A record number of people — more than 900 — attended a solar finance and investment summit in San Diego in March, reflecting the strong interest among developers and financiers in the solar market after Congress extended a 30% tax credit for US solar projects. Developers have until December 2019 to start construction of projects to qualify for a 30% tax credit. Projects that are under construction in 2020 qualify for a 26% credit. Projects that start construction in 2021 qualify for a 22% credit. The credit drops to 10% after that.

One issue on developers’ minds is whether they will be able to convert the tax credits — and accelerated depreciation that is equivalent to roughly another 26% tax credit — into capital in the tax equity market to help finance their projects.

Four tax equity investors and the tax equity head for the largest solar rooftop company did a deep dive into this subject at an annual conference hosted by the Solar Energy Industries Association in New York in late February. The panelists are Albert Luu, vice president for structured finance at SolarCity, Santosh Raikar, managing director for renewable energy investments at State Street Bank, Vicki Dal Santo, executive director for energy investments at JPMorgan Capital Corporation, Dan Siegel, vice president for renewable energy investments at US Bank, and George Revock, managing director and head of alternative energy and project finance at Capital One. The moderator is Keith Martin with Chadbourne in Washington.

 

MR. MARTIN: Albert Luu, what new trends are you seeing in the tax equity market?

New Trends

MR. LUU: The ITC extension changes things. Without it, we probably would have been in a position where there is more tax equity than projects. The extension means a lot more projects will make sense. Sponsors will resume the search for tax equity.

MR. MARTIN: Will the extension cause a slowdown in tax equity deal volume this year because people are no longer facing a deadline of year end 2016 to put all remaining solar projects into service?

MR. LUU: I don’t know yet. My guess is it will not have much of an impact this year. The other side of the ITC extension is it provides an opportunity for new investors to come into the market. The extension means somewhere between five and seven more years of more than a 10% investment tax credit. That is enough time to make it worthwhile for new investors to spend the time and money to get into this space.

MR. MARTIN: How much tax equity does SolarCity expect to raise this year?

MR. LUU: Last year we did a little more than $1.5 billion. This year, our public guidance in terms of megawatts deployed is 1,250 megawatts, so that translates into somewhere between $1.8 and $2 billion in tax equity that we will need to raise.

MR. MARTIN: Santosh Raikar, what new trends are you seeing in the tax equity market?

MR. RAIKAR: Over the last six months, we have seen a move away from distributed solar into utility-scale projects. For a long time, it was difficult to find good-quality deals among utility-scale projects. That is changing.

Yields are stable.

Apart from SolarCity, we have not seen a lot of sponsors in the residential space looking for the deals.

In terms of deal volume, there is a little bit of a slackening, not due so much to a shift in supply or demand, but because everyone was working hard, and everyone is just taking the foot off the pedal before diving back in. We see some shifting into 2017 of projects that sponsors had planned to complete in 2016.

MR. MARTIN: It seems like people took their feet off the pedal two weeks before the year end, and they have not put them back on yet. Is that your sense as well?

MR. RAIKAR: That’s right. I did not hear anything from sponsors until the first week of February or last week of January. Usually you come back after New Year’s Day and there is a significant amount of activity. We did not see that this year. We were busy in December locking up letters of intent for execution this quarter. We have a deal closing this week and then another deal closing in March.

MR. MARTIN: Vicki Dal Santo, what new trends are you seeing?

MS. DAL SANTO: It depends on the market segment. We see a little more competition for utility-scale projects and a little more aggressive structuring, maybe longer terms. Tax equity deals have traditionally been structured at six to seven years. We are seeing competition to go out to eight or nine years on those.

There has also been more focus on managing deficit restoration obligations on solar tax equity deals, since the tax equity only contributes about 40% of the fair market value of the projects. With the ITC and depreciation, deficit restoration obligations can get quite high, so there has been more focus on trying to bring those down and make sure that they reverse at an appropriate time.

MR. MARTIN: How large a DRO will JPMorgan agree to?

MS. DAL SANTO: Definitely facts and circumstances, but probably somewhere in the 30% range.

MR. MARTIN: Thirty percent is historically high.

MS. DAL SANTO: Yes.

MR. MARTIN: The term is the length of time the tax equity investor is expected to take to reach its target yield. From where is the pressure coming to agree to a longer term? There are more tax equity investors. Are the newer entrants pricing to reach yield later?

