PTC transferability emerging to support solar projects; experts weigh pros and cons

Developers are starting to use the production tax credit (PTC) to help finance their solar projects via transferability, even if this benefit was not utilized heavily prior to the August 2022 passage of the Inflation Reduction Act (IRA).

Prior to the IRA passage, the most typical way for sponsors to fund projects was to enter into joint ventures and leasing arrangements with other private companies that had sufficient tax liability. Generally, organizations capable of entering these arrangements as "tax equity investors" are large financial institutions and a small group of non-financial corporates.

The transferability feature invites a larger universe of taxpayers to take advantage of the credits, without the complication of the tax equity structure. Eligible tax credits for transferability include PTCs and investment tax credits (ITC). Since last year, transactions have successfully closed featuring that provision.

Jack Cargas, managing director and head of Tax Equity Origination at Bank of America, speaking at the Norton Rose Fulbright ‘Cost of Capital’ webinar on 11 January, pointed out that in 2023, direct tax credit transfer deals might have amounted to USD 4bn approximately, adding to the estimated USD 20bn to USD 21bn of traditional tax equity deals.

“We are seeing a growing interest from corporates and new investors in buying production tax credits,” says Keith Pettus, principal at Advantage Capital, who focuses on Renewable Energy Tax Credit Equity and Impact Investing. “I would not be surprised if the year ends recording a higher volume of transactions featuring transferability compared to last year.”

Advantage Capital arrange the purchase commitment for more than USD 500m of PTCs that will be monetized and leveraged by the loan facility over 10 years, in the financing of the 600 MWac Hornet Solar project in Texas, sponsored by Vesper Energy. The debt financing leveraged PTC transfer funding.

According to sources, more transactions featuring transferability are already under negotiation. However, not at the feverish pace anticipated after the passage of the law.

“Structuring debt transactions around these PTC or transferability deals is complex, we are in discovery mode yet, still not turning it into a standardized approach,” Pettus says.

An obvious benefit for developers deciding to monetize production tax credits is avoiding the complications of the tax equity joint venture and can retain full ownership over the asset.

On top of that, the project may have more debt capacity, which results in the sponsor having more access to levered capital.

“In comparing a project that elects the ITC vs the same project that elects PTC, the PTC project should have a higher term debt capacity because its operating cash distributions will likely be supplemented by paygo payments, which can be used to service debt,” points out Gary Durden, partner and managing director at financial services firm CRC-IB.

To Ori Greenfeld, chief financial officer at Ashtrom Renewable Energy, said that is a main reason why to select a PTC over ITC. “As the sponsor elects PTC over ITC, it does so on a yield comparison basis which is usually the option with less capital requirements from the sponsor,” he points out.

Ashtrom last year signed a green financing totaling approximately USD 270m with five lenders to fund the 400 MWdc Tierra Bonita solar project in Texas. In parallel, the sponsor concluded a Tax Credit Transfer Agreement (TCTA) covering the sale of PTCs to a highly rated institutional entity for an estimated value of around USD 300m over a 10-year period.

The project is backed by a PPA agreement to sell around 60% of the project’s electricity for a 20-year term to the CPS Energy (Aa2 Moody's), the municipal utility of San Antonio.

Structure

The risk profile of these transactions is different, calling for careful evaluation from the parties involved in the PTC purchase deal, as well as in structuring the non-recourse debt.

The novelty of it also leads to additional caution and evaluation. "We were drafting something that was not a copy paste and all parties tread carefully," says Greenfeld. The risk profile of these transactions is different, calling for careful evaluation from the parties involved in the PTC purchase deal, as well as in structuring the non-recourse debt.

“Project finance transactions structured around PTC and ITC have to mitigate for a different set of risks,” says Durden. “The PTC structure has to consider the production performance during a 10-year period. The primary way that tax credit buyers and tax equity investors accommodate this risk is by employing a structure that utilizes Paygo as well as with production haircut sensitivities. In the ITC structure this is not a factor because the investor receives the full tax credit when the project starts commercial operations.”

