Q&A: Santosh Raikar, State Street - Part II
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Q&A: Santosh Raikar, State Street - Part II

In the second half of this exclusive interview, Santosh Raikar, m.d., renewable energy investments, at State Street, talks to PFR managing editor Olivia Feld about the planning for the investment tax credit step down, competition with corporates for tax equity deals and appetite for renewables outside of wind and solar.

PFR: How is the imminent ITC step down affecting the market? Do you envisage a rush of deals next year assuming that the step down stays in place?

If you go to five people you’ll get five different opinions on what will happen to the ITC legislation. But most tax equity players are assuming that ITC step down will happen and they are trying to fill up their bucket as much as they can. At least, that is our business strategy. We are open for business and we are lining up as many deals as we can. From that perspective there are going to be a lot more deals in the market, there will be a lot more construction happening, there will be a lot more deal flow that will be seen coming to fruition.

PFR: With that in mind, a number of sponsors have said they are holding on to their own tax equity and choosing to use the credits themselves. Are you seeing more of this strategy in the market?

I don’t see a material change in that. There have been certain segments of the market that have self absorbed the tax capacity. It has been so and will remain so in 2016, and I don’t see any uptick or downtick in that particular segment. In fact, I think it’s the other way around, in the sense that the marginal projects, which otherwise would have otherwise gone to the strategics, are coming to the market for tax equity because you can get one more deal done through the tax equity route, as opposed to going back to your limited strategic pockets.

PFR: It’s been widely reported that there have been fewer and fewer power purchase agreements available. How does that affect tax equity lenders like yourself looking at backing quasi- or even fully merchant projects?

We wouldn’t do merchant solar projects at State Street. We are not necessarily looking into projects with 25-year PPAs alone. We are willing to go down to 15-year PPA, 10-year PPA, but we won’t go below 10 years. So we haven’t looked at hedge deals either.

On the wind side, there is a market for hedged wind deals and that market segment is well supported, meaning there is enough supply and enough demand for this product. We have not participated in hedged wind deals, and it is not for a lack of interest. There is nothing in our investment guidelines that says we cannot do hedged wind deals. But the reason we haven’t done hedge wind deals is purely economic.

What happens in typical hedged wind transactions, for example, there are certain turbine manufacturers who are willing to put in the tax equity. Furthermore, there are also commodity hedge providers who are willing to put in tax equity. We are a pure play tax equity investor. If the turbine manufacturer puts in tax equity, they already have made money on the turbine sales. If the commodity hedge provider is willing to put in tax equity, they already made money on the commodity hedges. I have worked with the commodities traders during my investment banking career and so I know how lucrative those deals can be. So for a pure play tax equity investor, what is there for us?

That has been the problem, because the deals are not attractive enough for us to be interested, and at the end of the day we have a finite bandwidth and we are focused more on solar than on wind, so what happens is we end up rejecting those deals or end up doing PPA deals on the wind side.

PFR: Google recently took tax equity in a wind project, what impact are those types of corporate entities having on the market right now?

There are two ways they can play. The first one is that they can participate in tax equity. We have partnered with Google in the past, which is public knowledge. From our perspective, although we are a long standing tax equity investor, we think that more players is better. Google has been a tax equity investor for a long period of time. There are newer players and we welcome their participation.

The second way corporates play into the market is by being an offtaker. We have a track record with one of the largest retailers in the U.S. and we like those deals. We don’t have too many of those corporate PPA deals, but we do get inquiries and we see more and more of those inquiries than in the past. We’re looking at those deals favorably because many of these corporates have very good credit ratings. Moreover, they have a genuine desire and need for green power and this is a very good entry into the market for the PPAs.

PFR: You mentioned you have partnered with Google. What kind of other partners and co-investors are you working with?

On the wind side, we have mostly done club deals. Again, there is nothing in our investment guidelines that says we have to do club deals. However, the size of wind deals is large enough to necessitate syndications. On the solar side, we have done primarily bilateral deals, with a couple of exceptions.

Part of the reason is that solar deals are small enough that we can do it ourselves. Also, working on a syndicated ITC deal is a little more difficult than a syndicated PTC deal. On the PTC side, there is a revenue procedure, on the ITC side there is no revenue procedure. Different institutions have different requirements and guidelines, so putting them together is bit difficult. On the PTC side, on the wind side, we have done work with all the major players. A lot of this information is in the public domain so you can look it up and see whom we are partnered with. Most of them have been financial investors as opposed to the corporates.

PFR: In the time that State Street has been involved in this market - since the 1990s - how have the tax equity structures evolved?

Unfortunately, it has been a one trick pony. We have done almost exclusively unlevered partnership flip structures. It is not for the lack of desire or appetite for other structures, but it has just been like that.

We can do solar sale and lease back structures. When I joined State Street, early on we saw a lot of deal flow in that market, but as the solar market has matured we have seen less and less of those deals. So the structural preference is more market driven than our appetite. If we can get a sale leaseback deal in the solar sector, we will be happy to do it.

