Some notes on cost of capital from Norton Rose Fullbright
Chock full of insights
TE demand is around 30+ billion this year; so supply is limited:
We estimate that the volume was $20 to $21 billion last year, roughly in the same ballpark as the year before. Some observers predicted a dip, but there was a fair amount of volume that slipped from 2022 into 2023, due primarily to construction delays.
TE volume:
We saw a slight uptick in tax equity volume in 2023 compared to 2022. We put the traditional tax equity at $21 to $22 billion in 2023. The $4 billion in tax credit trades sounds right.
Solar and wind mix:
We saw more like a 60-40 breakdown for the full year. That is 60% of solar projects choosing investment credits versus 40% production tax credits.
Growth in TE supply:
We see the supply of tax equity also growing as more investors are drawn into the sector, but at a slower pace than market demand. If the economy remains strong, we could see tax equity volume growing by single-to-low double digits. Most tax equity is moving to hybrid structures where the tax equity partnership is expected to make a tax credit sale.
PTC vs ITC:
We have done a number of such transactions. The facts have to be right. The two facilities in question need to be separate facilities so that one can qualify for PTCs while the other qualifies for an ITC.
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Not surprisingly, there was fairly strong demand from corporates for 2023 credits at year end. Some corporates are only interested in buying PTCs because PTCs have no recapture risk, and they are only buying credits from investment grade sponsors or they will require tax insurance.
Transfer deals:
We saw them starting at 90¢ to 93¢ for the most popular credits early in the year, but the prices moved up late in the year, when we closed a string of deals at 94¢, 95¢, 96¢ and even one at 97¢. These are prices per dollar of tax credit.
Tax insurance:
Rubiao Song, in what situations are you requiring tax insurance in tax equity and tax credit sale transactions? I am guessing it is when there is a significant basis step up or it is not an open-and-shut case whether the project was under construction in time to avoid the wage and apprentice requirements.
Recapture risk:
MR. SONG: Those are the big ones. Another one is in ITC transactions where the sponsor does not have a strong balance sheet to stand behind the obligation to indemnify for any recapture of the tax credit. Tax insurance to cover the recapture risk would also be very helpful.
Debt financing rates:
Tighter liquidity conditions affected the market pricing for deals. Everything for me starts with ESG plain-vanilla loans. We saw spreads move up slightly this year to between 162.5 and 175 basis points. That’s up from 150 basis points that I mentioned last year. You are potentially looking at almost a 7% all-in interest rate assuming you are not hedging the underlying rate.
ESG merchant deals financing rates:
For an ESG merchant deal, you should figure a premium of about 75 to 125 basis points. The extra premium varies depending on the sponsor, asset class, the amount of merchant exposure the lender will have to rely on to be repaid, and the size of the deal. For example, a very large deal may require many lenders to clear the market, and it means you have to make the last guy happy and then everybody in the lender syndicate benefits.
Pricing for pre-NTP development loans:
Pricing for such a facility ranges between SOFR plus 375 to 600 basis points, depending on the composition of the portfolio. Relevant factors are whether the portfolio has any operating assets, the extent to which they are contracted, and the track record of the sponsor.
DSCR ratios:
For fully-contracted solar, expect a coverage ratio of 1.25 times P50 and 1.0 times P99. Merchant solar is 1.75 times P50 and 1.4 times P99.
Contracted battery storage is 1.15 to 1.2 times P50. Merchant battery storage is at least 2.0 times P50, with a to-be-determined upper end of the range.
MR. CHO: Lenders are willing to structure tight coverage ratios if they feel confident about the cash flow. The more volatile the cash flows, the wider the coverage ratios.
A tight coverage ratio in the current market is 1.2 to 1.35 times P50. No one wants to see less than a 1.0 coverage ratio on P99 numbers.
MR. MARTIN: Beth, why 1.15 times P50 for contracted storage, which is less than for contracted wind or solar?
MS. WATERS: There is more certainty in the technology. We are more comfortable with it.
MR. MARTIN: For standalone utility-scale storage? That is very interesting.
Source: PFN