Four project developers did a rapid survey across the renewable energy finance landscape at the 14th annual Wall Street Renewable Energy Finance Forum in New York in late June. The conference is organized by the American Council on Renewable Energy and Euromoney.
The four are Jim Murphy, president and chief operating officer of Invenergy, Gaetan Frotte, senior vice president and treasurer of NRG Energy, Jim Trousdale, chief financial officer of Apex Clean Energy, and Michael Silvestrini, CEO of Greenskies Renewable Energy. (Silvestrini left Greenskies in July to become managing partner of Energia, an international project developer specializing in the commercial and industrial solar markets in Latin America and Asia.) The moderator is Keith Martin with Norton Rose Fulbright in Washington.
Wall of Money
MR. MARTIN: A panel of investment bankers at the annual Chadbourne global energy and finance conference earlier this month said there is a wall of money looking for projects. You are all project developers. Do you feel the wall of money?
MR. MURPHY: There has certainly been an increase in the capital available in the market, especially on the equity side. The supply of tax equity and debt has been pretty steady throughout, but as yield cos have moved to the side, there has been a lot of pent-up demand coming from institutional investors.
We see it, but it is differentiated money. Contracts are king. We have seen some interest in investing even at the development stage, but it is mainly money chasing contracted projects.
MR. MARTIN: So it is fussy money.
MR. MURPHY: Somewhat.
MR. MARTIN: Gaetan Frotte, are investors throwing money at you?
MR. FROTTE: Not entirely. I agree with Jim Murphy, with a couple caveats. There was a bit of a slowdown in tax equity at the beginning of the year. We were not seeing as much appetite because of the uncertainty in the wake of the presidential election last November. But the tax equity market has made a comeback.
Moving to debt, there is a lot of interest from lenders. We have been able to raise money on a back-levered basis from institutional investors at good rates.
MR. MARTIN: Mike Silvestrini, your experience may be a little different as a smaller developer.
MR. SILVESTRINI: Yes. Not only are we a smaller business, but we are also focused on the commercial and industrial solar sector. As the yield co market has shrunk, we are seeing that there are plenty of resources available for the utility-scale projects, but commercial and industrial solar is still pretty much in the same place it was three years ago. There is ample capital to build out our segment of the industry, but I definitely would not call it a wall of money.
MR. MARTIN: Jim Trousdale, there have been times in the past when CFOs have said people are throwing money at them. Is this such a time?
MR. TROUSDALE: It feels like it, to a degree. I started in the wind business in the early 2000s as a banker when wind was still a nascent market. Now it has matured to such a level that global balance sheets are coalescing around this asset class. The US is a good destination. We have a strong rule of law, stable currency and other attributes that are favorable.
There are maybe 35 or so tax investors in solar and wind. That is higher than we have seen in the past. On the lending side, there are probably 50 to 60 banks chasing deals, with new banks wanting to come to the market from places like Korea and Australia. Then on the equity side, like Jim Murphy, we are seeing countless new entrants. We hear from new potential investors every month, and the appetite appears strong.
MR. MARTIN: So let me break that down a bit. It seems like the scarcest item in this market is not money but developers like you. Does it seem like there are fewer developers building up pipelines of projects?
MR. TROUSDALE: It feels like just before the financial downturn of late 2008 when it was a turbine-constrained market, and anyone who had projects was in a good spot. There are a lot more turbines today, but good projects are scarce.
MR. MARTIN: Let’s talk about whether the wall of money distinguishes among types of projects; wind, solar, storage, gas. All of you are involved in some of those segments. Does the money differentiate among the sectors?
MR. FROTTE: I think it does, but the main differentiating factor is everyone wants projects with long-term offtake contracts, and it is long-term contracts that are scarce.
MR. MURPHY: What we have seen differentiating renewables from gas-fired — we are in both spaces — is the interest in merchant. I don’t mean merchant from day one, but maybe a project with a merchant tail. Investors seems to be more interested in merchant renewables than in merchant gas projects. Why? I guess because gas-fired power plants have significant fixed costs when the initial contract term ends that you do not have with renewables.
