Further, the best guess of the speakers is that the IRS will publish the updated guidance in March. In addition, it is arguably a good sign that industry representatives have not been invited by the IRS to have a meeting to either (a) defend the request for moving the deadline to the end of 2016 or (b) discus alternative proposals.
Compliance with PTC Eligibility Start of Construction Requirements
The representatives from financial institutions on the tax equity panel had consensus that investors have a hierarchy of start of construction transactions as to their comfort that the project, in fact, qualifies for PTCs:
1. Projects that “incurred” 5 percent of the total cost prior to 2015 to meet the safe harbor provided for in IRS Notice 2013-29 that will be placed in service prior to the end of 2015 (or the end of 2016 if the IRS issues favorable guidance) to avoid the “continuous efforts” requirement.
2. Projects that undertook “significant physical work” prior to 2015 that will be placed in service prior to the end of 2015 (or the end of 2016 if the IRS issues favorable guidance) to avoid the “continuous construction” requirement.
3. Projects that “incurred” 5 percent of the total cost prior to 2015 to meet the safe harbor provided for in IRS Notice 2013-29 that will not meet the placed-in-service safe harbor deadline, so they must meet the “continuous efforts” requirement.
4. Projects that undertook “significant physical work” prior to 2015 that will not meet the placed-in-service safe harbor deadline, so they must meet the “continuous construction” requirement.
“There are a lot of projects [to be placed in service] in 2015 for [J.P. Morgan] to deal with in due course. We are interested in working on [projects to be placed in service in 2016] but signing an equity capital contribution agreement for those projects will be in the second half of 2015.”
Yale Henderson, Managing Director – Energy Investments, J.P. Morgan Capital Corporation
“The PTC start of construction rules result in PTC-eligible projects being condensed in big companies that can write a check at the end of the year of $150 million [to meet the 5 percent safe harbor]. I’m not sure that is healthy for the industry.”
Paul Gaynor, EVP North America & Global Wind, SunEdison
Significant Physical Work Protocols
“The more roads, excavations and transformers, the better chance of your project moving up the hierarchy of projects that financial institutions have in the back of their minds.”
Yale Henderson
“The more construction the better, the better the record keeping the better”
Jack Cargas, a Managing Director – Renewable Energy Finance, Bank of America
Messrs. Cargas and Henderson each stated their institutions preferred 5 percent safe harbor projects but had invested in significant physical work projects (i.e., projects that did not meet the five percent safe harbor). And that their institutions did not have bright-line standards as to the minimum physical work required but were prepared to decline projects where the physical work seemed to be too minimal.
“One guy and a shovel at year end is not enough.”
Jack Cargas
“Weaker facts on physical work of a significant physical nature are helped by performing continuous construction. That shows the project did not just lay fallow until it obtained a PPA or a tax equity commitment.”
Yale Henderson
“Developers should try to meet continuous construction, even if they believe they will meet the placed-in-service deadline.”.
Tim Howell, Managing Director & Commercial Leader Power & Renewables, GE Energy Financial Services
Tax Equity After-Tax Returns
“In 2014, the range of after-tax returns was between 7.35 percent and 9 percent. The project that got 7.35 percent was a strong portfolio of projects with power purchase agreements (PPA). The 9 percent project was quite large and used a hedge, rather than a PPA. Hedge deals are generally in the range of 8 to 9 percent.”
Matthew Cammack, Senior Director, CCA Group
“Other key economic features are the size of the tax equity investor’s deficit restoration cap, what level of haircuts on expected production are included in the model as a matter of conservatism, the tax equity investor’s outside flip date if the project performs below expectation and the tax equity investor’s right to a cash step-up if performance is under expectation.”
Matthew Cammack
“Returns should be 6 percent after-tax. Returns are over-priced. The headline return rate has been unchanged even as there are more tax equity investors in the market and a longer history of the deals performing.”
Megan Schultz, V.P. – Finance, Invenergy
“But we [tax equity investors] take the risk of having ten years of tax capacity.”
Yale Henderson
“Much of the tax equity investor’s return is from tax capacity, which is outside the transaction. The tax benefits have limited value to the sponsor. It is not a zero-sum game.”
Jack Cargas
“The right metric to [measure the profitability of a transaction to a tax equity investor] is not to compare the [after-tax return] to [the tax equity investor’s] cost of capital.”
