United States: Renewable Energy Finance Forum Wall Street Soundbites: The Tax Equity, Debt And M&A Markets, Etc.

Last Updated: September 14 2018
Article by David K. Burton

Below are soundbites from panelists from the Renewable Energy Finance Forum ("REFF") Wall Street on June 19 and 20. The mood was upbeat.  There were many references to a "wall of cash chasing projects" as a metaphor for how competitive it is to win bids to finance or purchase projects.

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.

The topics covered include the tax equity, debt and M&A markets, C&I solar, offshore wind, bonus depreciation, storage, YieldCos and others.

Tax Equity Market

"Solar tax equity is 30 to 38 percent of the capital stack of a project.  Wind tax equity is 47 to 62 percent of the capital stack of a project."  – Managing Director, Boutique Investment Bank

"We are seeing a lot more wind.  We are using our tax equity capacity in wind in 2018.  Solar is looking good for 2019 and beyond."  Managing Director, Trust Company

"This year we will invest more in wind than in solar." – Managing Director, Money Center Bank

"We are seeing tax equity portfolios that are seasoned trade in a secondary market.  [Generally These are tax equity portfolios] that haven't flipped on time or that [have the benefit of material cash distributions] but not tax" credits.  – Managing Director, American Multinational Financial Services Company

"There is more tax equity now than there was before tax reform."  Managing Director, REIT

"2018 is a slow down due to tax reform and tariffs."  Managing Director, National Bank

"There is a lot less tax equity capacity due to the lower tax rate." – Managing Director, American Multi-National Investment Bank

[Explained: there may be more tax equity investors in the market than last year; however, last year the corporate tax rate was 35 percent, and this year it is 21 percent, so a typical tax equity investor has 40 percent less tax appetite (and ability to invest in tax equity) in 2018 than it did in 2017.]

"If you are in BEAT [(i.e., the base erosion anti-avoidance tax in enacted as part of 2018 tax reform)], you cannot compete in tax equity.  A couple of investors were hit with BEAT and exited." – Managing Director, American Multi-National Investment Bank

"We get ten requests for tax equity a week and say 'yes' to less than one a week.  We have to prioritize opportunities."  – Managing Director, American Multi-National Investment Bank

Tax Equity Investment Size

"Our ticket size is $20 to $200 million. If we originate $1.5 billion in a year, we syndicate off about $.5 billion." – Managing Director, National Bank

"Our ticket size is $25 to $200 million." –  Managing Director, American Multi-National Investment Bank

"Our ticket size is mostly $75 to $100 million. We only invest for our own account."  – Managing Director, Trust Company

"For wind, our sweet spot for ticket size is $125 million, but we have done lower. For solar, $100 to $200 million is our sweet spot. We rarely sell down." – Managing Director, Money Center Bank

Tax Equity Performance

"The lesson learned from our portfolio is to hit the due diligence really hard. Our portfolio's performance has met our expectation. The challenging part is transmission congestion."  – Managing Director, Money Center Bank

"P50 hasn't really been P50 for ten years, so we don't size to it.  If we had sized to P50, our portfolio would have had problems.   – Managing Director, American Multi-National Investment Bank

[Explained: P50 generally refers to the confidence level associated with the assumption about the availability of the wind or solar resource.  A "P50" case means that the projected level of wind or solar resource has a 50% chance of exceedance; a "P99" case means that it has a a 99% chance of exceedance.  Some tax equity investors out of conservatism (or skepticism) often size their investment at a probability level that is higher than P50, or at least model downside cases at those higher level.  There is greater importance to this issue in wind projects than solar projects.  First, there is much more variability in predicting how much the wind is going to blow than in predicting in how much the sun is going to shine.  Second, the production tax credit ("PTC") is currently $24 per megawatt hour (assuming the project started construction in 2016 or earlier), so the amount of the tax credit available to the tax equity investor varies with the production of the project.]

"Our portfolio is over 90% solar.  The variability in solar is very low.  Our portfolio is performing as expected." – Managing Director, National Bank

Tax Equity "Exposure" Issues with Respect to Certain Types of Projects and Geographies

 "For every [wind] deal outside Texas and Oklahoma, I see four deals in Texas and Oklahoma." – Managing Director, Trust Company

"We have concerns about congestion issues that we have to look at on a regional basis." – Managing Director, Money Center Bank

"We watch our concentration with respect to certain utility PPA offtakers.  We watch that, but it is not a huge issue." – Managing Director, National Bank

One Hundred Percent Expensing (i.e., Bonus Depreciation) Enacted in 2018's Tax Reform

"One hundred percent expensing is something you negotiate. It has challenges with your capital account."  – Managing Director, Money Center Bank