MR. MARTIN: The interest is in merchant wind, but not solar, correct? Why not solar? Or do you see it as well in solar?
MR. MURPHY: We see it as well in solar.
MR. MARTIN: There are no power hedges yet for solar.
MR. MURPHY: I was talking about projects where you have a contract for some period of time with merchant risk on the back end.
MR. SILVESTRINI: We look for financing for smaller distributed solar installations. You have to assume that you can assemble a large quantity of C&I solar assets in our case and an even larger portfolio for the residential guys and get them all to behave in a certain way and the contracts have to be relatively uniform.
There is no shortage of capital. The challenge is in putting together a financeable portfolio. Luckily, there has been a reduction in competition in C&I solar, at least at our level.
MR. MARTIN: To what do you attribute that?
MR. SILVESTRINI: I think people overestimated the growth trajectory of C&I solar. A lot of people expect it to have a hockey-stick growth profile, but if you look at it on a global basis, it has been 15,000 megawatts a year over the last three years. It has been relatively stagnant. What creates the sensation of growth is that it is an undulating marketplace. Markets come and go. They get hot. There is a pop of growth. It feels like growth, but every time that happens, there is another market segment that is getting turned off either for policy or economic reasons. It is more of a bubbling type of marketplace rather than a pure growth marketplace.
Companies that bet on a hockey-stick growth strategy and put a lot of debt on the balance sheet have suffered the consequences over the last couple years.
MR. MARTIN: Jim Murphy and Gaetan Frotte said everyone wants contracted assets. So I am guessing capital still is not plentiful at the development stage.
MR. TROUSDALE: We have been successful raising development-stage capital. It is more expensive capital, so we raise it sparingly. Tax equity and term equity are where capital is most plentiful.
MR. MARTIN: Where is the development-stage capital coming from? Is it from private equity funds?
MR. TROUSDALE: We have a group of family offices and wealthy individuals with whom we have built a good relationship over the years. The same group invested in a couple successful predecessor companies.
MR. MURPHY: I would add that we have seen some interest from sovereigns and from institutional investors looking on their behalves. We hear from the investment bankers that folks are looking for a platform. We have not heard that since about 2007. I am not sure how real that is, but we have been hearing it now much more than in recent years.
MR. MARTIN: People want to buy a development platform. I imagine your company is not interested in selling itself to someone.
MR. MURPHY: That’s correct.
MR. MARTIN: NRG is a public company. Gaetan Frotte, you have a different option than the others for raising equity. How hard is it in the current market to raise equity? When did you last raise public equity?
MR. FROTTE: We usually have enough cash on hand to finance a project, especially in the early stage. Four years ago, we created our own yield co that we used to raise equity capital. We have not done a big equity deal in a year and a half, but our public vehicles allow us to raise equity in the market when we want to, and that is how we would usually do it on the renewables side.
MR. MARTIN: Jim Murphy, Jim Trousdale, both of you are with very successful companies. You could go public if you wished. You have chosen not to. Why not?
MR. TROUSDALE: We have not needed to do so to date. We have had pretty good access to holdco-type risk capital. We have accessed or placed about $3.5 billion or more of asset-level financing among the equity and tax equity and debt. We have been able to raise the capital we need without having to go public.
We keep our options open. We have good controls and best practices in place, and we have audited financial statements from inception, so we certainly have an option to go public if it ever made sense. Our team has been focused on execution at the asset level, on getting projects built.
MR. MARTIN: Jim Murphy, when did Invenergy last raise equity?
MR. MURPHY: In our renewables business, we have been focused lately on monetizing assets as a way to raise equity. We felt that was a more efficient execution.
Typical Capital Stack
MR. MARTIN: Going across the panel, tell me what is the typical capital stack for your projects? How much debt, how much equity, how much tax equity? I am focused on renewables.