MS. DAL SANTO: The sponsor usually wants us out of the deal sooner rather than later, since we are not usually the cheapest funding piece in the capital structure. Nevertheless, some sponsors want longer terms, and some tax equity investors are willing to go out that far.

MR. MARTIN: Albert Luu, how do you feel about an eight to nine year flip rather than six to seven years?

MR. LUU: For us, it is about optimizing the capital stack, so typically we prefer to have the tax equity flip somewhere in the six-to-seven-year time frame. We would rather monetize cash in the debt markets at more attractive rates.

MR. MARTIN: Dan Siegel, US Bank has a large market share. What new trends are you seeing?

MR. SIEGEL: We are eager to see whether the tax credit extension leads to a lot of new tax equity investors. Most of our focus is on buy-and-hold investments, but we also have an active syndication practice.

A barrier to entry for potential new entrants was simply the fact that the 30% tax credit was about to expire. Giving it a longer life should bring more investors into the space.

With respect to asset type, we have had roughly a 50-50 split historically between distributed and utility-scale solar. That was weighted a little more heavily on the utility-scale side last year because, with the pending expiration of the credit, a lot of large utility-scale projects were looking in 2015 to line up financing before the credit expired.

We will remain active in both market segments. We expect the utility-scale market to remain strong. Projects will get larger and there will be more of them. Tax equity interest in those projects will remain strong. It will be generally a buyer’s market in some cases when it comes to competing to supply tax equity.

It is a different story for middle-market commercial and industrial projects. That will remain an underserved space and be more of a seller’s market.

MR. MARTIN: What about residential? Is it a buyer’s market or a seller’s market?

MR. SIEGEL: The larger residential rooftop companies have deep benches of tax equity investors that they work with, so tax equity for them is likely to be more of a buyer’s market. It depends on the relative market share of the developer.

MR. MARTIN: You are out actively beating the bushes to syndicate. How many tax equity investors do you think there are currently in the solar sector?

MR. SIEGEL: That’s hard to say. The number who are currently active is probably about 15. There are probably 30 to 35 in total when you include investors who have invested in solar at some point in the past. There is room for many multiples of that number.

Back-Levered Debt

MR. MARTIN: George Revock, what new trends are you seeing?

MR. REVOCK: Most deals today are done on an unlevered basis. However, there is growing interaction between tax equity investors and construction and back-levered lenders. That extensive interaction has not been there in the past. It is becoming a much bigger part of the negotiations in recent deals.

MR. MARTIN: How accommodating are tax equity investors to the needs of the back-levered lenders for predictable cash flow? Where else is there tension?

MR. REVOCK: There is tension around the indemnities that might have to be paid by the sponsor to the tax equity investor and what cash flow can be swept to pay them.

MR. MARTIN: Are there others sources of tension with back-levered lenders: for example, around the level of preferred cash distributions to the sponsor to cover debt service on back-levered debt?

MR. REVOCK: Yes. If a project or portfolio is underperforming, then the tax equity will be delayed in reaching its flip yield and will want an escalating share of cash flow to try to put it back on schedule. The lender will obviously balk at this. There is usually a negotiation about how much of the cash is protected for the lenders versus how much can be shifted to the tax equity investor in the downside case.

MR. MARTIN: Albert Luu, SolarCity has been active in the securitization market. How important is it to avoid cash sweeps to pay indemnities?

MR. LUU: It is important not just to be able to do a securitization, but also for any type of back leverage. The main tension points are around cash sweeps and transfer provisions. The sponsor is usually limited to transferring its interest to a qualified transferee. A back-levered lender will want maximum flexibility to transfer the sponsor interest if it has to step into that interest after a debt default. Those are two areas where we spend a lot of time having discussions with tax equity investors and lenders in an effort to find an acceptable middle ground.

MR. MARTIN: You have been using tax insurance to avoid the need for a cash sweep. Has it worked, and how much does the product cost?

MR. LUU: We used tax insurance for one of our ABS transactions in which we were doing a deal around partnership flips. It was an effort to address a concern from the rating agencies. It is an interesting product in that it can shift the basis risk outside of the partnership transaction. You are essentially swapping the counterparty risk on indemnities from SolarCity to a single A insurer. It is costly. The premiums are somewhere between 2 1/2 to 4%.

MR. MARTIN: Two-and-a-half to 4% of what?

