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Impacts of the Tax Law Change on the Solar Industry
Written By: Jen Neville
February 26, 2018
IC: Today, I have with me Dan Sinaiko and John Marciano, both partners and co-heads of Global Project Finance at Akin Gump. Today’s webinar is a preview of what you could experience at Solar Power Finance and Investment Summit, where over 1,000 senior solar financial and development executives gather to connect with top executives and network as well as get the latest on current and upcoming project opportunities for 2018.
Dan Sinaiko: Thanks for allowing us to participate here with you today. It’s a pleasure to be here. Without question, tax incentives are probably the largest impetus for the US solar market. So whenever Congress starts pulling levers in the tax code, even when those levers aren’t targeted at the solar industry, the people in the solar market feel it. We’re going to talk today about the impacts caused by the Tax Cuts and Jobs Act, what we see today, and what we expect for tomorrow. And our agenda here, as you can see, will cover what happened to the tax reform, what is in the Tax Cuts and Jobs Act that is germane to the solar industry, what the tax equity markets looked like before tax reform to get a perspective on how the impacts will be felt, and then where the market is now, and where it’s going? So we’ll start off, I think, with John giving us a rundown as to what is in the Tax Cuts and Jobs Act before moving into where the markets were, and where they are, and where they’re going.
John Marciano: Thanks Dan. So what happened? We have several things that changed. What didn’t change, and we were really afraid would, was the Investment Tax Credit. We have been hearing stories out of the people on the hill, we were going up to the hill every couple of days during the tax reform discussion, that maybe there would be all bets are off, everything’s on the table, and the investment credit gets cut idea. And when we first saw the house bill, we were relieved that the credit was still there but we were a little bit shaky that maybe they would muck around with the starter construction rules to show what you need to do to put your foot in the door. Thankfully, when the final bill came out, we were left pretty much unscathed down the investment credit.
What we do have is we have a lower tax rate. Lower tax rates generally mean you have a lower burden throughout the life of the project in terms of paying tax, but it also means that certain tax benefits aren’t worth as much. For example, depreciation is, if you have dollar depreciation, you take the dollar, you multiply it by your tax rate. That tells you how much you essentially saved on your tax bill by having that dollar depreciation. If the tax rate is 35%, it’s worth 35 cents, roughly. At 21%, we’ve lost some pretty decent chunk of value depreciation. The corporate AMT was repealed. That was a remitter on tax investment previously in some cases. So we’ve got that. I’m just going to burn through what happened because most people know in kind of broad brush and then we’re going to get into the meat. You might hear people talking about super bonus or expensing. Basically, the ability to write off the entire cost of the project. It could be for new projects. In the older days, bonus depreciation would only send new projects. The first owner got it.
Now we have a scenario where the first owner can get it, or if you’re the second owner, third owner, and fourth owner, you go down the chain, used equipment qualifies. So one of the things that we’re seeing is, do you qualify for the used equipment roles? And if you’re buying it from an affiliate, you don’t. And so basically, if you acquired it after September of last year from a third party, you can qualify for this 100% bonus. Now, there’s still the question of whether you can claim it, and we’ll get into that a little bit later with respect to your actual tax equity deal.
There are some exceptions. People that can’t claim bonus depreciation are companies that have their rates approved or established by a governmental entity.
So people think, “Okay, what does that mean?” That probably means, at least, that you have a deal. If the project is owned by a utility, you can claim bonus depreciation. It could maybe also include deals. For example, the avoided cost rates that you charge under a contract, and most of them are in the Southeast, those are approved by the local regulator. So technically, they fall under that rule. Now, we’re talking with the IRS trying to figure out if that’s really what they think Congress intended. But at the moment, it’s a little bit unclear whether projects in the Southeast can actually qualify for bonus on a go forward basis. Same thing with DG project. If you’ve got a project that the PPA assigned and approved by a school board or a town board or a city council, it technically falls into the rule. I don’t think that was the intent. And so because we don’t think that was necessarily the intent, there’s a lot of discussion going on up on the hill and behind doors at the IRS trying to figure out, “What do we have to do here to figure out if we have bonus for our projects?”