MR. FROTTE: It varies a lot depending on the type of project. For solar, the capital stack is usually about 40% tax equity, 30% to 40% debt and the balance true equity. I am talking about the operating phase.
MR. MARTIN: The debt is behind the tax equity in priority of repayment?
MR. FROTTE: Yes.
MR. MARTIN: Jim Murphy, what is your typical capital stack?
MR. MURPHY: About the same. We are more focused on wind where tax equity can sometimes push up to between 50% and 60% of total capital. The numbers are otherwise similar to what Gaetan said.
MR. MARTIN: The debt is back-levered debt?
MR. MURPHY: Back-levered debt. Sometimes the amount of back leverage available is just not worth the transaction cost.
MR. MARTIN: Jim Trousdale.
MR. TROUSDALE: Our average may be about 60% tax equity, 20% equity, 20% back leverage on projects where we have done all of those tranches.
MR. MARTIN: Mike Silvestrini, what is the typical capital stack in the C&I business?
MR. SILVESTRINI: It is similar to what NRG sees in solar: 40% tax equity, 40% debt and 20% true equity.
MR. MARTIN: Do any of you think that debt will return to the project level and be ahead of the tax equity in the capital stack? Why is it behind the tax equity currently?
MR. SILVESTRINI: The debt is usually senior to the tax equity in our financings. That requires negotiating an inter-creditor agreement.
MR. MARTIN: How much of a yield premium do you think you end up paying for the tax equity in such a structure?
MR. SILVESTRINI: It is tough to say, but I think it has been fairly nominal.
MR. MARTIN: Nominal, not 500 to 700 basis points?
MR. SILVESTRINI: Because of the uniqueness of our asset class, a limited number of market participants can swallow a portfolio of 100 individual projects that spread across 12 states. We have been seeing pretty consistent pricing.
MR. MARTIN: Does anyone think debt will return at the project level in renewables? Jim Murphy?
MR. MURPHY: Not in the next few years. I think tax equity is still more scarce than debt and, in the negotiation between the two, tax equity comes out on top.
MR. TROUSDALE: I agree with that. We have only done back leverage. It has been difficult to get tax equity to agree to be subordinated to the debt.
MR. MARTIN: All of you watch money rates. You have to raise money. The Federal Reserve Board is increasing the federal funds rate, yet we have 50 to 60 project finance banks saying they cannot find enough projects. Which direction do you think interest rates are going in this market?
MR. FROTTE: I think the spreads will remain where they are at the moment. We see them at 100 to 200 basis points above LIBOR. LIBOR may increase, but the spreads should not change. Perhaps the median spread is around 175.
MR. MARTIN: That is on back-levered debt because you are not seeing project-level debt?
MR. FROTTE: That is what we see for senior-level construction debt and back-levered permanent financing.
MR. MARTIN: For solar and also wind?
MR. FROTTE: For utility-scale solar. The spreads might be higher for community solar or distributed solar.
MR. SILVESTRINI: They are.
MR. MARTIN: In January during a Chadbourne cost-to-capital webinar, the bankers said spreads are 162.5 to 200 basis points over LIBOR for bank debt. Gaetan Frotte, you just raised institutional debt on a gas-fired power plant in Carlsbad, California. What were the rates for it? That debt was priced off Treasury bonds and was fixed-rate debt?
MR. FROTTE: Yes, it was BBB+ from Fitch, so investment-grade, 20-year debt, and it was the Treasury yield plus 170 to 200 basis points. It was a fairly cheap debt.
MR. MARTIN: The Carlsbad project has a power contract with whom?
MR. FROTTE: San Diego Gas and Electric. We raised some back-levered debt on a utility-scale solar project with a DOE loan at the project level and no tax equity, and that the spread was 100 basis points over LIBOR.
MR. MARTIN: What tenors are you seeing on term debt or back-levered debt?