MR. LUU: The policy amount.

MR. MARTIN: The potential payout.

MR. LUU: Yes.

MR. MARTIN: Let me ask the tax equity investors. Has any of you used tax insurance in your deals and, if so, to solve what problem?

MR. RAIKAR: I don’t think anyone will acknowledge in public having done so.

MR. MARTIN: Is there anyone less reticent?

MR. RAIKAR: We have not used it.

MR. MARTIN: Let me return to a point that Dan Siegel made. He said some solar market segments are shifting to buyer’s markets. Albert Luu, has the market shifted to a point where the negotiating leverage is on your side?

MR. LUU: What the ITC extension did was to allow other market segments to survive. Utility-scale and C&I projects would have been very tough to do with only a 10% ITC. The only market left would have been residential. The larger residential rooftop companies are able to raise capital, but there are always new challenges and the one today that we need to address is the regulatory environment surrounding net metering. That could be a deterrent for some investors. It is a headline risk for some potential new entrants.

MR. MARTIN: Why are C&I projects less likely than residential projects to pencil out without the tax credit?

MR. LUU: The cost structure for C&I is not that much lower than residential, but electricity prices are probably 30% to 40% lower than residential rates. Another problem is it is hard to standardize the customer agreements. Each customer wants to negotiate the contract wording.

Bank Regulatory Issues

MR. MARTIN: George Revock, some bank tax equity investors appear to be wrestling with regulatory issues. What are they?

MR. REVOCK: We are definitely affected by them. There are two issues for us. There is a stress test with the Federal Reserve and, as national bank, we have to get the US Office of the Comptroller of the Currency to sign off on every investment we make.

To date, the OCC has not yet signed off on tax equity investments in residential rooftop solar portfolios, which are essentially retail exposures similar to utility bill receivables. Accordingly, our focus has been on the utility-scale market. Most large financial institutions that make tax equity investments hold them at the holding company, which is not regulated by the OCC but by the Federal Reserve. Unfortunately, Capital One does not have the same ability as some other large financial institutions to invest through our holding company so we end up using our national bank, which requires the OCC to say it does not object.

With respect to the stress test, relying on the ITC for part of our return could be construed as detrimental since Capital One is not profitable under the severe adverse stress scenario. Generally, if a corporation does not pay taxes, then the ITC could generate a deferred tax asset or DTA. DTAs may adversely affect a bank’s tier 1 capital. This conclusion is especially unfortunate since Capital One continues to pay billions in federal income taxes each year.

MR. MARTIN: Why is the ITC a deferred tax asset, and why does that then make it harder to meet the tier 1 capital requirements?

MR. REVOCK: Good question. In past stress tests, other business lines have been considered to lose significant sums of money in the severe adverse stress case. These losses, in turn, make our ability to use the ITC in a downside scenario more tenuous.

MR. MARTIN: So you cannot count it as a real asset.

MR. REVOCK: Correct. Without adequate tax capacity, Capital One may be required to write it off for regulatory purposes. It is that potential write off and resultant impact on capital that creates concerns with tier 1 capital.

MR. MARTIN: Are there other bank regulatory issues that are starting to affect the market?

MR. SIEGEL: When banks look at what their annual investment amount may be, they look not just at what the bank’s tax capacity is, but also what that capacity is in a stressed environment.

We also see the issues that George Revock mentioned when trying to syndicate deals to other banks. Our banks, and other large banks, invest through a holding company using merchant banking authority. However, a lot of institutions either do not have holding companies or cannot allocate capital through the holding company, so, if they are national banks, they end up having to go through the OCC. To that end, there are some OCC interpretive letters that speak primarily to tax equity deals involving utility-scale projects.

One question for those banks is whether it is safe to rely on an interpretative letter issued to another bank about a specific deal or whether the bank is better served by asking the OCC for permission for its transaction. OCC approval is never certain.

MR. MARTIN: National banks cannot hold interests in real estate. Union Bank early on got an interpretive letter from the OCC that said a partnership flip transaction is not an investment in real estate. Union Bank suggested the transaction was close to a loan in substance. There have been some other interpretive letters since then, including one that walked back part of what the OCC said in the initial letter to Union Bank. Have there been any recent developments about the OCC’s view of partnership flip transactions?