So the base erosion tax effectively says, if you make payments to a foreign affiliate over a certain threshold – and I have 2% here because 2% is the threshold for banks, and banks are mostly the tax investors, it’s 3% for non banks. If you’re over a certain threshold of payments to foreign affiliates, then you have to pay at least a certain amount of tax, of regular tax. And so if you had $100 tax bill, if you had not paid all those payments to your foreign affiliates, then you need to pay at least certain percentage of tax on your regular tax. If you pay that, then the base erosion tax doesn’t apply. If you’re not at that minimum, then there’s a top-up tax, and the top-up tax has the potential of unwinding at least part of the investment credits. And so that’s throwing some of the banks, some of the insurance companies for a loop as they try and figure out, first, if they’re subject to the rule, and second, how they can plan to know, when they’re making their investments at the beginning of the year, whether they in fact will have their credits unwound at least in part. If you invest $100 thinking you’re going to get $100 of credit out of the deal, and you only get 80, it’s a bad deal. And the employees at the banks are very worried about having to go back to their bosses and say, “Oh no. I actually didn’t get the benefits I thought I was going to get.” There’s a lot of talk going into this. The good thing for solar, though, and particularly on the smaller end, if you’re doing DG projects, if you’re doing RESI, it’s more likely – it’s not 100%, but it’s more likely – that you’re dealing with a bank that is not subject to the rule, or an investor, a tax investor is not subject to these rules. The reason that they’re not subject is they’re often fully domestic, they really don’t make a lot of payments to foreign affiliates. If you don’t make payments to foreign affiliates, this rule just doesn’t apply to you. So most of the deals where you have syndicators as tax investors or if you have regional banks, regional insurance companies, fully US banks, no issue at all.
The multinationals, they have similar issues, but they’ve largely, it seems, been able to either assess where they are and determine that it’s not an issue, or rejigger some things. We were thinking the sky could be falling due to this provision, and it appears that perhaps it’s a little less dramatic than we had thought. There’s still some folks that had an issue there.
So corporate NOLs, the net operating loss, they can’t be carried back. They can be carried forward indefinitely now. They used to only be able to be carried forward for 20 years. The problem is, as you carry them forward, you can only use them to offset up to 80% of your income. So that effectively gives you sort of back-door corporate minimum tax of about 4.2%. We have an interest expense limitation. The interest expense limitation is 30% of your income. And the income, at least for now, adds back your depreciation. And so because these projects have so much depreciation in the early days, it’s really important to add that depreciation back in, otherwise, you can get subject to this rule. After 2022, or from 2022 on, then you don’t add the depreciation back in.
Dan Sinaiko: Thanks, John. That’s a really helpful review on where Congress took us with tax reform. Let’s take a look back, though, at where we were before tax reform. We’ve summarized where the markets where in terms of who was invested in the market. There were roughly two to three dozen investors investing in projects to monetize tax credits for solar projects in Q3 of 2017, before tax reforms started to really pick up steam. We have the multinational financial institutions: the Bank of Americas, the Citibanks, the JP Morgans of the world, who have global footprints, global depositor bases, and tying back to what John was alluding to in his technical analysis of the changes, folks who have to be concerned about the base erosion tax. We have national financial institutions, such as PNC or Wells Fargo, probably have less concerns about the foreign affiliate rules, but very significant players in the market, doing deals of all scales, different technologies. We have regional financial institutions. Some are smaller banks, MNTs, State Street regions, who are heavily invested in the market, and probably have even less concerns and less ties about some of the cross-border concerns. Insurance companies, like MetLife, Prudential, tend to be invested in larger projects, but definitely in the market perhaps more concerns with foreign ties. Then we have corporate and strategic players. These are folks like utilities, and large corporations, equipment vendors. People who have reasons to invest in tax credits for solar beyond just the financial gains.
People who have strategic interests in being invested in the solar market. Some of these folks will have multinational ties, some may not. Then we have the family offices and the unicorns, meaning effectively people investing for high networth individuals. These folks are looking to offset passive income with tax credits, and so they have a very different profile in terms of their impact from tax reform because the corporate tax rates really don’t affect them as much, although, everybody got a tax break. So there’s probably some compression on what’s happened there in terms of tax appetite. And then lastly, aggregators. Folks who are cobbling together syndicates of the foregoing categories of people, be they banks, financial institutions, corporates, to try and create liquidity in the market for tax investment.
