With tax credits for renewable project development drawing to a close, the competition between tax equity investors is intensifying. State Street Bank has committed around $1 billion in tax equity investments in in the last three years.
Santosh Raikar has been m.d., renewable energy investments at the Boston-based bank since January 2012. He leads a team that originates and executes tax equity deals, in addition to managing the performance of existing investments.
Previously, Raikar worked on the sponsor side, first as project finance director at Energy Conversion Devices and then as a v.p. in corporate development at Solyndra. Prior to this, he was a v.p. at Deutsche Bank and Lehman Brothers.
Raikar spoke with PFR managing editor Olivia Feld about finding financeable projects amid a lack of suitable deals and an influx of new players to the market.
PFR: Tell me about State Street’s history of involvement in the tax equity market and its total volume of investment to date?
State Street has been an investor in the renewable energy sector since 1992. We are one of the oldest tax-equity investors — very few people know that except for the people who have been investing that long. Moreover, we have made investments in each of those intervening years to date. I joined in January 2012 and we have closed 15 deals and we have committed roughly $1 billion in investment commitments.
PFR: How strong is State Street’s appetite for more tax equity deals?
We have been originating and doing roughly four to five transactions a year on an average, but we can do a lot more. Our abilities have been hurt not so much by our tax appetite or bandwidth, but more by the lack of deal flow. We don’t see an influx of good quality deals in the market and that prohibits us from doing more deals than we have appetite for.
Our portfolio right now is 50% wind and 50% solar, roughly speaking. We would like to increase the solar concentration because if you really look from the accounting perspective, from the earnings profile, from the credit delivery and the size of our team, solar serves our appetite and our needs better than wind deals. Unfortunately, as I said, there is a lack of deal flow of good quality solar deals and that is hampering our growth.
PFR: How would you define a high quality deal? What are the parameters for that?
It differs between the wind and the solar. On the wind side, we really want to deal with sponsors who have a lot of experience in operating large wind farms. If you look into our track record, which is fairly public, we have done mostly transactions with European utilities. In the U.S. we have done business with NextEra and other large developers with significant experience in developing and operating wind farms. Most of these counterparties happen to have strong balance sheets.
For the wind sector we would like to continue doing business the same way. We could do business with the financial sponsors, we regularly entertain inquiries from the financial sponsors, mostly private equity shops and infrastructure investors. They don’t necessarily have direct operating experience themselves but they have the financial acumen and the due-diligence process to make investments in the sector in a way that aligns with our interests.
On the solar side, on the contrary, we don’t have as high expectations or requirements in terms of the operating experience. We do want the developer to have a solid track record, particularly on the financial side, and we look at the solar deals more on the non-recourse basis, for example, so we are not relying heavily on the sponsor quality and creditworthiness. Due to the fragmented nature of the solar industry, it is unlikely we would have the same quality of developers as in the wind sector. By virtue of these factors and the fact that ITC deals have lower reliance on project performance, we can be more flexible in the solar sector than the wind sector.
PFR: What kind of sponsor do you look to work with? Do they necessarily need to be investment grade developers?
My point was, no one in the solar sector, unless they’re coming from the wind sector, is investment grade. The pure play solar developer — some of them are public, most of them are not — don’t have the investment grade credit rating we would like them to have. In that respect it’s a very open and very fragmented field.
What we need is basically two things: One is showing us that they have closed financial transactions. Particularly if you are looking at the utility-scale sector, they need to show that they have closed sizeable transactions, by virtue of developing, constructing and operating sizeable projects. Our investment appetite is significant. On the solar side, we can put up sizeable capital to work in a single transaction. Therefore, the developers need to show that they can execute tax equity transactions of similar size. It doesn’t mean they need to show they have done exactly the same amount or larger but they need to demonstrate the capability.
The second thing is they need to show that they have a strong pipeline that potentially can get us repeat business, and that is an important criterion for us because we are a small team so we want to build up on our relationships and do repeat transactions. I’ll tell you something: I’ve been on the road for the past two months, and I’ve been trying to gin up interest among developers and all I’m saying to the developers that if a standalone utility scale project is not available, we will consider a portfolio of smaller projects. But we will need to meet the investment minimum for the portfolio to be considered for investment. You’ll find it interesting that I am finding it difficult to get that type of portfolio.
