Federal subsidies are re-shaping deals this year, as the power industry copes with the expiration of the U.S. Department of Treasury’s cash grant program and a decreasing confidence in the long-term viability of the production tax credit, Mike Lorusso, managing director and group head of CIT Energy in New York, told PI in an exclusive interview. He expects a return to partnership flips and leveraged leases for contracted renewable projects, as well as a decreasing number of wind deals coming to market throughout the year. “Beyond this year though, my sense is that you’re going to see waning support from Congress for wind. As a result, a lot of wind developers are revisiting their future plans and their strategies,” Lorusso said.
Mike Lorusso |
What kind of structural innovations do you see in deals in the next year?
For deals that have PPAs, and those right now are just renewables, we’re probably going to see a return to the tax equity structures such as partnership flip structures, leveraged partnerships and leases or even inverted leases. We’re going back toward those structures because we no longer have the cash grant and there are very few projects that are grandfathered in for the cash grant. So I would say we’re seeing a bit of “back to the future” effect, where we’re going back to those structures now to accommodate the need for tax equity. We’ll probably see those deals done if they have long-tenor PPAs with a combination of a bank tranche, which would be shorter term, and a longer term institutional insurance-type tranche, to accommodate the larger deals and the need for longer-term financing.
In the merchant plant deal structures, they obviously don’t accommodate long-term funding because of the uncertainty of the merchant market. There you’re just going to see primarily a mini-perm structure and possibly a blend of a term B and a term A. When you get back to the original advent of the A and the B structure, the term loan B was taking the back-end risk, 100% cash flow sweep at a point and time and a nominal amortization and the A piece is getting more of a fixed amortization but gets out sooner. There may be some opportunity to use that structure to allow these merchant plants to get constructed. Alternatively, for aggressive commercial arrangements, sponsors could use an all term B structure or, for more conservative commercial deals, an all-commercial bank structure.
In terms of bonds, how do you see that segment of the market developing?
To do a bond, the bond buyers especially want to get paper rated. They’re a bit less industry specialized than commercial bank lenders so they usually want to see some existing performance and they typically don’t like to take construction risk. Bond financing per-se is not that attractive for project financing because you need the right size deal and certainty of cash flows which you only get in the fixed-price PPA-type deals and they want to see some demonstrated historical performance which you only get when those plants have been up and running. So some of these long-term deals use mini-perms to get through construction and then do a bond take-out at some time in the future.
What about institutional investors? Do you see them becoming more active?
There have always been a handful of sophisticated lenders in that space and, to varying degrees, they’re still around and active. It just has to be the right situation and the right strategic fit with the borrower. Some borrowers, even though they could get fixed-rate, long-term financing, may not want to lock themselves up with the make-whole premiums that they have if they want to do a refinancing. What happens with locking up the long-term financing is you’ve taken the uncertainty off the table for refinancing and re-pricings of your deal but you’ve also taken the optionality off the table to do something with that financing. That’s always a complicated equation for the borrower to try and solve: how they can optimize the strategic fit. That’s why we’ve only seen certain situations where there’s an institutional piece, whether it’s all institutional or whether there’s a blended commercial bank loan shorter term and a longer term institutional piece.
In terms of some of these large deals, what’s your sense of lender capacity in the market? It’s interesting because lenders would prefer to have 100 smaller deals than two mega deals because of concentration risk and lending limits which allow us to build diversity in our portfolio. Take an LNG deal: they’re massive, multi-billion dollar type deals, but they tend to be sponsored by major companies. Cheniere had Blackstone as well as underpinning contractual arrangements from several multinational energy companies and that allowed some of the large relationship lenders to step up for huge tickets. They normally wouldn’t do that in your basic project financing. For example, several lenders there went for $250 million each. So the capacity is there for these large deals if they have major, multi-national type sponsors or major private equity sponsors that can get their lenders to step up for a much larger than normal ticket size.
The capacity varies with the type of deal. For example solar sponsors tend not to be the same multi-national players. There tend to be more focused developer types or more specialized private equity. Solar projects for the most part now are smaller. In the past few years we’ve had a couple of major solar deals that were done under the loan guarantee program and that allowed them to get financed. The lender capacity is there for a medium to midsize deal. For a mega deal, you need the support from major sponsors to attract lenders to step up for a much larger than normal size ticket.
Generally, it seems like the deals have been done in a way that accommodates what otherwise would have been some limited capacity. If you are a smaller developer, trying to do a mega deal, you would run into capacity limitations and that’s where you would have to call on a multitude of sources to get your deal done. You would probably need to somehow combine a term B institutional piece, which are for the most part the non-bank lenders, a project finance type piece with commercial bank lenders and maybe a more traditional institutional piece. You’re going to have to call in all of your cards in order to get a deal like that done.
Are you seeing a lot of these larger solar deals out there in the market this year so far?
Right now, the largest deals we’re hearing of right now are in the $500 million to $600 million range. Those deals could, with reasonable effort, get done in traditional project finance or term B type universe of lenders. Another major LNG deal would have to go outside of that, but then again, as I mentioned before, that’s going to be a different structure with the same lenders but a different set of investors that could do a different type of financing.
You’re not going to see a $2 billion merchant power deal get done in the project finance sector and for that reason, you’re not going to see a $2 billion merchant power project.
Are there any other trends in project finance or asset-based M&A that you’re seeing emerging this year?
This year seems to be shaping up as the same level of activity as last year, maybe a little more active. I think this year will be the usual complement of M&A activity, so assets changing hands, whether its utilities selling certain assets in the private sector or within the private sector as private equity firms trade ownership inerests in assets. That level of M&A will be roughly the same as it was last year.
In addition to that, we are hearing and seeing some new construction in gas-fired generation in the merchant sector as previously discussed. Wind got a bit of a jump start. You’re going to see some deals getting done that were in late stages of development and just needed that boost. Beyond this year though, my sense is that you’re going to see waning support from Congress for wind. As a result, a lot of wind developers are revisiting their future plans and their strategies. So there will be some wind deals this year getting done in the late stages of development. Beyond that, I don’t think you’re going to see much more activity in wind.
In solar, we’re seeing continued activity for the midsized, and a few large-sized, deals and increased activity in the distributed generation sector. But, that’s always a challenge to finance because of the multitude of small deals they need to aggregate together in portfolios.
What will the tax equity component look like?
That’s going to be a major component in deals because of the cash grants. There are a few deals that have grandfathered themselves in but otherwise, without the cash grant and now dependent on the ITC or the PTC once again, we’ll depend on tax equity to get the renewables done. Similarly, as I said in solar, we’re seeing more activity in the smaller distributed generation and even some private equity shops trying to figure out how they can actually do residential solar. You still need tax equity to make those deals work so that’s another situation: how to get tax equity into those smaller, distributed generation deals, which is difficult.
Do you see any changes in the universe of tax equity players?
It’s more or less the same universe. The new blood came in last year when a few folks like Google stepped in to that space. But other than that, I don’t know if there’s any new blood in 2013. I think the players that got in last year are the new blood now that are looking at these transactions in tax equity.