The conditions of the market towards the end of last year, third quarter, beginning of fourth quarter, were very interesting. We saw in, I’d say, 2007, 2008, yields per solar tax equity in the 6 to 8 percent IRR range. Very low yields. When the market was disrupted by the the great recession, we saw those yields jump significantly. And all of the leverage in tax equity transactions really sat with the investors.
It took quite a while, but by the time we got towards the end of 2017, we had seen a significant shift in the relative availability of tax equity to the number of good projects that were available to fill investor books. As a consequence to that, we saw tax investors chasing deals. We saw complicated structures, multi-tier monetizations. We saw some merchant transactions, some interesting things in the market. Probably merchantless on the solar side, but in other tax equity structures, some complicated things. We also saw riskier projects, hedged projects, projects that didn’t have conventional offtake, projects with basis risk, projects with some environmental or land use hair on them. Things that, historically, we wouldn’t have seen a whole lot of appetite for in the past equity markets. But the investors were hungry and the deals were not robust in number, and so we saw tax investors chasing these types of deals.
We also saw, as I mentioned, a yield compression where we were back in the range of where we were in 2007, 2008. We saw utility scale IRRs pushing down towards that 6 to 8 percent range again. Residential and C&I ranges were a bit all over the map. I would say 8% would have been a really good deal for a residential/C&I portfolio. And we certainly saw much higher yields for certain structures of tax equity where the strategy modifies less cash, and was more geared towards a tax credit strategy in terms of returning capital quickly. But those yields had come down significantly. Availability of that capital for residential C&I investors was significant. We looked at that and compared it to the wind market, and we saw that the solar markets and the wind markets for tax equity on the utility side was fairly well comparable and pricing was very stable.
We also saw towards the end of 2017, that we had much more favorable sponsor terms. We saw some things in the market like flexibility with back leverage debt, flexibility on forbearance terms. A number of things that I think were not on the menu in, call it, 2012, 2013, 2014 were starting to creep into deals because tax investors again were very hungry for transactions and willing to dig in on risks and understand them. But, lastly, we saw a lot of deal syndications which picked up. It’s a signal that the market was maturing for sure in terms of the number of investors willing to play in the space. And because the deals were getting riskier, and because the yields are getting lower, I think there was a lot more interest in the investor side in syndicating that risk across a number of deals and saving powder to try and find richer deals instead of investing all in on one or two larger projects. So the market was very favorable, I would say, to sponsors by the end of 2017, but then we saw the disruption that came from tax reform. We can start seeing into kind of what has happened as a consequence of the details on tax from what John covered in the first part of the discussion.
John, you want to dig in on the where the market is?
John Marciano: So where is the market now, and where is it going? The idea is basically who cares about these changes to the tax law? Clearly, if you have taxes that you’re paying, you care about tax credits. You’d like to pay less tax. And so with the tax rate going down, we did see some reduction in the total capacity of certain investors to put their money to work. And so if you had an investor that would have had a tax liability of $6 billion, maybe they have a $4 billion tax liability now. So their total ability to take credit is reduced, their total ability to take depreciation is reduced, their total ability to sort of weather interest deductions is reduced as well. We haven’t seen as much attrition from the market as we thought we would. There have been some investors that have said, “Look, we normally do a ton of deals, but we’ve got all these term sheets. We already committed to basically from the end of 2017, and we have to sort of figure out which one of those are real before we start signing new ones in 2018.” Every single deal that we had signed up with a term sheet at the end of the year is still moving forward as far as I can see. We’ve seen some new investors come in even. This sort of talk about tax reform and the tax rate reduction and all these changes has gotten companies that normally don’t think about tax credit deals just thinking in that term, and we’re seeing a lot of new corporates come in. Individual tax rates didn’t change as much and so individual investors are starting to find ways to come in. And we’re seeing a number of funds formed with either high-networth individuals or family offices that largely comprises of individual-type investments, but not exclusively, where they’re more interested. They’re basically saying, “Look, I could give my money to the government and not get any return on it, or I can give my money to some sponsor and get some return.” It might not be private equity returns.