MR. SIEGEL: I don’t know. When we are working with institutions that have to go through the OCC, they usually try to get the investments qualified as public welfare investments. There are several ways to do that. One way is to show the investments serve low-income populations. Another is to show that they serve a low-to-moderate income area.

MR. MARTIN: Any other regulatory comments?

MR. REVOCK: Another potential issue is the Volcker rule. Banks have struggled with it, but concluded ultimately that these deals do not fall under that rule.

MR. MARTIN: The Volcker rule prevents banks from engaging in proprietary trading. The tax equity market has concluded that tax equity transactions are usually not covered transactions. It may be important to limit the number of tiers of legal entities.

Next question: we talked a little about the effect of the ITC extension. Santosh Raikar said the extension led to a slowdown in the market at the end of 2015 and the first part of 2016. Albert Luu said more projects will pencil out. Is there anything else that comes from this?

MS. DAL SANTO: Probably more tax equity entering the market. It generally takes a new tax equity investor a year or more to run through the traps within the organization to get approval to make investments. The extension gives institutions time to do that.

Starting Construction

MR. MARTIN: Let’s move to another subject. We have now had two rounds of experience with the IRS construction-start rules for the wind industry. The solar industry had experience with similar rules in the more distant past under the Treasury cash grant program.

What lessons do you think people should take away from the experience with these rules to date?

MR. REVOCK: Make sure you talk to reputable tax counsel. Follow the rules and document your compliance with them. You will have to prove to the tax equity investors who ultimately come into the deal that the project qualifies for tax credits.

MR. MARTIN: There are two ways to start construction. A developer can start construction of a project by incurring at least 5% of the project cost or he can start physical work of a significant nature at the project site or at a factory that is making equipment for the project. Will you finance projects that rely on the physical work test as readily as ones that rely on the 5% test?

MR. REVOCK: Yes in concept, but I will be looking to my tax counsel to give me a clean bill of health.

MR. MARTIN: Vicki Dal Santo, you are smiling.

MS. DAL SANTO: Just go into the physical work test with the understanding that tax equity investors will take a conservative view. The 5% safe harbor is an easier route for the tax equity market.

MR. SIEGEL: I agree with what everyone has said. Hire tax counsel and develop a plan. Make sure that tax counsel understands that he or she is going to have to deliver an opinion to the tax equity investor that the project was under construction in time to qualify for a tax credit.

You ran a great article in the most recent NewsWire about practical lessons from the last rounds to start construction. For us, the 5% test is probably a cleaner way to qualify.

If you are relying on physical work, make sure you take notes along the way and document what you are doing. Make sure you understand the scope of the project on which you need to start work. If there is a chance that a certain facility could be treated as two or more separate facilities, then make sure you are starting construction of each separate project.

Depreciation Bonus

MR. MARTIN: Good points. Congress extended a 50% depreciation bonus in December. Congress did more than just extend solar tax credits. Is the depreciation bonus extension expected to help the solar market?

MR. REVOCK: We have not seen it priced into any transactions yet.

MS. DAL SANTO: We have not either.

MR. MARTIN: Santosh Raikar is also shaking his head no. So nobody uses the depreciation bonus?

MR. SIEGEL: I think maybe it eliminates some of the tax capacity on the utility side.

MR. MARTIN: So the utilities disappear as potential sources of tax equity. Other things being equal, less competition on the supply side of the tax equity market tends to push up tax equity yields?

MR. SIEGEL: We do not take it into account in pricing. I will say that.

MR. MARTIN: Albert Luu, has SolarCity managed to get anybody to use the depreciation bonus?

MR. LUU: We have had a few tax equity investors take bonus depreciation. We continue to have those discussions. Our focus is on reaching the flip so that the assets return to SolarCity as early as possible.

We have some tax capacity ourselves, so we would like to take bonus depreciation even if the tax equity investor will not do so.

MR. MARTIN: Has there been an increase in the number of tax equity investors interested in residential solar?

MR. LUU: Yes. There has been a gradual increase where every quarter you have one or two new investors. It takes time to educate them.

It was a lot harder in 2015 to convince an investor to come into this market with the 30% investment tax credit expiring after 2016. We are now circling back to investors with whom we had conversations in 2015 and helping them get through the internal approval process.

MR. MARTIN: Do you just sit at your desk and people call you looking to invest tax equity or are you out beating the bushes to find investors?

MR. LUU: Every once in a while I will get a call, but usually I am on the road knocking on doors.

