"There is a great deal of attention focused on this space; it's a landscape that a developer loves to be in," John Carson, senior vice-president for project finance at Connecticut-based Noble Environmental Power, told delegates participating in Infocast's recent Wind Power Finance and Investment conference in San Diego.
Much of the attention Carson is talking about is coming from banks and other lenders anxious to be in the market. "There were virtually zero financings in the debt market at the beginning of 2009, but by the end of the year there was significant activity," said Jeffrey Chester, who heads the wind practice at law firm Kaye Scholer. "We have more than 30 banks actively providing debt to wind projects."
The competition among those banks has meant developers are seeing increasingly attractive terms for borrowing money. "One of my first bosses once said that bankers have two attitudes towards their clients: we either kick ass or we kiss ass," said Chip Carstensen, managing director of investment bank Nord/LB New York. "Well, I can officially say we are back in kiss-ass mode now."
But with the effects of the crisis lingering, there is only so far banks will go. "I think the big difference is that people are paying much closer attention to credit now," said Carstensen. "We have all these banks chasing the deals, but we still have to check all the boxes. A strong track record, good wind regime, good turbines and a good off-taker; people are not compromising there. But we are seeing margins coming down, we are seeing terms stretch out and we are seeing people take bigger slices of the deals."
Nord/LB had a limit of $40 million on what it would lend to a single project, he said, but that has now been raised to as high as $75-100 million a deal. The story is the same with other lenders to the sector, Carstensen added.
Banks are also willing to lend their money for longer. "It is dramatically different to the autumn or even the beginning of this year," said Luisa Fuentes, senior member of the project and structured finance group at Societe Generale in New York. "Whereas before, people were stuck in the sevenor eight-year range, now we are going out ten to 12 years and have even been involved in some 15-year fully amortising transactions. That said, you do pay a premium for those transactions." Amortising transactions are finance deals where the liability is gradually reduced over time - such as mortgages.
The cost of debt has been decreasing and, although lenders at the conference were reluctant to be too specific, Gisela Kroess, director of project and commodity finance at Unicredit-HVB, told delegates it ranges from 250 to 325 basis points over the rate at which banks can borrow funds. Where a specific project falls on that scale depends on a number of factors. "That is a fairly big range," she said. "The trend is downward, but it is still a function of who the sponsor is and if the deal is solid."
However, the rise of the solar energy market is going to create big demand for capital for utility-scale photovoltaic and concentrating solar power projects, which could have a dampening effect, said Kroess. "If you are a sponsor with a good track record and have a solid project, you definitely have a lot of the banks knocking on your door and prices going down," he said. "But I do not think pricing will go down as fast as some sponsors hope. I think it is somewhat counterbalanced by the huge demand for capital."
Transitional times
The debt market for wind is in transition in other ways, too. During the financial crisis, banks pulled away from a structure where one or two lead arrangers would underwrite deals and then sell off pieces to other investors because of the risk. Developers instead had to deal with a club of banks. Each bank had an equal voice in the transaction. "It is difficult for the developer because it means you are going to get the most conservative structure and probably less debt sizing," said Carstensen.
The trend is now turning back to underwritten deals, although lenders are mitigating their risk by incorporating what Matthew Ptak, vice-president at German bank BayernLB, describes as "pretty substantial" market-flex language into the agreements, which allows them to change the terms of the loan based on investor demand.
The crisis also caused banks to narrow their focus to core clients, making it difficult for developers who did not have a relationship with a lender to break into the market.
"Last year we had our set relationships and trying to get capital allocations for anyone off that list was almost impossible; it was hard enough for people on the list," said Kerri Fox, head of structured finance in North America for the Spanish bank BBVA. "But we are in a position now, and I think a lot of banks are, where we are adding a lot of new relationships. That is a good sign for the market."
Some of the interest lenders are showing in wind power can be traced back to the crisis itself. "The effect of the financial crisis really demonstrated internally to our bank the strength of the project-finance model," said Ptak.
The US government's policy response to the crisis has also helped carve out a larger role for banks in the financing equation. Prior to the financial meltdown, wind development was almost exclusively driven by the $0.022/kWh federal production tax credit (PTC). Most developers do not have a large enough tax bill to use the credit, so they have to find larger investors who can. Most of those so-called tax-equity players did not want to see long-term debt on a project because having banks in the mix gave them less control.
When the crisis hit, the number of major tax-equity investors plummeted from 18 to four. Congress responded by changing its incentives to the industry, including, for projects that start construction in 2009 or 2010, the option of a cash grant equivalent to 30% of eligible project costs instead of the PTC. The grant has dominated financing structures since the rules were finalised last July. "Given the scarcity of tax-equity, what we saw in 2009 was that developers financed their projects mainly with term debt and cash grants," said Chester.
Tax-equity returns
There is still a role for tax-equity in US wind farm financing, however, and that capacity is also on the rise. Bank of America, the largest corporate taxpayer in the US in 2007, is one investor looking to get back in.
