Infocast’s Solar Power Finance & Investment Summit was held in San Diego on March 20 and 21.  Below are sound bites from the speakers and panelists. The sound bites are organized by topic, rather than chronologically. They were prepared without the benefit of a transcript or recording and are edited for clarity. Although, this was a solar conference, there are some points addressing wind.

Topics covered include the tax equity market, the start of construction rules, tax risk insurance, sponsor equity returns, the debt market and storage.

The Tax Equity Market

“There was 10 to 12 billion dollars of tax equity transactions in 2018, but there is a half a billion dollars of smaller transactions that are not included in that headline number.” 
— Managing Director, Money Center Bank

“There are approximately 30 solar tax equity investors.”  
— Managing Director, Financial Advisor

“In the last 18 months, two tax equity investors exited the market and one entered.”   
— Managing Director, Money Center Bank

“We’ve seen some tax equity investors back off from investing due to lack of tax appetite.” 
— Senior Managing Director, Specialty Insurance Broker

“There is $20 billion of demand for tax equity predicted in 2020. There’s a big boom.”
 — Managing Director, Money Center Bank

“Solar tax equity yields are six to seven percent.”
— Managing Director, Financial Advisor

“Solar tax equity yields are 6.5 to eight percent.”  
—  Managing Director, Leasing Financial Advisor

Commentary: The difference between the ranges quoted by the two advisors could be that the lower range was quoted by an advisor that has more sponsor clients and the higher range was quoted by an advisor with more tax equity investor clients.

 “There’s been spread compression, which we have not seen before in twelve year history of the tax equity market.” 
— Managing Director, Money Center Bank

Commentary: “Spread compression” refers to the difference between what the bank pays in interest to its depositors and what it earns on its investments. 

 “Tax equity yields used to be a function of supply of demand, now the investor’s cost of funds is an issue.” 
— Managing Director, Money Center Bank

“We are seeing a lot of new corporates enter the tax equity market. They are looking to go green and find solar yields to be attractive.” 
— Principal, Big 4

 “We are seeing a few IRS audits. The IRS is starting to dig into solar deals.”
— Principal, Big 4

 “The IRS does not have a centralized coordinated effort going on right now to challenge investment tax credit (ITC) basis, but it is something we will see more and more of.”
— Principal, Big 4

Tax Equity Structures

 “We did our first partnership flip in 2018, before that it had been all leases.”
— Director of Energy Finance, Trust Company

 “A lease lets us put out larger dollars of investment without chewing through as much tax capacity.” 
— Director of Energy Finance, Trust Company

Commentary: This point is best demonstrated by an example: In a sale-leaseback, the tax equity investor invests $1 million in a solar project with a fair market value of $1 million. The solar project qualifies for a 30 percent ITC or $300,000 and 100 percent bonus depreciation worth $178,500 (i.e., the $1 million cost of the project less the $150,000 ITC basis adjustment and then multiplied by a 21 percent corporate tax rate).  

To use those tax benefits in the current year, the tax equity investor must have $478,500 of tax liability for a sale-leaseback. So if the tax equity investor has $10 million of annual federal corporate income tax liability (before tax equity and other tax motivated transactions), it invested $1 million in a transaction that consumed about five percent of its corporate federal income tax liability for the year.

In contrast, for a $1 million solar project a tax equity investor would invest approximately $500,000 in a partnership flip structure. The tax equity investor would be allocated 99 percent of the same tax benefits above or $473,715.

Accordingly, the bank could use all of its $10 million of tax appetite and invest $20 million in 20 sale-leasebacks or it could use all of its $10 million of tax appetite and invest $10 million in 20 partnership flips. 

 If you are a banker and one of the metrics for your bonus is volume of dollars invested, you may find it more appealing to use the bank’s tax appetite to invest $20 million in sale-leasebacks than to invest $10 million in partnership flips. Nonetheless, the partnership flip is the more prevalent structure in the solar tax equity market.

 “We’ve seen a trend towards sale-leasebacks for larger solar projects.  Typically, sale-leasebacks had been used for smaller projects.”
—  Managing Director, Leasing Financial Advisor

But then two panelists had different perspectives over what types of projects leases are being used for.

“Leases are only being done on projects with longer PPAs.”  
— Director of Energy Finance, Trust Company

“With a shorter offtake agreement, you have deficit restoration obligation [(i.e., negative capital account issues) with a partnership flip structure.  You can avoid that with a lease.”  
— Managing Director, Financial Advisor  

“A lot of sponsors like the lease pass-through structure because it provides some tax losses for them.  The sponsors now need tax losses as they are starting to owe tax.”
—  Managing Director, Leasing Financial Advisor

“Corporate tax equity investors tend to be more open to the lease pass-through structure.”
—  Managing Director, Leasing Financial Advisor

 “We like the partnership flip because it does not really have the concept of payment default, unlike a sale-leaseback.  We have no appetite for the lease pass-through.” 
— Managing Director, Money Center Bank

 “We are not an inverted lease provider.” 
— Director of Energy Finance, Trust Company

 “Start of Construction” to Qualify for Full Tax Credits

A wind project must have “started construction” in 2016 to qualify for a full 2.4 cent per kWh production tax credit or a 30 percent ITC, while a solar project must start construction in 2019 in order to qualify for a full 30 percent ITC. There are two ways to start construction: (1) in the applicable year incur five percent of the total cost of the project (the “Five Percent Safe Harbor) or (2) meet the significant physical work test (PWT), which can be done with onsite work or offsite work.  The guidance expressly provides that work performed on a custom step-up transformer by a manufacturer under a binding contract with a project owner qualifies under the PWT.