We have been fortunate to have done deals with everybody on this panel. It is time consuming to do the first deal, but once you create a template in the residential sector, then it is easy to do subsequent deals.

Raising Tax Equity

MR. MARTIN: Let me turn to the tax equity investors. It has always seemed like each of you wants to do business with the same handful of brand-name players and not with companies that are less well known. Is that a fair comment and, if so, how do you decide on the cutoff?

MR. RAIKAR: The sponsor quality matters. There is a limit to the number of deals we can do. There are no criteria per se, but if you find a sponsor who has done business with JPMorgan, then the internal discussions become easier. Having said that, we have done business with some sponsors ahead of JPMorgan.

MR. MARTIN: It seems like the market is flush in tax equity — $13 billion last year in wind and solar — and yet a lot of people trying to raise it have a hard time doing so. Where is the line between companies that can raise tax equity and companies that cannot? Is it the size of the company? The size of the deal pipeline?

MS. DAL SANTO: I don’t think there is a bright line. We look at the amount of experience that the sponsor has, how long it has been in the business, and how many projects it has currently operating. We look at the amount of capital it has to backstop indemnities and to give it a buffer to withstand volatility in the business. Another factor is how many dollars we will be able to put out the door in tax equity over a six-month period.

MR. MARTIN: We ran an article in the February Project Finance NewsWire called How to Lose a Banker in 10 Minutes. What are some tips for people about how to lose a tax equity investor?

MS. DAL SANTO: Tell the investor that every customer agreement is separately negotiated and there are 25 different offtakers.

MR. RAIKAR: I will give you an example: what is your after-tax IRR? That question always puts me off.

MR. MARTIN: Why does that annoy you?

MR. RAIKAR: Because it turns on the peculiarities of each deal and the payoff in solar projects is so small.

MR. MARTIN: Are there any other ways to lose a tax equity investor?

MR. SIEGEL: Our tax capacity is a scarce resource. We have a host of sponsors with whom we work regularly, and we have put a lot of time into our documents. It is a turn off to go into a deal with a sponsor who expects us to spend more time on the transaction than he or she has spent. Do your research. Make sure that you have talked to the right people. Have a model built by a reputable firm that understands how the transactions work. Talk to tax counsel.

MR. MARTIN: So be well organized. George Revock?

MR. REVOCK: Good points across the board. Another way to lose a tax equity investor is to approach the market before you have a power contract. If it is not signed, you are merely thinking about it, it is a pipe dream or the utility still has to get the public utility commission to approve it, then it is premature to be talking to tax equity. The project should be shovel ready when you start talking to us or at least be pretty close to it.

MR. MARTIN: Make sure the project is fully baked. Albert Luu, what issues are coming up in IRS audits?

MR. LUU: We have disclosed that a couple of our funds are under IRS audit. This is to be expected. Our investors are large taxpayers. Some are in the CAP program where their deals are audited in real time.

Basis Per Watt

MR. MARTIN: It seems like the basis risk is the largest risk on the tax side in these deals. Do all of you agree? Vicki Dal Santos is nodding yes.

MR. RAIKAR: Yes

MR. MARTIN: Dan Siegel and George Revock are nodding yes. Tax equity investors, do you have a benchmark price per watt that is a cap on what you are willing to treat as the fair market value of a utility-scale project or rooftop solar system: for example, $3.10, $3.50, $4 a watt for a residential rooftop system?

MS. DAL SANTO: We do not have a firm line, but we certainly take a close look at the appraisal. We make sure it is credible.

We prefer that the appraiser use the cost approach and market comparables. We think the market should be more focused on comparable sales and that appraisers should make more effort to gather such information. We think that the cost and market comps are much more informative than discounted cash flow, which has a lot of subjectivity to it.

MR. MARTIN: So you prefer comparable sales data. How does that work in the residential solar sector?

MS. DAL SANTO: Many sponsors are selling their systems outright to customers, so you could look at the sales prices for a start.

MR. MARTIN: Do you hold them to that direct sales price or do you allow an increment above it because the assets come with tax benefits?

MS. DAL SANTO: We allow an increment.

MR. MARTIN: Dan Siegel, what is the internal discussion at US Bank when you are trying to decide whether you can live with the fair market value proposed?