The base erosion tax, as I mentioned earlier, it appears that it is not as meaningful of a provision as we initially thought. There were a number of deals at the end of the year that were put on hold, or downsized, or the terms were changed as people basically said, “Oh, no. I might not be able to use these benefits.” Most of that effect, to the extent it’s still happening, is really seen lying in the wind sector. Solar is coming out okay. Even the multinationals or the foreign banks that we had been talking with about the potential impact, as Dan mentioned, even they have muted their response to the base erosion tax, basically saying, “Yes, we’re thinking about it. And yes, we want a structured time to get out of it if we can, but we love the low tax rate. And secondarily, we’re not really sure that we’re in it, for one. We’re trying to find ways out, and we have a syndication options. We’ve built up these big foundations of knowledge relating to tax investments, we can go out, sign up, underwrite a transaction, and sell down the entirety of the project going into service with the sponsor not even seeing a hiccup because they just know what they’re doing.” And so while there is some base erosion tax effect, I think it’s not going to be that meaningful at the end of the day.
Hardly anyone claimed bonus depreciation prior to tax reform becoming an issue. Hardly anyone. Where we did see it was in SALI transactions. In non-SALI transactions it causes issues from a partnership modeling standpoint. And so it’s always been fairly difficult to work bonus depreciation in. Now that bonus depreciation is bigger, it’s 100% immediately, those partnership modeling issues that we had before are even more pronounced. And so there’s only a small number of tax investors that are willing to allow bonus to begin with in solar transactions. If they do allow it they usually require a very large, we call it, deficit restoration obligation so that they get all of the losses and none of it bounces back over to the sponsors. But a lot of the reasons that people want to claim bonus in this market is solar companies are actually becoming big businesses. They are making money, their tax bills are going up, they’re selling projects at a profit. There are deals that had been throwing off losses are now in a position where they are throwing off income. And so a lot of the sponsors really want the depreciation. So we’ve been kind of twisting the arms a number of investors to permit bonus and to permit the sponsor to get some benefit of that. We’re seeing some takers. It’s a slow march, but we’re seeing some takes on that.
I think that’s something to watch. It’s something that most of the investors haven’t really raised any stink about. At the end of the day, most of the deals are back levered, so the interest deduction limitations are things that would apply to them at sort of their OCO levels. And to the extent they have leverage and the interest deductions are limited, that might make them sort of offset some of their decrease tax liabilities on the lower tax rate and have a little more interest in tax credits. One of the things that we’re seeing is there’s a huge amount of interest in secondary sales. So we have old projects that have been operating for, some of them, 10 years, kind of the early stage project. We’ve got some that have been operating for one or two years. What I call kind of spent deals are the ones where the tax equity transactions are already sort of burned off. The tax equity are out of the deal or they’re about ready to get out of the deal. The sponsor is saying, “Oh, I’m going to get rid this person that sort of has been, not in the way, but they require some hand-holding.” If the tax investor is not there, it’s a lot easier to go out, raise capital, raise debt, sell the project. The lower tax rates are making the projects worth more. The lower tax rates are making the investors interest a little higher, so it’s a little more expensive to get the investor out of the deal, but it’s very interesting. Dan, do you want to jump in on some of these benefits?
Dan Sinaiko: Sure. And just to emphasize the point that John was raising, we are seeing a lot more secondary transactions and evaluations on those deals are improving because of the tax rate decrease. It’s a bit of a push and pull between getting the tax investor out with a fair market value buy out after the flip date, but the long-term net, the long-term cash flows and streams from the sponsor tickets in these transactions seem to be increasing in value as a consequence of tax reform. Tax benefits have decreased in value, and I think this is not surprising. There is less tax appetite in the market, and there is less effective ways to monetize some of the tax credits than we had prior to tax reform. However, because the structure of the solar tax credit allows for it to be absorbed immediately, there’s less concern over the long term about the availability of the credits relative to the tax appetite that an investor may have in say a PTC deal where you’ve got 10 years of monetization runway.