“We can accept the Five Percent Safe Harbor.  We can allow the sponsor to utilize the PWT.  People are trying to use ever decreasing metrics as to what qualifies under the PWT.”
— Managing Director, Money Center Bank

 “The IRS standard is lenient and generous in stating that there is no minimum level of work required for PWT.  We are extremely comfortable with starting work on one component of a transformer, but you will find varying views between various law and accounting firms.” 
— Principal, Big 4

 “We need a ‘will’ opinion on start of construction whether or not there is insurance” for the start of construction tax credit risk. 
— Managing Director, Money Center Bank

“There are some investors more willing to rely on insurance to cover start of construction risk.” 
— Senior Managing Director, Specialty Insurance Broker

Solar Tax Equity After the ITC Phases Down to Ten Percent in 2023

“There has been an equipment finance industry for sixty-plus years.  Deals have been done over that time without ITC.  Deals will still get done at a ten percent ITC.” 
— Managing Director, Money Center Bank

“The phase down of the ITC means that tax equity will go down.  With a smaller tax equity contribution, folks will have accept larger deficit restoration obligations (DROs) or nonrecourse debt.”
— Managing Director, Financial Advisor

Commentary: If the ITC is in fact allowed by Congress to phase down to ten percent, then tax equity investors would typically want to invest about 15 percent of FMV in a partnership flip structure.  Then if the tax equity investor is allocated 99 percent of the depreciation based on the FMV of the project, the tax equity investor’s capital account will become negative.  There are three ways to address that negative capital account issue: (1) the tax equity investor provides a DRO for the projected negative amount and agrees in a liquidation to pay that amount to the partnership, (2) there is senior secured nonrecourse debt that is allocated to the tax equity investor, which would mean the tax equity investor is subordinated to the lender or (3) the losses are reallocated to the sponsor (which is likely inefficient and potentially raises other issues). 

 “Capital costs continue to go down and module efficiency continues to go up. Those get factored into a ten percent ITC case too.” 
— Managing Director, Financial Advisor

Tax Equity for Wind

 “We are seeing sponsors in the market for wind tax equity for the end of 2020.” 
— Managing Director, Money Center Bank

Commentary: This is because under the tax credit rules for wind, a wind project to be eligible for a full tax credit work must have started on it in 2016 and to avoid providing that the work was performed continuously from 2016 to completion the project must be complete by the end of 2020.

“Wind projects [due to their longer construction period] need to secure a tax equity commitment further in advance than solar projects do.”
 — Managing Director, Money Center Bank

 Bonus Depreciation

“We see bonus depreciation in maybe one in five deals.” 
— Principal, Big 4

“We love bonus depreciation in sale-leasebacks.” 
— Director of Energy Finance, Trust Company

“Mostly we see bonus depreciation modeled in inverted leases in which over half of the depreciation is allocated to the sponsor.” 
— Managing Director, Financial Advisor

Base Erosion Anti-Abuse Tax (BEAT)

The impact of BEAT is relatively minimal in ITC transactions; you only have one year for which BEAT is a concern, while for production tax credit transactions (PTC), the tax credits are for ten years.”   — Principal, Big 4

Commentary: Under BEAT, excessive payments to foreign affiliates can result in an inability for a taxpayer to use all of its tax credits.  The ITC is claimed fully in the first year a project is placed in service, while in contrast PTCs are claimed over a ten year period. Accordingly, for a PTC investment BEAT is a concern for the investor for ten years, while for an ITC transaction  BEAT is a concern for the investor only for one year.

Tax Risk Insurance

“In 2015, SolarCity purchased the first insurance policy to insure the risk that the IRS disagreed with the amount of ITC the appraiser opined a portfolio of rooftop solar projects qualified for. The premium was five percent of the maximum insurance payout, there was a high deductible and the policy paid the financiers only if SolarCity failed to. Now, premiums are 2.5 to 3.5 percent, paid one time at the outset, for true insurance with no deductible for a policy with a seven-year term.” 
— Senior Managing Director, Specialty Insurance Broker

“After Alta Wind, one of our insurers backed off, but in general that case has not caused a material adjustment to premium levels.” 
— Senior Managing Director, Specialty Insurance Broker

Commentary: Alta Wind is a Federal Circuit case in which the court concluded it is possible for a power purchase agreement (PPA) or other project contract to have value as an intangible that is not eligible for the ITC or accelerated depreciation.