MR. MURPHY: We see term lenders willing to go out closer to the full PPA term.
MR. MARTIN: For bank debt?
MR. MURPHY: Including banks, yes. The number of banks willing to lend that long has thinned out compared to where the number was a year ago. But we still see some banks — not US banks — willing to lend for that long.
MR. MARTIN: In the past, it has been the Japanese, Canadian and some European banks that have been willing to lend that long.
MR. MURPHY: You called it. It is Japan, CoBank in the US, and a few European banks.
MR. MARTIN: So the story on debt is no upward pressure on interest rates at the moment because of the large number of banks chasing deals. Longer tenors are available. Have the rest of you seen such tenors? Usually the bank market is seven to eight years.
MR. SILVESTRINI: Our PPAs in the C&I space tend to be a little shorter. We have a lot of 15-year deals and some even shorter than that, and we are seeing 15-year fully amortizing debt or 15-year amortization with a bullet payment for the balance at the end of 10 years.
MR. MARTIN: Gaetan Frotte has done institutional debt or project bonds that run usually the term of the power contract. Have any of the rest of you gone into the institutional market?
MR. TROUSDALE: Apex has not accessed the institutional market yet at the project level. The long-term bond market requires make-whole payments that are a barrier to refinancing. A lot of our projects have been shorter dated with merchant exposure on the back end. Such projects are more suitable for the bank market.
MR. MARTIN: We are at historic low interest rates. The trend in the longer term seems to be up and yet you do not want to lock in interest rates because the need to make a make-whole payment. Explain what that is.
MR. TROUSDALE: It is a prepayment penalty to prepay the bond. I agree that as interest rates start to increase, it becomes more attractive to borrow in the fixed-rate bond market. But fixed-rate bonds work best for projects with long-term offtake contracts with utilities to get the most efficient financing.
MR. MARTIN: Jim Murphy, you have done portfolio debt. Was it in the institutional market or the bank market?
MR. MURPHY: We have done both.
MR. MARTIN: How do you decide which makes more sense?
MR. MURPHY: We tend to favor the bank market for the same reason that Jim Trousdale mentioned. We do not like make-whole payments. It is a very expensive proposition to trigger the make-whole because you are basically making a payment equal to the net present value of not just the difference in the underlying rates, but also the margin.
MR. MARTIN: Have any of you tried green bonds? They are a form of corporate-level debt.
MR. TROUSDALE: Apex has not directly, but we believe some sponsors who have purchased our projects have tapped the green bond market to raise the purchase price.
MR. FROTTE: We acquired a wind farm two or three years ago and issued $500 million of high-yield, 10-year bonds to do so. Because it was a renewable acquisition, the bonds were considered green bonds. It was a good experience. There was not a lot of incremental demand for the paper, but that was several years ago. I understand the market has improved since then. There is growing interest among institutional investors in investing in renewable assets.
MR. MARTIN: As a public company, if you have a choice among bank debt, institutional debt, green bonds, how do you decide which to take? We just heard make-whole payments turn people away from project bonds. Beyond that, is it just a matter of the cost of the money?
MR. FROTTE: Exactly. To be clear, I am totally in line with my fellow participants. I did not like the make-whole at all a couple years ago. We did not do institutional debt before, but that market has been a lot more efficient and better priced, and we decided to raise fixed-rate institutional debt for some projects that are already stable in operation. But at the end of the day, it is a question of economics and terms.
New Debt Trends
MR. MARTIN: Are there any other new trends in the debt market?
MR. TROUSDALE: Full underwriting has returned, with a sell down in the syndicated market.
MR. MARTIN: Full underwriting means a bank will offer to bring in others in a syndicate, but if it cannot find others, it will put up all the money. There was full underwriting in the distant past. How long ago was it before now when one last saw such underwriting?
MR. TROUSDALE: Feels like a long time to me, maybe even going back to before the financial collapse in 2008.