Depreciation is still a concern. As John said, expensing is not likely to be a significant piece of these transactions simply because of the ability to absorb the tax benefits immediately, but we still may see makers and other depreciation strategies that will allow us to monetize, albeit it at a lower value because of the lower demand for the tax benefits. Tax investor tickets are getting smaller, which sounds on its face like a bad thing and we’ve seen some of the reductions, the 10%, 8 to 12 percent reductions in tickets, which could be challenging in terms of having a smaller piece to fill the capital stack. And as a consequence, again, of the the lower supply, we see pricing degrading. BEAT may or may not have pushed some investors out of the market. Some will certainly depart. Trying to pin down with investors who is actually out of the market is a challenge. Nobody seems to be keen to admit that right now. And again, with lower tax rates, there’s just less need for the tax credits and tax benefits.
Bonus is not typically part of the structure here. It has historically not been much of a needle-mover for solar tax equity deals, although sponsors at this point want to see the tax investors step up and accept more aggressive depreciation to try and recover some of the value in terms of more expensive tax equity, less demand for tax credits. So there’s some push and pull there. But the fact that there is a smaller tax investment means you need to allocate less cash and distribute less cash to the tax investors. And that means that there’s larger strips of cash that can be monetized through debt products, or other equity coming into the stack. So it does free up some cash, having less tax investment in the structures.
Although I would expect that that’s not net-net a win, it does create other opportunities for different parties to play in the capital structure. Or parties to play in the capital structure to a greater extent.John may talk about some of the things he’s seeing about kind of uptake and things that may be coming down the pike.
John Marciano: Sure. One of the things that we did see at the beginning of the year – and obviously it’s only mid-February, so it’s still early – but some of the investors were sort of trying to figure out where they were, what are they interested in doing, and kind of waiting, biding their time trying to find the perfect project. In the meantime, there are a number of investors that are just scooping up every deal they can find to the point where the good deals are going to get snapped up quick. Last year we had not enough projects, everyone and their mother was looking for projects. Every time I went to a conference, multiple people, almost everyone I talked to would say, “Where can I find projects?” We’re going to have the same problem this year. What we might find is some of the investors that have waited, they might have not as many places to put their money. So what we are seeing is investors that don’t think they have as much task capacity for this year, they are saying, “Well, I’m still going to come into the deal. If I can’t use the credits immediately, I’ll carry them forward. I can carry them forward for 20 years, so I lose a little bit of value, but at least I’m holding my market share.” And so with that in mind, we are seeing a little bit of a decline in the amount of non-utilization fees. They are either not there at all or they are lower. And really in the past couple of years, non-utilization fees have been ranking off as there are a lot more well-heeled sponsors to deal with and the investors are always trying to find the best deals. The sponsors were looking for the best deals with the investors as well. And they were signing up several deals. Maybe filling up their tax partnerships, maybe not. And so the non-utilization fees were big issues. That’s really kind of flipped on its head.
One of the things to think about, though, is, do we have execution risk? So with new investors coming in, if they are corporates or a new syndicator you haven’t seen, is there a risk that your deal, you go down the road and then they piece out on you and you basically don’t do the deal or don’t do exactly the deal that you thought you signed up for? And there are certain investors that have been around the market for a decade and you know that if you get a term sheet from that person, you are going to close. That’s always a really interesting part of the deal. One of the things we are seeing is that valuations are becoming just more and more of an issue.
As costs come down and people are selling projects, or they’re doing inverted leases and they are trying to figure out the value. Getting good valuation advice and good reports that are well-thought, like someone from Marshall Stevens or Alvarez or DI, they are well regarded and they’re really important pieces to that puzzle. Sort of inconsistent with some of the more sponsor-friendly stuff, since we have a slight increase in pricing and a slightly smaller tax investment out of the total capital stack, one would think that the total number investors is going down and that these things like non-utilization fees would flip on their head, but it’s really showing that there is a disruption in the market. We will see in the next couple of months exactly which direction it’s going. There is some thought that the increase in pricing might just be temporary as people sort of try to grab something after the tax reform passed. The hope is that it is just a blip and the prices are coming back down.
