keybanc capital markets

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US renewable energy assets have attracted interest from a wide range of investors around the world in recent years, with capital pouring in from Asia-Pacific, Europe and the Middle East. This influx has been driven by the high quality of the projects, the returns relative to other long-term assets, and, increasingly, by environmental, governance and social (ESG) investment criteria. In this Q&A interview, Andy Redinger and Dan Brown, managing directors at KeyBanc Capital Markets, discuss this surge in demand, its impact on the market for renewable energy assets in the US, and what global investors need to consider when evaluating opportunities in this sector.

PFR:          The renewable energy industry seems to be plowing through everything in its path right now. Taking a longer-term view, can you give a sense of how the market for US renewable energy assets has grown in recent years?

Andy Redinger, KeyBanc Capital Markets:           Renewable assets have quintupled in the last ten years, and the growth rate seems to be accelerating.  The number of gigawatts added each year has been phenomenal. 2020 and 2021, pre-COVID, were projected to be some of the biggest years in wind and solar additions in the US.  But if you think about it, that makes sense. With the costs of solar, wind, and financing all steadily declining, plus a wall of new money focused on sustainable investments, no one should be surprised to see that type of growth.

                   Thinking about our group, we've more than doubled the size of the group, if not tripled it, over the last ten years to take advantage of the increased financing and advisory opportunities. The renewable market has grown fast and continues to be on a very steep trajectory.

PFR:          And as the market has grown, KeyBanc Capital Markets has played a role in bringing new investors into the US renewables market. What kinds of new entrants have you seen buying US renewable energy assets over that time?

Dan Brown, KeyBanc Capital Markets:      The most recent development is that we are seeing the oil majors come into the sector. They've been in and out before – when you think about Shell and BP, then they exited – but now it seems like they have returned. So I think that's a meaningful new development, seeing the oil majors become big players in terms of investing in renewable assets. For a period of time, it looked like they were mainly going to be active as counterparties for power purchase agreements or investors in offshore wind but now I think we're starting to see a trend where they're becoming either equity investors in renewable platforms, or buying single assets outright.

                   I don't think you could have any kind of discussion about this without talking about the prevalence of ESG [environmental, social and governance] funds. They are everywhere.

PFR:          And over that time, with these investors coming in from elsewhere, how have incumbent market participants responded?

Redinger:  Many incumbents have gone downstream. They've been in the space longer, have gained valuable experience, and become more comfortable investing earlier in a wind or solar project’s lifecycle. Incumbents have figured out the bang for the buck, or the optimal risk-return profile, is earlier in a project's lifecycle than investing at FNTP [final notice to proceed].

Brown:      I don't know if this is just necessarily an incumbent trend. The trend we're seeing, broadly, is people are moving to earlier-stage development assets.

PFR:          Are you seeing more auctions that are open to a wide range of buyers, or more bilateral deals? And has that balance changed?

Brown:      We've never been fans, at KeyBank, of really broad auction processes. Our view is that if you hire a bank, the bank should already have an idea of who the best five or so buyers are. We've been fans of having more targeted processes, and I think the market is starting to agree with us. There is auction fatigue around these large, 50-plus participant auctions. This was true pre-Covid, and it's just been amplified by Covid.

PFR:          Moving on to the assets themselves, how have they changed over time? What are you seeing more of in the market and what are you seeing less of?

Redinger:  We see shorter-term offtake agreements, definitely seeing a merchant component to the assets. Dan, are you finding anything different?

Brown:      Yes, we're starting to see some non-investment grade PPA offtakes; we see more community solar; and we're certainly starting to see residential solar gaining in popularity.

                   From the equity side, the migration away from long-term utility-contracted assets continues. Those are almost like unicorns. So the migration has gone from: 'I’m comfortable looking at long-term contracted operating assets’ to: ‘I’m comfortable with construction risk’ to: ‘We can evaluate merchant risk’ and now: ‘‘I’m comfortable with non-traditional offtakes.’

                   As the market continues to evolve, equity investors, debt investors, and tax equity investors are increasingly comfortable with renewable assets, no matter how they’re constituted.

PFR:          Investors have gradually moved toward earlier stages in the development process. Can you go into a little bit more detail on how the market for early-stage development projects has developed? What kind of investors are you seeing there, and how do they structure investments in those kinds of projects?