MR. MARTIN: Is its return a sign of the desperation among banks to find deals?
MR. TROUSDALE: The smart banks can do the work and understand the risks. We had a successful sell down, so we would like to think the bank we did it with was smart and did a great job. The other trend is the bank market can take down $1 billion or more on a single asset deal. Our transactions do not get that large, but it is a sign of the depth of the market.
MR. MARTIN: What other new trends has anyone seen?
MR. FROTTE: We are starting to see more acceptance for community solar deals. It seems like banks are getting more comfortable with the risk profile.
MR. MARTIN: I count five community solar tax equity deals to date, plus one large revolving debt facility. Has there been broader acceptance than this by the financial markets?
MR. FROTTE: We were doing it with one or two banks, and now one of those banks is waiting to underwrite the whole thing as a plan to syndicate it to a number of other banks that are looking at that market. Time will tell how many come into that syndicate, but there is broader acceptance.
MR. MARTIN: Any other new trends? Jim Murphy, you are at the center of a lot of financings.
MR. MURPHY: One thing that was new this past year was banks providing equipment financing, and it was a little different style of financing than we saw before the financial crisis. People were taking positions in wind turbine equipment to satisfy the 5% test so that projects using this equipment are considered under construction in time to qualify for production tax credits, and financial players were coming in behind to underwrite part of that, with some pretty strict rules and conventions about how the debt would have to be amortized, and how quickly the equipment would have to be allocated to projects. That was a new product this year.
MR. MARTIN: What is the difference between that and a turbine loan?
MR. MURPHY: It could be the same thing. The equipment could be turbines. It could be other things as well.
MR. MARTIN: According to press reports, there could be enough turbines stockpiled to allow another 30,000 to 70,000 megawatts of new wind farms. Existing wind capacity is 83,000 megawatts. It seems like the market is fairly long in turbines.
MR. MURPHY: People were making an educated investment in the equipment knowing that they have a four-year window during which to place it, and there would be other alternatives, likely simply using the equipment in new projects whether or not it serves as a basis for qualifying for production tax credits.
MR. MARTIN: Are there other new trends?
MR. SILVESTRINI: Our business is pretty stable in terms of financing. It is a flow business. The principal challenge for us is trying to maintain a steady flow. We look for the right banking partners who can close repeat transactions with a rhythm that can take advantage of the C&I market.
MR. MARTIN: The C&I market is fine without new trends. It just wants predictability.
MR. SILVESTRINI: Consistency, that’s right.
MR. MARTIN: Tax equity yields have fallen into the 6% range for utility-scale solar, the 7% range for wind, and are still probably around 9% for distributed solar. What new trends, if any, are you seeing in that market aside from falling tax equity yields? Gaetan Frotte, you are shaking your head no, meaning no new trends?
MR. FROTTE: Not much.
MR. TROUSDALE: The tax equity investors have been more willing to underwrite more complicated structures, like corporate PPAs and proxy revenue swaps. I am not sure it would have been possible to finance projects with such contracts a couple years ago.
MR. MARTIN: Other new trends?
MR. SILVESTRINI: The risk that Congress would cut the corporate tax rate was like a speed bump in the first quarter this year. The tax equity market slowed while investors tried to evaluate the effects. The potential for a 2017 rate reduction seems to have receded.
MR. MARTIN: Let me see a show of hands from the panel. How many of you think a corporate tax bill will be enacted this year? [Pause] Zero. How many of you think one will be enacted next year? [Pause] Half our panel.
Let me ask the audience. How many of you think a corporate tax bill will be enacted this year? [Pause] No one. How many think one will be enacted next year? [Pause] A distinct minority.
Gaetan Frotte, what effect has the threat of corporate tax reform had on NRG?
MR. FROTTE: We have had to tinker with our tax equity structure. The tax equity investment will be re-sized when the project is completed. There could be a cash sweep to return part of the investment to the investor, depending on where tax reform settles.
