Partner, Big 4 Firm

“Bonus is not going to be often elected in solar or wind.  Bonus reduces tax capacity [that could otherwise be used for tax credits] and limits the clients [(i.e., project sponsors)] we can benefit with our tax capacity.”  Managing Director, Money Center Bank

Tax Equity Structures

“The smallest sale-leaseback we’ve done is $300,000.  Sale-leasebacks don’t need professional financial modeling and the legal costs are lower.”  Vice President, Industrial Bank

Due to lower documentation costs, “sale-leasebacks bring efficiencies for smaller projects.” Vice President, Regional Bank

“The most common structure is the partnership flip.” Vice President, Industrial Bank

“We’ve been doing sale-leasebacks since 2007.  We’ve been doing partnership flips for two years.  We’re seeing sale-leasebacks come back into favor.” Vice President, Regional Bank

“A couple of years ago, sale-leasebacks were out of favor due to not being the structure preferred by yieldcos, but sale-leasebacks are back in favor.” Vice President, Regional Bank

“The after-tax internal rate of return is so high for solar that we do not present it to syndication candidates; we present the return on investment instead.” Vice President, Midwestern Bank

Financial Accounting for Tax Equity

“One of the biggest challenges we see is the [financial statement] accounting.  The [financial statement] accounting can be very lumpy [(i.e., large amounts of accounting losses in some years and large accounting profits in other years)] and very pre-tax dilutive [(because tax equity transaction generally lose money pre-tax but are profitable after-tax due to the significant tax credits, which appear below the line in a profit and loss statement)], and there is a lot of stranded tax appetite because of it” (i.e., potential investors with tax appetite that do not invest because of the financial accounting for tax equity).  Vice President, Midwestern Bank

“I don’t know if there is path forward to get that cleaned up.”  Partner, Big 4 Firm

“For publicly traded corporations that trade on EBITDA, tax equity is dilutive.  So the market needs privately held corporations or public corporations that trade on metrics other than EBITDA.”  Executive Director, Manufacturing Corporation

“Most companies we work with as syndication partners for tax equity are corporates.  They compare investing in tax equity to stock buybacks or investment in their core business.”    Vice President, Midwestern Bank

Tax Risk Insurance

“We see many insurance requests for ITC eligible basis insurance.” Senior Managing Director, Insurance Company

“For $100 million in ITC, we would charge a $3 million premium for a seven-year non-cancellable policy.”  Senior Managing Director, Insurance Company

“We bought insurance on two transactions to cover tax basis risk.  The cost of such insurance has come down significantly.”  Director, Money Center Bank

“We’ve done a couple of transactions with very narrow tax insurance.”  Managing Director, Money Center Bank

“We use insurance, not because of discomfort with the underlying tax risk, but because of aggregate exposure to a developer that provided an indemnity.”  Vice President, Midwestern Bank

“We are seeing requests for insurance to insure whether wind projects started construction to qualify for the full production tax credit.” Senior Managing Director, Insurance Company

Political Climate

“With a full Republican government, the fact the ITC was untouched in tax reform signaled to new investors that it is safe to invest.”  Vice President, Midwestern Bank

“There is a lot of favorable support for renewables in Washington, DC.  Renewables is becoming less political.  They slid the orphaned tax credit extension[3] in without an issue.”  Executive Vice President, Financial Services Company

Debt Structuring

“Debt service coverage ratios are at 1.3 or 1.2.”  CEO, Solar Finance and Development Firm

“In Europe, we see a debt service coverage ratio of 1.25 on a P50 basis for solar project financing.”  CEO, Solar Finance and Development Firm

“European project finance banks underwrite gas-fired projects at a 1.15 debt service coverage ratio.  Solar has less risk due to the lack of fuel price risk.”  Managing Director, Financial Advisory Firm

“We offer a 15-year loan for a 25-year power purchase agreement.”  General Manager Renewable Energy Finance, Small Business Bank

“As we have more history in solar, I think you will find advance rates going up.”  General Manager Renewable Energy Finance, Small Business Bank

“Banks are starting to bid based on their cost of funds, rather than what they think a loan should trade at.”  Head of Project Finance, Western Bank

“We can’t be the back leverage lender and the tax equity investor at the same time due to concerns about overexposure, but we can do construction debt that is taken out by our own tax equity.”  Managing Director, Japanese Bank

“Commercial lenders are best placed to lend at ‘notice to proceed’ (NTP) or close to NTP.”  [NTP is when the contractor starts building the project.]  Managing Director, Canadian Bank

“As we move towards smaller deals, we have to be more flexible as to what we require from developers before our money goes out the door.  I don’t know why we need 100 page independent engineer reports anymore.”  Managing Director, Southeastern Bank

“Some of our competitors are construction contractors that provide financing.”  Managing Director, Southeastern Bank

“For the first time, all credit markets are healthy and stable.”  Head of Project Finance, Western Bank

“US project finance is dominated by international banks.”  Head of Project Finance, Western Bank

Market to Acquire Solar Projects

“Projects are trading at six to seven percent after-tax yields right now.”  Managing Director, Financial Advisory Firm

“It took a while for people to realize that solar isn’t wind and is a lower risk asset.  I think of solar like commercial real estate.”  CEO, Solar Finance and Development Firm