MR. SIEGEL: We have outside tax counsel on any transaction. Step one is gauging his or her temperature. We do not have any firm ceiling on developer fees, but we have a general sense where they fall typically in the market. Any outlier raises red flags. Similarly, if there is a deferred developer fee, we want to make sure that it is paid within a reasonable amount of time. We pay attention to stacking of fees. In many deals, there are both EPC margins and developer fees, and there is some sensitivity around stacking.

We get appraisals. We have benefited from dealing with a large number of sponsors, particularly in the residential sector. That gives us a pretty good sense about where the fair market values are falling, and we can usually spot ones that are outside the norm.

MR. MARTIN: Do you limit the percentage markup you are willing to accept above cost?

MR. SIEGEL: That is really hard to do because different residential rooftop companies have different business models. There are some residential companies that are purely financing platforms. They acquire projects on a turnkey basis from local installers or channel partners. There are others that are more vertically integrated where one would expect to find various forms of embedded profit along the way.

MR. MARTIN: George Revock, is the discussion at Capital One any different than what Dan Siegel just described?

MR. REVOCK: It is a combination of what Dan and Vicki said. We spend a lot of time looking at the appraisal to make sure the analysis is credible and not at odds with what the same firm or other firms have said about other projects or portfolios. For utility-scale projects, we like to see comparable sales data, and we like to know the facts surrounding each sale so that we can assess the extent to which it is a good indication of value in the project we are considering financing.

MR. MARTIN: If basis risk is the largest tax risk in these deals, then what is the next largest risk?

MS. DAL SANTO: I don’t know about tax risk, but another large risk, especially in residential solar deals, is the potential for changes in state policy.

MR. MARTIN: So the possibility that net metering rules will change. Does anyone have a different candidate for the next largest risk?

MR. SIEGEL: I think Vicki is right. The risk of a change in net metering is probably the next biggest risk.

MR. LUU: In terms of tax risk, I would say change in law.

Capital Stack

MR. MARTIN: UBS put out a paper that said tax equity is on average about $1.75 per watt of the capital stack for SolarCity systems. If that is the right number, then what is the total capital stack per watt?

MR. LUU: $1.75 a watt is in the neighborhood for tax equity. You can back into that number from our financial statements. It is roughly 40% of the fair market value of the system. That is typically what tax equity funds.

MR. MARTIN: How much of the capital stack is back-levered debt? UBS suggests it is about 80¢ a watt.

MR. LUU: We raised roughly $2.70 a watt last year.

MR. MARTIN: So the $2.70 must be 95¢ in back-levered debt and $1.75 in tax equity. Does the amount vary if you do a securitization rather than a bank deal?

MR. LUU: I think the advance rates in the two debt markets are roughly the same. They are between 60% and 70%. I think there is a market developing for what we would term cash equity, where you are able to match the long-term stable cash flows under 20-year contracts to investors who want to hold the paper, and they will monetize 100% of the contracted cash flow left over after the tax equity and back-levered lenders take out their shares.

MR. MARTIN: There is speculation in the market that SolarCity and perhaps others, like Sunrun, will sell portfolios as a way of creating a benchmark asset valuation. Is there any truth to the rumors? The speculation is that the discount rate used by the buyers will be somewhere between 7% and 9% for this type of asset.

MR. LUU: Your comment about the speculation is accurate.

MR. MARTIN: The announcement by SunEdison on July 20 last year that it had agreed to buy Vivint not only led to a collapse in SunEdison’s share price, but it also pulled down the share prices of all the residential rooftop companies. Has this affected how the tax equity investors view the sector?

MR. REVOCK: The underlying credit at the homeowner level is fine. We started paying more attention to the operating risk, because billing and collections, which are usually contracted out, could involve subsidiaries of these entities.

MR. MARTIN: Let me move to another question. We talked about some of the risks in solar tax equity deals: basis risk, net metering tariff changes, change-in-law risk. Has there been any change in how these risks are allocated between the sponsor and the tax equity investor? [Pause] The answer must be no. What about change-in-law risk? Who takes it in the current market?

MR. LUU: That is a risk that is often shifted back to the sponsor. However, we are starting to see some discussion around a division of change-in-law risks. The main focus by tax equity investors has been on the potential for a reduction in the corporate tax rate and for a scaling back of accelerated depreciation.

MR. MARTIN: Who bears basis risk in the current market?

MR. RAIKAR: That is usually on the sponsor.

MR. MARTIN: Albert Luu, do you agree?