MR. MARTIN: So the tax equity investor sizes its investment based on current law. If the law changes, it may get part of its investment back in a re-sizing of the investment.
How has talk of tax reform affected Invenergy?
MR. MURPHY: We see investors sizing their investments in anticipation of tax reform being enacted. That means they are investing less at the front end. They may invest more if the final tax rate ends up higher than they assumed.
MR. TROUSDALE: We have had to run sensitivities early in the year showing what happens at various corporate tax rates. To Mike Silvestrini’s point, it feels like a rate reduction this year is no longer expected. We are easing up on that internal exercise. People are trying to work constructively to address the risk in 2018. Can we pass some of it to the offtakers in power prices that are already very competitive and cheap?
MR. MARTIN: In your modeling, did you conclude that lower tax rates will mean a higher cost of capital overall?
MR. TROUSDALE: Potentially, depending upon the timing. Returns could increase if the rate reductions are phased in over time, giving us time to claim most of the depreciation against the current tax rate. The longer the gap between when the project is completed and when the rate goes down, the more likely the return is to increase.
MR. MARTIN: In cases where the lower rate leads to a higher cost of capital, can you quantify the hit?
MR. TROUSDALE: That is difficult to say because we find ways to optimize. We think we can get back to where we were.
MR. SILVESTRINI: The challenge in the C&I market is being caught flat footed by a rate reduction with projects that are caught somewhere in the development lifecycle where they have exposure to construction finance, but the features of the takeout may have changed as a result of the tax rate change. The fact that we are a flow business leaves us somewhat more exposed. That said, our exposure is nothing like getting caught at the wrong phase of development or construction of a billion-dollar energy project.
MR. MARTIN: One of the things under discussion in tax reform is to deny interest reductions on debt. Are you worried about that? Some people had talked about locking in debt in advance of any vote in the House tax committee this fall so that the interest remains deductible under transition rules.
MR. FROTTE: It is too hypothetical.
MR. MARTIN: Another thing under discussion is a reciprocal tax. That is Trump’s term. The House Republicans’ term is a border adjustment where you do not get any cost recovery on imported equipment. Has that affected how you negotiate for vendor contracts. Do you focus on where the equipment comes from?
MR. SILVESTRINI: The potential for a solar import tariff is the only thing we are focused on right now.
MR. MARTIN: So it is hard to feel worried about a sore foot when your head is aching badly.
MR. SILVESTRINI: Yes.
MR. MARTIN: Suniva filed a petition in late April asking for high tariffs on imported solar equipment.
MR. SILVESTRINI: We need to think about what types of partnerships we want to form to head into the fray. One of the techniques used in these times is to stockpile equipment. Obviously there are financial consequences from holding onto things that you hope become more valuable if they are bought before the tariff is applied. It is a major distraction for a company interested in developing projects.
MR. MARTIN: Does it affect the price you promise customers today for electricity?
MR. SILVESTRINI: It does. Some customers are willing to keep an open outlook and let us to come back and discuss a price adjustment if a tariff is applied. Sometimes it is a take-it-or-leave-it scenario and we have to hustle to get projects in the ground. At some point we will have to cut off those types of transactions if the risk profile seems like it might put us upside down economically.
MR. MARTIN: Can you buy insurance for this risk?
MR. SILVESTRINI: Not that I’m aware of.
MR. MARTIN: Jim Murphy, are you affected by the threat of tariffs?
MR. MURPHY: It is not something you can price in at this point in a utility-scale solar project. If you try to build it into pricing, you are not going to win anything. We are seeing a number of contracts from the offtakers that are very rigid on change-of-law risk. The developer is going to wear that risk.
MR. MARTIN: Can you push the risk off on vendors?
MR. FROTTE: We are trying. We are talking to all of our vendors about how best to mitigate the risk. No one knows where things will end up. The risk is impossible to price.