“There are still a lot of sponsors out there buying projects.”  CEO, Solar Finance and Development Firm

“There are about 20,000 variables that will determine if a project is still economic after 2022 when the ITC ratchets down to 10 percent.”  CEO, Solar Finance and Development Firm

“We’re in a very favorable market for project valuations.  That’s why we see for sale portfolios of projects that are still under construction and portfolios of Class B partnership interests for sale.”  Managing Director, Boutique Renewables Advisor

“In 2007, people were underwriting a 20-year project life; now we are at 35 years.  There will be more debt underwriting and more of a merchant tail.”  Managing Director, Financial Advisory Firm

“There are still a lot of costs to be taken out of the system.” CEO, Solar Finance and Development Firm

“Canadian pension funds used to only buy projects at the commercial operation date, but now they are taking construction risk.”  Managing Director, Canadian Bank

“There are less projects available.  Buying projects at NTP is very expensive.  A lot of pre-NTP projects are priced more appropriately.” Director Project Finance, Global Solar Developer

“Some infrastructure investors will fund development capital in exchange for the right to buy the project once developed at a preferred rate.”  Managing Partner, Canadian Private Equity Fund

Market for Power Purchase Agreements (PPAs)

“We are seeing ten-year PPAs in North Carolina.  That makes you take a view on the price of electricity in years 11 to 35 in order for the pricing to work.” General Manager Renewable Energy Finance, Small Business Bank

“To win a 5 megawatt PPA in North Carolina, you have to bid at below four cents a kilowatt hour.” General Manager Renewable Energy Finance, Small Business Bank

“We advised on a ten-year PPA deal.  We used an inverted lease structure, so the tax equity was not exposed to the merchant market after ten years.” Managing Director, Boutique Renewables Advisor

“The market is going to have to get its arms around ten year PPAs.” Managing Director, Boutique Renewables Advisor

“We don’t try to guess what the market is going to be in year eleven.”  Director, Money Center Bank

“People are not pricing in accurately the duration of the credit risk associated with solar PPAs.  The hurdle rate should be higher the shorter the PPA term.”  CEO, Solar Finance and Development Firm

“Power demand has flatlined for six or seven years.”  Managing Director, Financial Advisory Firm

“I would not count on PPA pricing going up.”  CEO, Solar Finance and Development Firm

“PPA pricing continues to be under pressure.” Managing Director, Structuring Advisory Firm

“Solar hedges are big in Texas but haven’t really caught on [elsewhere] yet.” Managing Director, Structuring Advisory Firm

Battery Storage

“We have been waiting for two years for someone to bring us a tax equity deal that is solar plus storage.  We believe in the technology.”  Director, Money Center Bank

“If the offtake market starts demanding storage, then we will start seeing the storage opportunities we are all looking for.  Offtake drives the market.” Managing Director, Structuring Advisory Firm

“Batteries are going to be used to manage basis risk.”[4] Chief Investment Officer, Energy Private Equity Firm

“Any market in which solar is achieving significant penetration is going to have price risk, [due to the intermittency of solar,] and storage will help address that risk.  Storage allows a project to mitigate price risk by pushing delivery to the grid into the evening” when supply from solar declines and demand increases.  CFO, Solar Developer

“The banks are going to have to get comfortable with storage.” Managing Director, Southeastern Bank

 

[1] Our explanation of BEAT is available at page eight of our article on tax reform: https://www.taxequitytimes.com/wp-content/uploads/sites/15/2018/03/2018-and-Onward-The-Impact-of-Tax-Reform-Energy-Law-Report-tax-reform.pdf .

 

[2] To oversimplify, assuming the transaction does not involve debt, a DRO is necessary under the partnership tax regulations for a partner to be allocated tax losses and distributed cash in excess of the sum of its contributions and the taxable income allocated to it.  A DRO is a promise by a partner to contribute cash to the partnership, if (a) the partnership liquidates and (b) at the time of liquidation the partner has a negative capital account (i.e., it has been allocated losses and distributed cash in excess of its contributions and taxable income allocated to it).  DROs are typically provided by tax equity investors, and the rule of thumb used to be that tax equity investors limited them to 20 percent of their contribution to limit the exposure to the contingent obligation to contribute capital.  However, solar transactions are being structured with DROs that are multiples of, and even wind transactions are typically exceeding the old rule of thumb by a material amount.  There is nothing wrong with a large DRO from a tax perspective, so long as the tax equity investor has a reasonable expectation of sufficient financial wherewithal to satisfy the DRO, if the partnership liquidates at a time when the tax equity investor has a negative capital account.

[3] For information about the extension of the tax credits for the orphaned tax credits, please see https://www.taxequitytimes.com/2018/02/bipartisan-budget-act-partially-reinstates-orphaned-energy-tax-credits/ .

[4] “Basis risk” in the context of a corporate PPA means that the project’s owner sells the power at the price available at the node, but financially settles with the corporate “buyer” based on the price at the hub. For instance, the corporate PPA provides that the corporate buyer contracts for power at $30 a MWh, so if the price at the hub is less than $30 a MWh, the corporate pays the project owner the difference and if the price at the hub is more than $30 MWh the project owner pays the corporate the difference. What actually happens is the project owner sells its output for the spot price at the node.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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