This is the second of 10 articles taking an updated look at our most widely read stories of the year. The first article can be found here: CMBS.
The U.S. solar industry was built on tax credits.
At the federal level, the Investment Tax Credit (ITC) allows both residential and commercial developers to offset 30% of their costs. Various states also offer credits.
Since it was introduced in 2006, the ITC has helped boost annual installations of photovoltaic systems — panels and related components — from 104.7 megawatts of direct current to 6,201 (MWdc) in 2014.
That’s nearly enough energy to power a million average American homes. As of the end of 2014, the total cumulative installed capacity had reached 18,400 MWdc.
Developers typically do not have the tax liability to use these credits for themselves, so they bring in “tax equity” investors to capitalize their projects in exchange for use of the credit. But the ITC is being phased out, which is one of the reasons that there is so much interest in securitization as an alternative source of financing.
But until the tax break is fully phased out, any securitization of solar assets has to avoid jeopardizing it for existing investors. Many of the features of the legal structure required to execute a securitization could expose tax-equity investors to a potential “recapture” of their unvested credits.
The first, known as an “inverted lease” was pioneered by SolarCity, the largest residential developer, in 2014; and in 2015 it was used by a second developer, Sunrun, in the $100 million Callisto Issuer 2015-1.
In an inverted lease, also known as a pass-through lease, the sponsor invests in a lessor entity, which owns the assets and enters into a lease agreement with the tax equity investor as lessee.
As Ronald Borod, senior counsel at DLA Piper, explains, under the IRS code, the lessor can elect to pass the tax credit through to the lessee, even though the lessor is the only owner of the assets. “This causes less friction with recapture or reduction in the tax basis, as the tax equity investor received credit on the basis of the pass-through election and not because it owns the asset,” he added. “It can continue to receive the benefits of the tax credit even if the ownership of the assets changes during the five-year period, provided any subsequent owner of the assets is required to honor the rights of the lessee under the lease.”
Another arrangement used by tax equity investors is the partnership-flip structure. SolarCity used this in its first two deals, and also in its most recent deal, the $123.5 million SolarCity LMC Series 2015-1.
In this arrangement, the tax equity investor and developer are partners in the same partnership, which owns the solar assets and related contracts (PPAs, leases, etc.). The sponsor would securitize the cash flows, instead of the actual assets, in an approach known as back leveraging.
In the case of a recapture of tax credits in 2015-1, SolarCity would be responsible for any losses incurred by equity investors.
This is why SolarCity itself has expressly agreed to make good on any recaptured tax credit. If for any reason the developer can’t cover the lost benefit, two insurers — Underwriters at Lloyd’s, London and Columbia Casualty Company — will cover up to 35% of the ITC claimed by the tax partners.
There’s another, simpler way to tackle tax equity: start with portfolios that don’t have any. That’s the approach of Benjamin Cohen, chief executive of T-REX, a firm facilitating aggregation of solar assets for a securitization or whole portfolio sale.
AES Distributed Energy also seems to be collateralizing a tax-equity-free portfolio in a $100-million ABS that is in the works. — FO