MR. MARTIN: How many of you are trying to get equipment past US Customs before November 13 when the US International Trade Commission must make a recommendation to the president? [Pause] Two.
Trump said he wants to put 1,250 megawatts of solar panels on the wall he wants to build between the US and Mexico to pay for the wall. He has not yet made a connection between the tariffs and the cost of the wall. How many of you think tariffs will ultimately be imposed on solar panels? [Pause] None.
MR. SILVESTRINI: It is really difficult to say because this president is so hard to predict. It would be so detrimental, particularly to utility-scale projects, that it is hard to believe a tariff would be imposed.
MR. MARTIN: No one on our panel thinks a tariff will imposed. What about the audience? How many of you think Trump will ultimately impose tariffs? [Pause] Out of an audience of a couple hundred people, three.
Special Financing Challenges
MR. MARTIN: Jim Murphy, you mentioned that developers are moving to proxy revenue swaps and corporate PPAs. What special financing challenges do such arrangements present?
MR. MURPHY: I see a couple things. Number one is the credit of the offtake is different than what people have been used to underwriting with utility credits. The view of a utility credit was there is a customer base sitting behind the utility. A bank can feel confident the financing will be repaid based on the creditworthiness of the utility. It does not have the same level of confidence with a corporate PPA because that is a different business model.
We have also seen commercial and industrial customers being unwilling to offer their parent support behind the credit for the contract. That has led to some interesting discussions about what is the appropriate level of credit required for the offtaker. Those are tough conversations because there is no science to it.
MR. MARTIN: Does anyone see other special financial challenges beyond what Jim Murphy mentioned?
MR. TROUSDALE: Apex was an early adopter of the proxy revenue swap when it was a new product. We had three tax equity investors, a lender and an 85% owner who had to get comfortable with the product. The effort added time to our financing schedule, but at the end of the day, we closed on the financing, and we did a second one.
MR. MARTIN: So the market is figuring out how to get comfortable with such arrangements. What about community choice aggregators in California: unrated entities organized at the county level to buy renewable energy for county residents under long-term contracts? Has any of you done a CCA contract?
I see four people shaking their heads “no.”
Gaetan Frotte, you mentioned community solar. What special challenges are you running into trying to finance such projects?
MR. FROTTE: It is a hybrid type of project where you are selling subscriptions to a mix of residential and commercial and industrial customers. The projects rely on net metering to give the subscribers bill credits for the shares of electricity to which each subscribes. The electricity goes to the local utility. Community solar is limited to certain states. We are doing it mainly in Colorado, Minnesota and Massachusetts. We are starting in New York, as well.
MR. MARTIN: Mike Silvestrini, you could do community solar. It is not much of a switch, and yet you have chosen not to do it. Why not?
MR. SILVESTRINI: I look at community solar as sort of an artificial pricing mechanism where solar can avoid transmission and distribution charges. That makes me wonder how sustainable the business model is long term. Being behind the meter gives us a better argument for deserving transmission and distribution discounts, and so we focus on getting behind the meter, staying on the roof, and staying onsite with our customers. There is still plenty of room for growth in the rooftop market.
MR. MARTIN: Jim Murphy, The Financial Times quoted Francesco Starace, CEO of Enel, this morning. Starace said he thinks storage will surprise people by becoming transformational much sooner than the market currently expects. You are doing standalone storage. How are you financing such projects?
MR. MURPHY: We have not done project financing on storage. We have only done vendor financing. I do not know whether the bank market is ready to finance projects whose revenue stream comes from providing frequency regulation to the grid. You need predictable capacity payments.
MR. MARTIN: Is anyone else doing storage?
MR. SILVESTRINI: We are adding some storage to our commercial and industrial solar installations. The storage is folded into the financials for the solar system. We have several of those in different states. It has not been a problem.
New Financial Products
MR. MARTIN: What new financial products have investment bankers or anyone been pitching to you in the last year?