As for the inverted lease back structure, we have dabbled in that, spending a lot of time on it. Again, the kind of deal and structures that were put in front of us were not congruent with our risk appetite on the tax side, which has been the main impediment in doing inverted lease structures. We have been spending a lot of time this year assessing what the step down of the ITC will do to our product offering , and through that reassessment we have figured out what structures would work in 2017, if the ITC goes down to 10%, but it’s harder to pinpoint given the deal flow we are busy with.

PFR: With that in mind, and as we are seeing solar securitizations slowly creep up in terms of prevalence in the market, how would you respond to lenders who say tax equity structures pose difficulties for ABS and wider back leverage?

I’ll answer that question in a broader way, because back leverage matters both for residential and utility scale projects. On the residential side, our investments haven’t been part of the securitizations we have seen in the market. Part of the reason is that most of the deals that have been securitized were in inverted lease structures, and we haven’t done that structure, as I just mentioned.

Our investments have been part of back leveraged facilities, which are basically back leveraged loans, for both residential solar and utility scale solar and wind projects. Some of the issues that come forth under the securitization side also come under the back leveraged lending side. The difference is, when you compare to securitization, back leveraged lenders are a lot more malleable, more flexible, they understand the risks better, compared to the rating agencies, and there is an evolution and an education part that needs to happen for the unleveraged partnership flip structure for it to make its way to securitization.

I don’t want to say that tax equity is not a constraint to back leveraged loans, but there are banks that are flexible and they are smart about tax equity and they have been able to step up and understand the tax equity structure and work within the constraints imposed by the tax equity itself. We have been proud participants in certain back leverage facilities, and if you look into who the lead underwriters are, I would say they are smart enough to be part of those back leveraged facilities.

PFR: Does State Street focus solely on federal tax credits or do you also cover state credits?

No, we don’t have state level tax capacity. We are a Massachusetts bank, and our presence is primarily in Massachusetts, so that’s how it is and we don’t handle state level tax credits.

PFR: A question I'm keen to ask you is - and you alluded to this - how do you plan for the impeding ITC and PTC deadline?

For now, the ITC stepdown matters to us a lot more than the PTC shutdown because the credit delivery is different. In an ITC deal, the credits are upfront, so let’s say we are doing X number of deals and getting X hundred million dollars of tax credit, then going from 30% to 10% is a big jolt, whereas on the PTC side a similar number of credits are delivered over a 10-year period, which works to the tax bottom line on an incremental basis.

If the wind PTC were to go away, the incremental impact would be somewhat muted. That’s the difference between the two credits. So for the ITC we have ramped up our execution capability. Since I’ve joined here, we have executed 15 deals, so we have gotten better and better in terms of execution risk assessment, origination and all that, so we now have a smooth functioning machine that we have been ramping up for this day and for this year.

What happens in 2017? The ITC goes down from 30% to 10%. That means if you have the same amount of tax capacity, you have to do roughly three times more deals, right? What we do see is that the supply and demand will be a lot more balanced compared to what it is now. That means some sponsors will have better appetite to self absorb some of the credits, and that means they will not need tax equity. Also, certain tax equity investors who entered the market with the allure of the 30% tax credit might find it less lucrative to monetize tax credits at a 10% rate, so they might go away.

Finally, as I discussed before, the ITC step down would necessitate newer structures, and certain tax equity investors may not be comfortable with the risk reward balance. But overall, what will happen is there will be a lot more balance in terms of the supply and demand and by virtue of that there will be more rationalization on some of the terms, both economic and legal. So far as State Street is concerned, we will continue deploying tax equity despite the ITC step down.

PFR: Can you elaborate on what you might be trying?

We have been spending a lot of time on that. I’m still hoping for the extension of the credit, which means life will be the same, so therefore I don’t want to get the genie out of the bottle and give the impression that we are open to some of the other structures that today we are saying 'no' to.

PFR: We have talked a lot about wind and solar. Are there any other generation assets that you look at that qualify for the PTC or ITC? I’m thinking of storage, for example, which people are saying can become more pertinent to the financing community, and also other types of renewable generation assets such as geothermal or others.

We have done biomass projects in the past but what we are finding is that solar PV and wind are a lot easier to execute, a lot easier to understand, with fewer variables, plus there has been enough to go around. So why would one kill oneself to do something else when you can get ITC or PTC, which another generation technology will give? With these tools, you cover a pretty large swath of projects, so we really have not been pursuing biomass or geothermal generation projects.

Energy storage is different and more interesting. We have been watching that market fairly closely, but we haven’t been close to doing any deals yet. It’s also a function of how much credit is available, and there are scalability issues and technology maturation that we need to see, but if the market changes in solar from 30% to 10%, that might be the area we might be looking at more proactively.

PFR: Finally, what’s your outlook for next year?

For 2016, we are chasing a lot of deals. As I’ve said, we have had a lot less done than we had anticipated, partly for the same reasons we talked about: the PPA issues, the sponsors changing course. But we are very active and we would like to get as many deals as possible locked up by the end of this year, through letters of intent or term sheets. Then we can solely focus on execution next year. We are primarily looking at solar ITC deals as of now. Wind PTC will be different next year. We will be doing wind PTC deals too, but we would like to defer it until next year, until we are clear on our ITC deals, clear about our tax appetite and filling our tax capacity, and then we’ll look into the wind projects.

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