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Dan Sinaiko: Just to add on to that. The higher pricing is in some ways unlocking new capital for the markets. Because sponsors don’t have 6 to 8 percent or 8 to 12 or 15 percent tax equity, the more expensive players in the market, to the extent they still are willing to execute – and again we are not hearing people backing away from the market – have a real opportunity to step in and say, “I can give you transaction certainty today. I’m a little more expensive, but if you’re willing to make the commitment now, I can give you confidence that you’re going to get your deal done.” And each sponsor I think will have its own view on the market and whether it makes sense to wait out this kind of short-term disruption as the tax investors figure out where they are.
But I do think that there is the chance for some of the historically more expensive investors to get in, locked down commitments early in the year, Q1, Q2, and we’ll how that plays out. But I think it is a real opportunity to increase the supply of tax equity in the short run as the pricing becomes more attractive to investors.
John Marciano: We see the secondary sales of partnership interests have increased.The fact that the cash flows are subject to lower taxation makes the projects and the cash flow more attractive, particularly in an environment where we’ve got highly structured projects and investors who are looking to clip coupons. So you take a pension fund, someone that is looking for very safe returns on their money, and now, because the cash flows are going to be subject to lower taxation, it’s going to be a real benefit to investors like that and their ability to show a return to investors, and pensioners, and whatnot. So we are seeing definitely an uptake in interest in the secondary sales purchases.
The other benefit there is the expensing and deductions being available to not just new assets but also assets that are acquired in the secondary market. Again, creating more value for secondary buyers, and in turn creating more value for sponsors. The interest expense limitations may cause some of the debt that has historically back levered over the last few years to reevaluate whether that needs to be project-level debt. If there are concerns about the interest expense compressing the value of interest deductions, then we may see more asset-level deals as compared to back leverage. That will certainly raise complications, and perhaps have impacts on pricing if you’re talking about asset-level debt and the need to cooperate with tax investors who don’t want to lose their investments if the projects don’t perform and suffer recapture.
And then lastly, bonus, which may not be available to some project and may be available in secondary purchases. I think bonus historically has not been a huge tailwind for solar investors and solar sponsors. So this may not be the most important issue, but certainly some of the constraints around who can take bonus in the regulated ratepayer or regulated rate entities such as utilities in cities and their ability to absorb bonus may limit some of the structures that we can see. Although just historically accelerated depreciation hasn’t been all that valuable, all that heavily utilized in the market. So the inability of certain players to monetize it, I would say, is probably not a huge issue but it’s something to consider.
Dan mentioned some risks are shifting to the sponsor, while John then presented a side that said there are less investor-friendly terms than in the past years. Can you explain that?
Dan: Absolutely. In terms of risk shifting to sponsor, and I’ll let John respond as well, but I think we’ve seen some of the execution risk, the risk around what the real impacts of tax reform are, being shifted towards sponsors such that the tax investor may have incremental off ramps that we may not have seen in the past as a means to mitigate the risk associated with what is still somewhat an unknown. And I think those are sort term dislocations to kind of address these issues, and that emphasizes the point that, look, if you’ve got it a slightly more expensive tax investor who’s got the ability to execute on more certain terms, there’s value there. And each sponsor, again, will have its own view on whether it’s worth that value, or whether it’s worth riding it out, or taking more execution risk on, but I think there are terms that are trying to address some of the unknown risks where sponsors are, at least in the short run, being asked to live with it.
John: Yeah. For example, at the end of the year, we had a number deals where projects could float into 2018. And some of those investors basically said, “You know what, if a project goes into 2018, I’m not doing it. Sorry.” And that sort of execution risk is a big deal particularly when you have a project that you already built. You’ve already built it, you’re just waiting for the utility to turn it on, and the tax investor says, “Well, it took three days to long, so sorry.” That’s a problem. And so that presented opportunity this year for some enterprising investors to swoop in and grab small projects, or one-off projects that were kind of left stranded. And if anyone has interest in those types projects, certainly let me or Dan know because we have a number of sponsors that were left in that situation. At the same time, what I was mentioning was really the pricing. The pricing has gone up. Now, we’re seeing, as I mentioned earlier, less of the non-utilization type fees, but that fact that you’re getting less from the tax investor is really counter and inconsistent with some of the easier terms we’ve seen. It’s a true disruption. A lot of the terms are not consistent. In some way they’re tougher, in some ways they’re easier. Over the next couple of months, we will see which direction it’s going.