"One hundred percent expensing for wind takes away our tax capacity available for solar." – Managing Director, Trust Company

"The incremental [pricing] benefit for sponsors from 100 percent expensing is small." – Managing Director, Trust Company

"We don't encourage [including] expensing [in deal models], but we've done it."  – Managing Director, American Multi-National Investment Bank

Wind "Begun Construction" for Production Tax Credit ("PTC") Eligibility Analysis

"We look at all three methods" to determine if a wind project began construction in 2016 in order to qualify for a full PTC. – Managing Director, Money Center Bank

[Explained: The three methods are spending five percent of the total cost of the project, on-site significant physical work, or off-site significant physical work.  The REFF conference took place before the IRS issued Notice 2018-59 with the begun construction guidance for solar; therefore, there were no comments on that. Nonetheless, the guidance for solar is nearly identical to the guidance for wind, so the spirit of the panelists' remarks about the wind guidance is generally applicable to solar too.  Our analysis of Notice 2018-59 is available here.]

"Start of construction is so dependent on the facts and circumstances. I feel like a tax lawyer."  – Managing Director, American Multi-National Investment Bank

"There is bifurcation of deals: those from big sponsors that don't have hair on them and marginal deals from less well capitalized sponsors." – Managing Director, American Multi-National Investment Bank

"We are expecting to see insurance products around [insuring] start of construction [tax] issues." – Managing Director, National Bank

Financing Commercial and Industrial ("C&I") Solar Projects

"C&I is awful lot of work. It is more complex than a utility scale deal." – Managing Director, American Multi-National Investment Bank

"We're still trying to figure out the way to do C&I: there isn't one.  From a legal cost perspective, C&I is expensive." – Managing Director, National Bank

"C&I is hard. There are other opportunities out there." – Managing Director, Money Center Bank

"A lot of lenders are scared of distributed generation ("DG") solar.  We try to take the approach of being efficient enough for the sponsor while still meeting the bank's requirements."  Head of Project Finance Americas, Dutch Based Bank

Financing Offshore Wind

"Offshore wind is $700 to $800 million of tax equity per project.  That means four or five tax equity investors, and it can be difficult [for a sponsor] to negotiate [with that many] as people have different views on issues." – Managing Director, Trust Company

"The biggest issue with Cape Wind that did not move forward was [raising] tax equity. The new offshore wind projects must be cognizant of that, especially since some are quite large." – Managing Director, Japanese Headquartered Multi-National Bank

"Offshore wind has been around for a long time and has a good track record in Europe." – Managing Director, London Headquartered Bank

"We're quite excited about upcoming offshore wind transactions.  We've banked offshore wind in Europe." – Managing Director, Canadian Headquartered Bank

"I am violently excited about offshore wind."  Head of Project Finance Americas, Dutch Based Bank

"It remains to be seen how offshore wind deals are structured to raise the large amount of capital needed." – Managing Director, Canadian Headquartered Bank

M&A Market

"There seems to be a lot more dry powder than there are projects." –  Managing Director, Boutique Accounting Firm

The rates of return required to win a bid to purchase a solar project are "6.5 to 7.25 percent after-tax unlevered for utility scale solar and 8.25 to 9.5 percent after-tax unlevered for wind, with a huge issue for each as to how to value the merchant tail" (i.e., the period after the term of the power purchase agreement ("PPA")). – Managing Director, Boutique Investment Bank

"Buyers are either valuing merchant tails or discount rates are at Treasuries levels."  – Managing Director, Swiss Headquartered Investment Bank

"The market has moved to using a dual rate for discounted cash flow ("DCF") valuation or projects: one rate for the contracted period and another rate for the uncontracted period." – Managing Director, Boutique Investment Bank

"Developers are selling earlier to utilities.  [The developer] may get less profit than if they held [the project] construction, but it gives them cash to recycle into new projects."  – Managing Director, American Multinational Financial Services Company

"The risks taken by developers have been bailed out by reductions in module prices, but I don't know how long that goes on." – Managing Director, Solar Panel Manufacturer

"People winning PPA awards are assuming falling equipment prices.  Utilities will step-up and buy projects if they are uneconomic to the developer." – Managing Director, American Multinational Financial Services Company

"Often developers are optimists.  PPAs have deadlines.  In a declining cost environment, the motivation of the developer is to wait [to start construction].  But developers can wait too long and run out of time to raise the capital stack.  Then the developer has to sell the project [to an investor with sufficient cash to get it constructed] in time to meet the PPA deadline."  – Director, Private Asset Manager