MR. SILVESTRINI: We are seeing a lot more interest from family offices in providing tax equity, which obviously creates challenges with passive loss and at-risk rules. We have not closed a deal with one of those types yet, but there is definitely growing interest from such investors.
MR. MARTIN: Is anyone else seeing any new financial products?
MR. TROUSDALE: It may not be new, but we are seeing construction debt that converts into back-levered debt after construction. It is a way to get the advance rate on construction debt as high as possible. It is helpful for companies like ours that do not have big balance sheets.
We are also being pitched equity with preferred cash distributions that have features in common with debt. We have not executed on it, but we are being sent proposals.
MR. MARTIN: What are the advance rates currently on construction debt? 90%, 95%, less?
MR. TROUSDALE: I think 80% to 90% on the construction loan, and you can get as high as 95% if you include some mezzanine debt.
MR. MARTIN: Jim Murphy and I are old enough to know you could go over 100% at some points in the distant past. What other new financial products are you being pitched? Gaetan Frotte, you mentioned hybrid debt, bank and institutional debt at the same time. Why would one do that?
MR. FROTTE: We see it more with conventional power plants. We have not done it yet for a renewable energy project, but there is no reason why it would not work. You have a tranche of bank debt that is fully amortizing over seven to 10 years, and then a tranche of institutional debt that has a term equal to the PPA term and that requires less amortization up front. It is a better way to maximize the amount of debt on a project and match the tenor of the PPA without having refinancing risk at the end of a typical mini-perm instrument.
MR. MARTIN: So you end up borrowing more. How much extra leverage do you get?
MR. TROUSDALE: These are called A/B structures. You should be able to borrow 5% to 10% more.
MR. MARTIN: Are there any questions from the audience?
MR. MENDELSOHN: Michael Mendelsohn from SEIA. Is NRG moving down into unrated credits and does anyone on the panel have any evidence that there is a difference in cash performance between rated credits and unrated credits as offtakers in the C&I sector?
MR. FROTTE: In our community solar and distributed solar deals, we look at the offtakers on a portfolio basis. We will accept a percentage — say 10% to 20% — of customers who are sub-investment grade. The banks set the limits. They will usually accept some sub investment-grade types or lower FICO scores, say below 650, in some of those deals.
MR. MACK: Larry Mack from Key Bank. Are you paying more for underwritten debt and, if so, why do you need an underwritten transaction rather than a best-efforts deal?
MR. TROUSDALE: The greater certainty about timing may be worth it. In large utility-scale wind deals, there are a lot of banks that have to come together and that can be a bit unwieldy, so having a single bank that can run it and get it done quickly, and then syndicate afterwards, sometimes has value.
MR. MARTIN: We are down to our last question, and let’s go across the panel. What is your biggest current financing challenge?
MR. FROTTE: The biggest challenge is finding offtake contracts.
MR. MURPHY: I agree. This is a good time for financing. It is a difficult time for developers looking for offtake contracts. This industry has a tendency to race to the bottom. Staying disciplined is a challenge.
MR. TROUSDALE: The business uncertainty under the new administration is a little disruptive.
MR. MARTIN: You are a master of understatement.
MR. SILVESTRINI: We have an almost opposite scenario. We have always been contract heavy, and delays in project financing and getting that velocity to line up with our ability to acquire new customers has been our greatest challenge since we opened our doors, and it remains the biggest challenge today.
MR. MARTIN: Is that because it is time consuming to arrange financings or the capital is unavailable?
MR. SILVESTRINI: They are complex transactions because of the number of offtakers in multiple locations and variations in offtake contracts. There is quite a mix in a 100-megawatt portfolio. It takes a lot of brain damage to get across the finish line. Ideally, you could raise a war chest and then find customer contracts, but that is too complicated to finance, so we are always playing catch up to put the financing in place.
It is a little clunky. We would prefer to wash, rinse and repeat, but it requires a lot of effort by the financial sector to help companies like ours find an acceptable rhythm.