MR. LUU: Yes.

MR. MARTIN: Is that changing?

MR. LUU: We understand there are now some transactions where the basis risk is shared.

MR. RAIKAR: Just to be clear, there is a sponsor indemnifying and potentially providing a parent guaranty to ensure payment of any indemnity. We also need a cash sweep to cover any indemnity, and this is where there is tension between the tax equity investor and the sponsor and, if there is a back-levered lender, with that lender as well.

Solar developers usually don’t have as strong balance sheets as wind developers, so the ability to sweep cash is very important.

We like the solar sector, but we need to feel confident there will be enough cash to pay indemnities. In 2015, we did not do any investments in residential solar and we do not foresee any such investments in 2016. A utility-scale project is easier for us to handle.

We closed a utility-scale deal in October where we had to work out a compromise on the cash sweep. It took a while, but once we figured it out, the back-levered lender said it would be happy to staple its financing to any tax equity we sign up in the market.

That gives you a sense of where the tension is and one of the reasons why we have been sticking to utility scale.

Community Solar

MR. MARTIN: Next subject, can community solar projects be financed in the tax equity market?

MR. SIEGEL: I think so. We have been looking at it for a while. We are active in the relatively small community solar market in Colorado. Our bank is headquartered in Minneapolis, so we have an interest in the Minnesota program.

It has been slow to get off the ground, but we think it can be financed. I think some of the challenges are going to be around valuation: what is the proper way to value projects that are utility scale, but that have rotating subscriptions? Sometimes the subscriptions vary depending on the type of subscriber.

There is obviously some execution risk. It is a new market. People need to understand the relative legal positions of the developers and utilities. One of the benefits of community solar is the projects are not on the customer’s site. That makes it easier to maintain the asset value after a customer default.

MR. MARTIN: You don’t have to rip the panels off the roof.

MR. SIEGEL: You can swap subscribers. That is the theory. We do not know yet how well it will work in practice.

MR. MARTIN: We made a list of risks earlier: net metering, change in law, basis risk. Dan Siegel, you just mentioned another risk for community solar. Is there anything else that should be put on the risk list for community solar?

MS. DAL SANTO: It is closer to the rooftop model in terms of inefficiencies, and that is one concern that we have about community solar. Can you make the deal efficient? How many PPAs are there, are those PPAs standard, can you get a large enough size transaction to make sense to do a deal?

MR. MARTIN: We are at the end of our allotted time. Let’s give the audience a chance to ask a couple questions.

MR. HUNTER: Chris Hunter, Brightfield Energy. There was close to $13 billion in tax equity for renewables in 2015. With the five-year extension of the ITC, one could make an argument that we will see a larger volume of high-quality projects in the future. In 2017, 2018 and beyond, we might need $20 billion or more of tax equity a year. In the absence of new entrants, will the 15 or so players who are currently in the market be able to step up to meet that need or might we see a real shortage of tax equity?

MR. MARTIN: Vicki Dal Santo, JPMorgan was about $2 billion of the $13 billion market last year. Do you have room to do more?

MS. DAL SANTO: We have more tax capacity. If there are good deals to be done, we would certainly try to go after them. We are more constrained by resources than tax capacity. There is a limit on the number of deals we can put through our shop at any one time.

MS. CHRISTENSEN: Cynthia Christensen with Namaste Solar. Can you talk about your thoughts on combining tax equity with PACE debt?

MR. SIEGEL: We are looking at a small PACE fund in California. We have not closed it yet. I think it can be done. Part of the challenge with PACE is it is such a quilt work of programs, so when we are working on a particular PACE program, the expertise we gain is only in that particular PACE program. The challenge is the scalability of the model. That is where we are struggling a bit.

MR. MARTIN: Albert Luu, what percentage of the deals you do are inverted leases versus partnership flips?

MR. LUU: We like to be somewhere in the four flips to one inverted lease range.

MR. MARTIN: Why?

MR. LUU: To optimize our tax position. We keep the depreciation in inverted leases.

MR. MARTIN: How many of our tax equity investors are doing inverted leases? Raise your hand. [Pause] We have one: US Bank. George Revock, why is Capital One not doing them?

MR. REVOCK: In an inverted lease, the tax equity ends up being the bottom piece of the capital and, from a credit perspective, that is difficult for us. We would also need to structure the lease to have a longer term than we are willing to consider.