"The difference between commercial real estate and renewables is the residual value: commercial real estate, generally, goes up in value, while renewables do not."  – Managing Director, Boutique Investment Bank

"We have lost competitive auctions a little bit due to the fact we have more discipline and a little bit due to the fact we have private equity money." – President, Renewable Energy Private Equity Fund

"It is super hard for a developer to be EBITDA positive and hold on to its projects for 20-years."  –  Managing Director, Boutique Accounting Firm

"You have to have a lot more capital to get a wind project off the ground than a solar project due to the deposits that have to be made for a wind project." – President, Renewable Energy Private Equity Fund

"Comparing cost of capital is challenging because it is all about your assumptions: one person's 6% is another person's 9%."  – Director, Private Asset Manager

Investments in "Platforms"

"Pension funds don't like single digit returns, so they are taking more risk.  Pension funds three to four years ago were [investing in] operating assets only.  Now, they are buying platforms [(i.e., a development business) that bring with them] operating assets."  – Managing Director, Boutique Investment Bank

"Twelve months ago, no one was interested in investing in platforms [(i.e., a development business)].  Today, many people are looking platforms to optimize their investments." –  Managing Director, Regional Bank

Investors are thinking "maybe I can get a higher return with a little bit of operating assets and a lot of projects in the [development] queue." –  Managing Director, Regional Bank

"Facing all of the competition on the origination side, buyer are finding justifications to buy platforms." – Director, Private Asset Manager

"Anyone who wants to be positioned in the coming renewables wave has to be positioned now.  That's why we see buyers acquiring platforms."  – Managing Director, Solar Panel Manufacturer

Construction Debt

"We expect to see a margins of 150 to 225 bps over LIBOR for construction debt." – Managing Director, Institutional Asset Manager

"Build-sell transactions [in which there is a purchaser obligated from the outset to buy the project at a firm price at completion] are a different animal [than a typical developer building a project and hoping to raise tax equity or sell it].  It is really a trade receivable" and can raise construction financing below 150 to 225 bps over LIBOR.  – Managing Director, Boutique Investment Bank

"Almost every construction loan [(other than build-sell transactions)] has a tax equity take-out." – Executive Director, Spanish Headquartered Bank

"We had one sponsor present us with a tax equity take-out from a fund of tax equity investors that wasn't rated.  That was not acceptable to the bank as a construction lender."  – Managing Director, Japanese Headquartered Bank

"Most people view construction risk as relatively easy to handle, unless the project has an idiosyncrasy." – Managing Director, American Multinational Financial Services Company

Debt Structuring

A put to sell power to an insurance company "lowers the debt service coverage ratio ("DSCR") from 1.25 to 1.1.  That increases the debt [as a percentage of the total capital stack] from 42 percent to 52 percent, reducing the need for equity."  – Managing Director, Boutique Investment Bank

"With a mini-perm [debt structure], we have a 'legal' maturity in about seven-years.  If [the debt] doesn't get refinanced [at year seven], we have a cash sweep that pays off the loan during the balance of the PPA term." – Head of Project Finance Americas, Dutch Based Bank

"Debt is much easier to obtain and close because of the abundance of it." – President, Renewable Energy Private Equity Fund

"Our borrower clients have a lot of leverage in negotiations in the market at the moment." – Managing Director, Canadian Headquartered Multi-National Bank

"Sponsors know they have the negotiation leverage and are pushing every button." – Managing Director, Japanese Headquartered Multi-National Bank

"One of the beautiful things about bank financing is that it is flexible.  You can structure around risk that are understandable and quantifiable."  – Head of Project Finance Americas, Dutch Based Bank

"Life insurance companies are able to lend 40 years on hydro.  As a bank, we don't go quite that long." – Managing Director, Japanese Headquartered Multi-National Bank

"Banks got burned on biomass in the 1990s, so it is not my favorite asset class." – Managing Director, Japanese Headquartered Multi-National Bank

"Sponsors being reasonable in their IRR curves is much appreciated" (i.e., not modeling debt service as payable too far out into the later years of the project). – Managing Director, London Headquartered Bank

"When renewables deals start exceeding a billion dollars, you need to either combine bank debt and institutional debt [(e.g., insurance company as a lender)] or go to the bond market." – Managing Director, Japanese Headquartered Multi-National Bank

"It is easier [for a borrower] to [negotiate] concessions in a smaller deal than a larger deal because smaller deals do not have to be syndicated." – Managing Director, Japanese Headquartered Multi-National Bank

"I like working with early stage developers because it is like a partnership, rather than taking terms." – Head of Project Finance Americas, Dutch Based Bank