“Tax insurers’ sweet spot is insuring issues that tax advisors are between a ‘more likely than not’ and ‘should’ level of comfort.” 
— Senior Managing Director, Specialty Insurance Broker

The PPA Market

“PPAs are getting signed up at increasing low rates. It raises a question of whether in future years PPA rates will cover operating costs. We have turned down PPAs at too low a price.  I hope that message gets back to the off-taker market.” 
— Managing Partner, Renewables Project Development & Holding Company

“Subsidizing this industry with tax benefits has pushed PPA rates down. With a smaller ITC, the value will have to come from a higher priced PPA.” 
—  Managing Director, Leasing Financial Advisor

Commentary: It may not be that easy. The offtakers may expect the manufacturers and sponsors to accept lower returns. The offtakers are only going to agree to higher PPA rates, if they cannot otherwise enter into contracts to meet their renewable energy targets.

“PPA prices are so low that you are going to start to see merchant projects in some parts of the country.  In pretty much every downside scenario with a merchant project, you get 90 percent of your money back before 20 years, but with a low price PPA you do not even” in a base case.
— Managing Director, Energy and Infrastructure Advisor

Sponsor Returns

“With tax reform, the internal rate of return of a given project went down. Fortunately, we’ve seen equity yields compress, which means projects get built.” 
— Managing Director, Financial Advisor

“If interest rates go up, it will be a lot riskier. Projects are getting returns of six or seven percent, which is better than the stock market, but the returns will fall if debt costs go up.”
— Managing Partner, Renewables Project Development & Holding Company

“We would all like to see a pre-tax return of seven or eight [percent] or more.” 
— CEO, Solar Development Company

“Markets are becoming even more local than they once were, and the margin for error is getting even larger.”
— CEO, Solar Sponsor

“Patient capital understands that the development cycle never plays out as planned.” 
— Chairman, Solar Development Company

“We could see the efficiency of panels go up 45 percent. That would mean a project in Massachusetts would have the same output a project in Florida does now. You have to stay nimble.”   
— CEO, Solar Development Company

“We are a finance company that employs engineers. We have a source of electricity that relies on the sun coming up, so we have a generation source that is predictable and bankable.  When you combine that with a PPA, you effectively create an annuity that is perfect for a pension fund.”
— Founder, International Solar Developer

Debt Market

"In commercial and industrial (C&I) portfolios, we are working with borrowers to remove some of the conditions precedent to funding that you would see in a utility scale solar deal. For C&I to grow, we have will have to be a little more flexible.”  
— Managing Director, Investment Bank

“Borrowers are looking for diligence light for C&I, particularly for projects under one MW.”  
— Managing Director, Regional Bank

“In C&I portfolios, we are looking for 80 percent offtakers with investment grade credit ratings.  There are banks out there that are more aggressive.”  
— Managing Director, Regional Bank

“We like a seven-year mini-perm debt structure.”  
— Managing Director, Regional Bank

“We would be careful about doing deals that were 100 percent exposure to a California utility.” 
— Managing Director, Japanese Headquartered Bank

“I am looking forward to the ITC step-down as it will mean there is more of a need for debt in the capital stack.”
—  Banker, Small Business Bank

“Spreads are compressing in the back leverage market.”
— Managing Director, Financial Advisor

“We are not that active in West Texas with respect to term exposure.  We will do construction financing in West Texas.”  
— Managing Director, Regional Bank

Storage

“There is a lot of complexity with retrofitting utility scale solar to add storage.  A lot of times the interconnection has to change.  We haven’t seen a lot of retrofits, but that could change with the price of batteries falling drastically.” 
— Chairman, Solar Development Company

“In 15 years when you have to face these residual values that [solar sponsors are including in their economic models], you may decide to add storage or change your solar technology.”   
— CEO, Solar Development Company

“We’re very bullish on storage; the challenge is finding deals: the storage market is small.  We’ve done solar and storage, wind and storage, and gas and storage.” 
— Managing Director, Japanese Headquartered Bank

Community Solar

“I am really excited about community solar for low to middle income customers because we are going to enable people who may be having a hard time paying their power bill to save ten percent.”   
— Chairman, Solar Development Company

Growth of Solar

“There is 64 times more solar in the world than there was in 2005.  There is more solar in 2019 than McKinsey projected in 1995.”
— Founder, International Solar Developer

 “There are 350 million people in India who do not have access to electricity.”
— Founder, International Solar Developer

“The energy companies of yesteryear have a natural inclination to move into the renewables space.  The European oil and gas companies have moved quicker into renewables.” 
— Founder, International Solar Developer

“For the last 100 years, oil and gas companies have created the energy that runs our economy.  They continue to see themselves as dominant and do not think in five-year chunks but in 50-year chunks.”
— Founder, International Solar Developer

“I can build a solar plant in Spain and power almost anywhere in Europe because Europe has one grid. That is not the case in the United States. This makes the US a really challenging market, but it is an exciting market.” 
 — Founder, International Solar Developer