PFR: Do you think the market is heating up in terms of greater competition for those deals?
The tax equity market has become more liquid recently because of the new entrants. There are always smaller deals that are done in bilateral fashion and that particular segment of the market has expanded because of the general publicity about solar and people knowing what works and what doesn’t work. A lot of times I go to the conferences and I hear that tax equity is the biggest elephant in the room and there is so much of a supply constraint. Some of that is true. But the market is a lot more liquid than it used to be, and the real challenge now is not so much about the supply of tax equity, but really the quality of the projects and finding good projects that are financeable.
PFR: Some smaller-size sponsors tell me that they struggle to get tax equity investment. How would you respond to their claim that it’s the bigger, more established sponsors that scoop the investments and the smaller shops lose out?
It is true that the smaller ones are finding it difficult, but the reason is not the size alone. Many times we find that power purchase agreements have issues that are difficult to rectify within the time frame to achieve a financial close. Some of these deficiencies are found at a later stage because developers just competed and got the PPA without paying attention to what they were signing up for, and they didn’t think about the bankability per se, and then they have a problem.
The second issue is the pipeline. There are very few developers, and I am not looking at the highly creditworthy developers here, who can give a consistent pipeline which fits the criteria.
Third, many times developers are chasing something that is not available in the market. For example, many times we get inquiries for levered partnership flip transactions. Now, how many deals are done on levered basis? These deals tend to be small and are usually done by high net worth individuals or smaller corporates who have a limited amount of tax appetite. Most of the mainstream market is geared towards back-leverage, because back-leverage works when sophisticated lenders get involved who can get their arms around such a structure. People are looking for something that is not out in the market.
Fourth, developers tend to over-optimize each transaction. What it means is that they are looking for every penny that they can squeeze out of each transaction. I am not suggesting that you shouldn’t have an economically efficient transaction. Instead, what I am saying is that if you’re a developer, you should take a broader vision and try to make money on a 200 MW, 400 MW, 1,000 MW portfolio as opposed to your small $50 million project, because if you are spending your time, energy and resources on optimizing a $50 million tax equity transaction, you’ll never get to work with a size that will allow you to access to mainstream tax equity investors.
Fifth, many times the sponsors just get tired. Closing a tax equity deal with a lender, whether a construction loan or back-leverage, is not an easy feat, but the developers want to go through the process, they want to be the sponsor and the cash equity owner. But when they go through the process they find the process beyond their capability and they flip the project, which means they sell it to a larger sponsor. They don’t have the endurance to weather the pain of working a deal through the financing process and then they lose heart. I am not suggesting that this happens only with small developers. Even the larger, more established developers flip projects. We work with someone with a good intent and then they switch the course, and they say: “Sorry for two months of work. We’ll pay for the expenses but we’ll sell the project to someone else.”
PFR: SunEdison and its yield companies are pausing their acquisition pipeline, and there could be other yieldcos following in their footsteps. How does that impact your deal flow?
There are a lot of things happening in the market, and I don’t want to necessarily name the names, so I will put this in a broader context. Whenever there is a deal that we are working on, let us say that the sponsor changes the course, then oftentimes one of two things happens: They sell it to a strategic sponsor who does not need tax equity, and therefore we are out of the door. Alternatively, they go to a sponsor who has their own financing plan around tax equity and therefore all the work that we have done is basically thrown out of the window. Now, once in a while we may get lucky and the new acquirer might say, “Oh, State Street has worked on this project and therefore I would like to continue that the process,” but that happens rarely and by the time we reengage, the terms could change to the point that we might not have the same interest, or by then we have diverted our attention to another deal, and therefore lose the focus that we had before.
PFR: Is that something you are concerned might be happening more often?
Yes and no. It has happened to me personally and to our firm enough times that whenever we look at utility scale projects, we spend a lot of time scrutinizing whether this deal is going to close. That’s what we focus time on before we sign on and start working on the project. What’s happening now is that the impending ITC step-down is forcing developers into realistic expectations because they don’t have a lot of runway. Earlier this year they had more than a year to play the optimization game, to get the most economic benefits to themselves. Now they don’t have the luxury of time, which I think makes the scales a lot more balanced because you have to do something now or else you’re going to miss the timeline.
Check back next week for the second installment of this Q&A.