"No matter how mature the business gets there are still issues to be worked through in these transactions." – Managing Director, Canadian Headquartered Multi-National Bank

Green Bonds

"We aren't seeing green bonds in the renewables power generation market because the environmental impact of renewables is apparent.  Therefore, renewables does not need the 'green bond' label to access the capital markets." – Managing Director, London Headquartered Bank

"Our bank has issued green bonds to fund our renewables investments, but the green bonds were not secured by projects; rather, the green bond was a senior obligation of the bank.  There was a tracking mechanism with respect to how the bank invested the proceeds." Head of Project Finance Americas, Dutch Based Bank

Storage

"Twenty-five percent of new projects have storage associated with them."  – Managing Director, Boutique Investment Bank

"Every request for proposal ("RFP") [for a PPA] we see has a storage component; the question is whether it is mandatory or an option." – Managing Director, Boutique Investment Bank

"I am optimistic that there will be improvements in storage to effectively make solar and wind base load power that projects can charge more for." –  Managing Director, Boutique Accounting Firm

"We're quite excited about storage." – Managing Director, Canadian Headquartered Multi-National Bank

"We are not in a position to finance stand-alone batteries providing ancillary services [to a utility].  We need contracted cash flow, similar to a PPA." – Managing Director, Japanese Headquartered Bank

Corporate PPAs

"We are seeing more deals come through with corporate PPAs than utility PPAs.  The challenge is all corporate PPAs look differently, so they take more time to underwrite."  Managing Director, London Headquartered Bank

"Corporates have been a big beneficiary of lower PPA rates.  They are certainly going to continue to be part of the offtake market." Managing Director, Swiss Headquartered Investment Bank

"Some corporate PPAs look more like hedges."  – Managing Director, Japanese Headquartered Bank

"The large consumer facing companies, like Walmart, have gone green; now, they are going to force their supply chain to do the same.  Those companies will be less well-known and harder to underwrite." – Head of Project Finance Americas, Dutch Based Bank

A corporate PPA transaction "is complicated with merchant tail risk, basis risk and a tax equity investor." – Managing Director, Japanese Headquartered Multi-National Bank

[Explained: "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.]

"Five years ago, no one was running basis risk models."  Managing Director, Solar Panel Manufacturer

Merchant Projects

"We've seen power prices in places like ERCOT only go in one direction, so financing a merchant tail of a project is not easy.  We are a fan of [including] merchant tails in a portfolio of other types of contracts." – Managing Director, Canadian Headquartered Multi-National Bank

"Mezzanine [lenders] are happy to take merchant risk, and they make [the borrower] pay for it" through higher borrowing costs. – Managing Director, Japanese Headquartered Multi-National Bank

"There was just the first back leverage capital markets deal with merchant tail risk" (i.e., the back leverage lenders valued cash flows in the financial model for the period after the minimum term of the PPA).  – Managing Director, Japanese Headquartered Multi-National Bank

"The problem with [concept of] of merchant projects is that it kills the barrier to entry." – Director, Private Asset Manager

"The only way merchant works is with storage." – Director, Private Asset Manager

"I think we will see the first merchant solar project in Texas." – Director, Private Asset Manager

Utilities' Economics

"All of the investor owned utilities have been in year past able to take advantage of bonus depreciation to eliminate their tax appetite.  After tax reform, utilities can't do that. So some utilities are going to invest in renewables." – Managing Director, Regional Bank

"Utility stock prices are off due to tax reform and their cost of capital."  – Managing Director, American Multinational Financial Services Company

YieldCos

"Yieldco growth requires going back to the equity market every time [the yieldco needs to fund a transaction].  The public market can't sustain that."  Managing Director, Bulge Bracket Investment Bank

"A yieldco is fantastic on the way up, but once the stock market stops believing in you then you are in a death spiral."  – Director, Private Asset Manager

"YieldCos were marketed as yield plus growth, but they companies were really just yield.  The market should have understood that better." – Director, Private Asset Manager

"The yieldcos that have been successful have been the ones that have been realistic with their investors."  – Director, Private Asset Manager

"Let's see if the yieldcos can recover.  When they got into trouble the pension funds came into the market."  – Managing Director, American Multinational Financial Services Company

"Long term contracted renewables assets belong in private hands [(like a pension fund)] that can control its own cost of capital, unlike a yieldco." – Director, Private Asset Manager

Engineering, Procurement and Construction ("EPC") Contracts

"EPC has been commoditized for a long time.  You are seeing the smaller guy die." – Director, Private Asset Manager

"Some EPC contractors are just putting a wrapper around sub-contractors and slapping a premium on it.  Does that make sense in a world where have to take cost out?" – Director, Private Asset Manager

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