Jack Cargas
“After the flip, these projects are going to pay taxes like a champion and most of that tax cost will be borne by the developer.”
Bernardo Goarmon, EVP – Finance, EDP Renewables North America
Depth of the Tax Equity Market
“Most tax investors are comfortable at $50 to $75 million per investment.”
Matthew Cammack
“Institutions [that invest in tax equity] are writing bigger checks [than in prior years] on a per-project basis.”
Jack Cargas
“If we [(Bank of America)] like a project, we really like a project. We’ve been able to write somewhat larger checks.”
Jack Cargas
“JP Morgan is generally comfortable investing $100 million per project. We’ll go larger in larger portfolios.”
Yale Henderson
“GE EFS’s maximum investment per project site is $150 million.”
Tim Howell
“Mid American is making pure tax equity investments as opposed to prior years when it would only buy projects outright.”
Matthew Cammack
“I wouldn’t say there is a deep secondary market for tax equity. It is pretty complicated to sell down.”
Tim Howell
“Most tax equity investors want to establish relationships with developers by making direct investments.”
Yale Henderson
Tax Equity Structuring
“I haven’t seen a pre-paid PPA deal in years.”
Jack Cargas
“There’s no good reason for a levered partnership [(i.e., to give the lender a mortgage over the wind farm)]. Our last levered deal was 2008. The premium then for a levered deal was 250 to 300 bps.”
Yale Henderson
“There are very few tax equity investors who will do levered partnerships.”
Matthew Cammack
“I give all the credit [for back leverage replacing the senior secured debt] to the project finance debt market’s ability to accommodate back leverage. There is not a huge economic driver for project level debt.”
Yale Henderson
“I don’t think levered tax equity deals exist [any more]. I don’t know a project finance lender who would agree to forbear for 10 years (i.e., the period PTCs are available).”
Megan Schultz
PTC v. ITC for Wind2
“Of the 24 wind deals closed last year, there were only three ITC projects and one of those was a partnership flip.”
Matthew Cammack
“With the new [higher performing turbine] technology, ITC does not make sense.”
Tim Howell
PPA v. Hedge v. Merchant
“We’re seeing an increase in the number of hedge transactions. The hedge provider is often Merrill Lynch Commodities in transactions in which Bank of America is a tax equity investor. Based on our reading of the section 45 rules, if the tax equity investor is related to the hedge provider, then the tax equity investor may not provide more than 49.9 percent of the tax equity. So in those deals, there must be at least two tax equity investors.”
Jack Cargras
“The key to hedge deals is a liberal and robust tracking account to address under performance, which is basically a loan from the hedge provider to the project.”
Yale Henderson
“We’ve done some merchant deals. We focus on minimizing the cash we get in those deals.”
Yale Henderson
“The hedge transactions have been done in ERCOT. There’s talk of doing a hedge transaction in PJM in the near future.”
Jack Cargas
“A lot of tax equity investors won’t do hedges. Most of the deals we did last year were hedges, but the tax equity investors were us and the hedge provider.”
Tim Howell
“We’re looking at offtake arrangements with industrial companies. Those contracts are somewhere between a PPA and a hedge.”
Megan Schultz
“A project gives up 30 to 40 percent of the value the merchant curve is showing when it enters into a PPA or a hedge.”
Michael Storch, EVP & Chief Commercial Officer, Enel Green Power North America
“A developer must put up a great deal of capital just to meet the requirement to get a PPA with a utility.”
Michael Storch
Market for Sponsor (i.e., Cash Equity)
“Canadian pension funds are offering a great cost of capital for minority positions in both operating and development projects. Therefore, so far EDPR has not yet transacted with a YieldCo.”
Steve Irvin, EVP, EDP Renewables North America
“GE EFS invested a billion dollars in renewables last year; half of that was cash equity.”
Tim Howell
“If you have a portfolio with proven technology, long-term PPAs, and no curtailment or environmental issues, then it is a most liquid market.”
Paul Gaynor
1 This post was prepared without the benefit of a recording or transcript and some quotes were edited for readability purposes. If there are any misquotes please contact the author for a correction.
2 Wind projects are eligible for either a PTC of $23 per MwH for ten years or a one-time 30 percent investment tax credit (ITC).