On the lending side, production risk remains the same factor to mitigate. Although Greenfeld finds similarities between a loan monetizing a PTC purchase agreement and debt backed by a PPA. While the PPA offsets price volatility in the spot market, the production risk exists, and the structure must find ways to mitigate it.

“Essentially, lenders are taking production risk in ITC deals by sizing debt based on future cashflows,” says Greenfeld. “Future sales derive from market, called merchant, or a PPA at a settled price. The same is with the PTC: the lender would usually require an offtake, like with the PPA, that will commit to purchasing the future PTC at a settled price, namely at a discount in relation to the face value of the credit.”

Offset

To find comfort, lenders tend to seek external consultants that analyze the projected performance of a project, and size the debt based on future cash flows -cover ratios- in a conservative way.

This is why production forecast becomes a critical input to the analysis, says Jason Kaminsky, chief executive officer at kWh Analytics, a data and climate insurance product provider. The company created the Solar Revenue Put is an insurance policy that serves as a credit enhancement that insures the performance of solar assets, according to the website. It improves lender terms by de-risking the asset with an insurance-backed production protection for up to 95% of expected energy output.

“Given the historical data showing that independent engineers’ estimates are historically over-forecasted, we think we will see executives push for more accuracy; taking the PTC and then underproducing may be a worse economic outcome than taking the ITC. But you need accurate production forecasts to decide,” Kaminsky notices.

Sam Kamyans, a partner with Kirkland & Ellis points out that another point of concern for lenders is the creditworthiness of the tax credit buyers, the same as the offtaker in a PPA.

“A deal structured around a single credit-worthy tax credit buyer that has committed for a period of five to 10 years, would be easier for lenders to find comfort, compared to a transferability deal that sells its credits to multiple buyers,” Kamyans adds.

From Greenfeld’s perspective, a main challenge in deal execution is that regulations are new, requiring time to understand it. Lenders are usually risk averse by nature, approaching new things with caution.

Funding construction

Although in general structuring a project finance transaction around PTC can generate more aggregate value over time than a one-time 30% ITC, the advance rate to fund construction might not be as strong.

Some sponsors facing longer construction periods, well over a year, due to hurdles with supply chains, permitting and availability of skilled labor, may need to start incurring in development and construction costs prior to securing a tax capital commitment.

“Until a tax capital commitment is obtained, lenders will not fund a tax capital bridge loan, which means sponsors will have to search for alternative sources of construction capital. In some cases, the sponsors will fund construction costs on their own balance sheet until the tax capital loan can be secured,” says Durden from CRC-IB.

Moreover, the tax equity bridge loan that is traditionally part of a debt package around tax equity, would not be a fit for a PTC transfer deal.

“Transferred PTCs are monetized as produced without the guaranteed commitment that you see in a tax equity structure. Banks are evaluating how to size and price PTC based loans in a transfer deal, but deals are getting done,” says Kamyans.

The geography of the location of the project and the projected performance, the capacity size, and the balance sheet of the sponsors are all factors that play into the final decision.

“For sponsors is a balancing act, because a transaction around PTCs and credit transferability can result in larger monetization over time, but the construction cost would require more equity capital from the sponsor, says Pettus from Advantage Capital. “Key factors to consider are the project size and the sponsor’s access to capital during construction.”

A project finance banker mentioned that to supplement capex needs, some sponsors are also taking equity bridge loans. Alternatively, another solution is calling for a minority equity sale to a cash investor.

In summation, the new transfer provisions enable variations on the tax equity structures, which for years have resulted in a steady volume of transactions done, and in doing so, creating a bottleneck of projects that must wait to access funding. With more education, the expectation is that new credit buyers will join the marketplace and that more transactions will come to fruition, enabling the energy transition goals.

*This story was originally published exclusively for NPM subscribers last month.

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