"Since the fiscal crisis we have been in a pretty significant tax-capacity-constrained environment and for much of last year our response to that was to step away from this market in particular," explained Jack Cargas, the bank's managing director of energy and power finance. "We are probably in a dozen businesses that invest tax-equity in transactions and this was the only one we exited from, and that is probably a function of the fact this is one of the highest tax-usage businesses there is. But we are back in this marketplace; we are looking for deals."
What deals become available to tax-equity investors remains to be seen. Although the option is still there to take the PTC, most developers at the Infocast conference expressed a strong preference for the grant. It is simpler and, unlike a PTC deal where the tax-equity partner gets most of the economic benefits in the early years of the project, provides a cash return to investors. "It makes it much easier to build a business," said Ciaran O'Brien, chief financial officer of St Louis-based Wind Capital Group.
The payout is not dependent on how well a wind farm performs. "Taking the risk of ten years of production off the table from day one and paying me a grant is an enormous benefit," said O'Brien, referring to the fact that the PTC is dependent on the amount of power a wind farm produces over time. "When it is a marginal call you will probably err on the side of caution and take the grant, unless you have a screaming wind resource."
Because it is based on production, projects with a high capacity factor are probably better off taking the PTC. "If you are approaching a 40% capacity factor you have to give it some pretty serious consideration," said Jim Murphy, chief financial officer of Chicago-based Invenergy. Capacity factor is the percentage of maximum output achieved by a plant over a year.
A second area of tax-equity investment is helping developers who opt for the grant to take advantage of the depreciation tax benefit, known as the modified accelerated cost recovery system (MACRS). This allows for the accelerated depreciation of wind farm assets, providing a tax benefit equivalent to 25% of the value of the project.
"We are still looking to do a tax-equity deal even with the grant because there is value in the MACRS that we are looking to monetise," said Murphy. "Maybe it is a lesser share of the total economics that needs to be monetised, but we are still looking to do that."
There were 19 tax-equity deals that closed in the US market in 2009, worth about $1.8 billion, says John Eber, managing director for energy investments at JP Morgan Capital Corporation. About half of those, accounting for about $1 billion of the total, were PTC transactions left over from 2008. "There were five or six, maybe seven grant deals that actually got funded last year."
This year, he says, should look significantly different. He expects only about 10-15% of deals to use the PTC. Marshal Salant, head of alternative energy investments at Citibank, agreed. "All the deals we are looking at right now are cash grant. For new deals, maybe one in ten will be PTC."
Changing deal structures
But one of the more interesting questions facing the market, says Eber, will be how many deals get done without any tax-equity at all. "Companies have options now," he said. "They do not need to use tax-equity and a lot of companies did not last year. There was an awful lot of debt raised in the marketplace last year. More than $5 billion worth of debt that went into projects last year, which is more than double what went into projects in prior years."
Some companies did not monetise the MACRS credit last year because they could not find tax-equity, but others made a conscious choice not to. The benefits can be carried forward 20 years and used to offset future project income.
That approach could be one way to fill the void in the tax-equity market that remains, despite the fact companies are starting to come back. "I would say the biggest theme for this year is going to be supply," said Jeetu Balchandani, a director at MetLife investments. "Looking at the pipeline of transactions that are going to be coming to market this year, it is going to far outstrip the tax-equity available."
Such scarcity usually means an increase in the returns tax-equity investors expect. But while yields are higher than the 6% range they were in before the financial crisis, and now sit at 8-9% for deals with no long-term debt, Eber expects they will remain stable because developers can choose to go ahead without a tax-equity partner. "It puts pressure on the tax-equity side," he said. "We cannot just price up our product to wherever we want it, because it will price itself out and debt will be more attractive."
For Hunter Armistead, executive director of California-based Pattern Energy, having options is key. Financing under the PTC regime was rigidly structured and left little room to manoeuvre.
"Now you start with a situation that is the right place for tax-equity to be," he said. "It is not required to do a deal. The deals can stand on their own. So now it is a question of how do you make them better."
Pattern has been working on a couple of project financings, Armistead said. "They are completely different structures," he said. "That is very refreshing. You can design something that matches your corporate financial objectives as opposed to being forced into something that you will never be able to explain to anyone anyway."
The worry Armistead and other developers have is that the cash grant option expires at the end of this year. While the industry and congress are looking at ways to keep the payments, projects that start construction in 2011 or 2012 will have to take either the PTC or an investment tax credit, which allows them to deduct 30% of the capital cost in the year it came into service (“uåX˜äŠÊ˜·³Ç, April 2010).
"If you go back to a PTC structure before this business is fully repaired, I think it would damage the opportunities in terms of how far this industry could go in the US," said O'Brien. "There is not enough tax capacity to take on 5,000-9,000MW a year. It just does not exist in this market."
Interestingly, tax-equity players also agree on the need to reduce the tax intensity of US wind incentives. Citibank, says Salant, believes there could easily be a demand for $10 billion or more in tax-equity in 2010 and 2011. "The days of casual dating are over in tax-equity investing," he said. "It is a precious commodity and people are going to have to use it with their most important relationship clients."
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