Dan: Yeah. And we saw, for example, in terms of better terms, and I don’t recall seeing this– tax commitments kind of straddling years, where a tax investor may be uncertain about what they can absorb in 2018, so they’re willing to roll a commitment into ’19, which is interesting. May not be where the market lands, it may be a short-term band-aid, but it’s not something that we’re accustomed to seeing.
John: Yeah. In the past, you saw 6 to 9 month, maybe 12-month commitments, now we’re seeing 24-month commitments.
IC: How does the interest expense limitation favor solar project-level debt, and how does that affect projects in general?
So if you’re a sponsor that cares about the interest deductions, you’re not going to have any meaningful amount of income from the partnership for the first number of years, but you will have a lot of interest. And the interest expense limitation is determined at the taxpayer level, which is the lowest in the capital stack partnership or corporation. And so often almost all the deals we’re seeing now have a partnership that is the sponsor of the transaction and that sponsor partnership, which is essentially a partnership between a cash investor and a sponsor, that’s where you do the math for the interest expense limit. And so if for the first number of years that partnership’s getting 1% of the income, the interest expense limit is meaningful because the limit is effectively zero. So we’re seeing the debt pushed down to the project level where there is income and in some cases that allows you to raise more tax equity as the tax equity has an easier time claiming all of the depreciation that’s gone on.
IC: Are you seeing any renewed interest or new interest in sale-leasebacks from any tax investors?
Not from tax investors per se, but absolutely from sponsors. Many sponsors have done the math and they’ve basically said, “Look, we’ve got sale-leasebacks, several versions of inverted leases and then partnership transactions.” If you do the math, the highest value is usually in the sale-leaseback. You can raise the most money from a sale-leaseback. The downside is that you don’t have the project anymore after you’ve gotten the money. So it really depends on your focus or whether you’re interested in it, but lots of sponsors that we’re seeing now are interested in doing sale-leasebacks on a number of projects and partnerships or inverted leases on some others so that they can, for as many projects as possible, get the highest value possible and then still hold on to some assets so that they can offset their own tax bill.
From the investor’s side, I think this is a religious question for a lot of investors; what are we, what do we believe in. And some investors have made the commitment to be in the sale-leaseback market. They understand the product, they understand the risk, and other investors just haven’t been there. And to the extent the economics are compelling, you could see some tax desks moving their organizations into that space, but I think at this point, in my view, it’s just too soon to say whether historically flip-based desks are going to move towards sale-leasebacks. And that may be where sponsors push the investors, but it’s just too soon I think to see that type of transformation.
IC: Why is the inverted lease a more attractive structure post-tax reform?
I think it was very attractive pre-tax reform as well, the problem was you didn’t have enough investors that were willing to do it. But at the end of the day, the inverted lease comes as close as possible within the tax rules to effectively selling the credits. You’re leaving as little cash with the investor as you can because the tax investor is expensive. You want to pay the tax investor back with tax goodies, you don’t want to pay them back with cash. The inverted lease, particularly the one that has the lessee owning part of the lessor, allows you to hold on to– if you’re the sponsor, allows you to hold on to as much cash as you can see.
Impacts of the Tax Law Change on the Solar Industry
Written By: Katherine DeMetre
January 29, 2018
The entire solar industry has been focused on the potential (and actual) impacts of tax law change on the tax equity market since President Trump was elected. Despite efforts to steer the President away from solar tariffs, we should know whether that tree actually bore fruit in the near future. Regardless, sponsors have addressed the potential for changes in various ways. In this webinar, we’ll catch everyone up on what Congress was (or wasn’t) able to accomplish and how the industry is reacting – both in their documents and at the water cooler.