Redinger:  With as much money as there is chasing construction-ready or operating wind and solar projects, it was only natural for investors to start to look at pre-FNTP or earlier stage projects. The market for pre-FNTP projects is getting more crowded each year, with many investors having to invest earlier in a project's lifecycle to achieve their stated investment returns.  We are seeing the right mix of investors, including infrastructure funds, ESG focused private equity, and insurance and pension funds looking to invest in earlier-stage projects. Investment structures have varied from outright sales to earnout structures, with some portion of the agreed-upon amount being paid upfront.

PFR:          You’ve got investors either buying or backing existing developers, or even in some cases setting up their own. How has that affected the shape of the market and the competitive dynamics?

Brown:      I would say one of the ways that, tactically, we’ve seen these funds come to play is that they post development LCs [letters of credit]. This used to be something that was mainly in the arsenal of the more strategic players. Banks are also becoming a little bit more comfortable taking LC risk pre-NTP in certain circumstances. That has been something that has affected the market, and it’s increasing access to capital earlier on in a project’s lifecycle. Even sponsors who used to be develop-and-flip players have more flexibility than they used to, in terms of holding onto assets a little bit longer and being able to find more creative partnerships with different players. Those are some of the ways that it has affected the market.

PFR:          And as this capital moves earlier in the development process, how does that leave the market for projects at a later stage, whether they’re contracted, shovel-ready or operational? Have the kinds of investors buying those assets changed as well? Have valuations changed?

Redinger:  That’s where the feeding frenzy exists. Late-stage investors or investors looking for right down the middle of the fairway projects tend to be the most aggressive from a valuation perspective. We find those investors have typically sourced a cheaper source of capital, and tend to be more risk-averse. The type of investor chasing these “later stage” projects has not changed significantly: infrastructure funds, insurance and pension funds, ESG focused private equity. Still, their return requirements probably have from just a few years ago.

                   Some early investors/funds, where higher returns were advertised, are almost forced to go earlier because there’s just too much money chasing operating or late-stage projects that has driven down yields pretty significantly.

PFR:          Does it depend on the type of offtake contract? Or is it equally the case for a hedged solar project in Texas or a utility PPA?

Redinger:  A 20-year utility PPA, that’s the perfect spot. Anything less than that will trade a little bit differently than that, but a 20-year busbar PPA is a golden ticket.

Brown:      What’s changed is that there is a market for the 10 to 12 year PPA as well, or even eight years in some cases. I think that’s definitely different. While you may not necessarily get the same return, if you’re looking at where those projects are located – several of them are in Texas – the amount of time and dollars it takes to develop those projects is certainly less than if you had to go through the process of siting a project in California and getting a 20-year offtake. That’s part of the reason we’re seeing the prevalence of all those assets: (a) they’ve got phenomenal wind and solar resources, and (b) the development time-cycle is compressed. So, if you’re a developer and you’re planning not to be the ultimate owner, there are still some pretty good economics to be had, even if you don’t have the 20-year busbar PPA.

Redinger:  You can be a lot more creative with your model with a shorter-term PPA. In a 20-year fixed-price PPA, it is what it is. Whereas a shorter-term PPA, you can make your own assumptions about power prices. We internally sometimes refer to this as ‘model magic.’

PFR:          At what point in the value chain are tax equity and debt typically being added to projects? Is that the same as ever?

Brown:      Tax equity is pretty much the same as ever. You’re crafting ECCAs [equity capital contribution agreements] at NTP. We had a couple of developers trying to push the envelope to get them somewhere before mechanical completion, with various degrees of success.

                   The debt market is maybe a little bit more in flux. In some limited cases, you might be able to get debt proceeds pre-NTP. Maybe not to the same level as you might at NTP. But the wall of capital exists everywhere, including in the debt market, and people are being creative.

Redinger:  It’s important to develop a relationship with tax equity. Dan’s right: When it comes in hasn’t changed. But the relationships have changed. Having a  prior relationship with a tax equity provider has become even more important, especially going forward, when everyone – including me – thinks that there’s going to be a reduction in the amount of tax equity, because corporate profits are going to be lower at the places that provide the tax equity. So, having that relationship where you’ve done deals previously is essential.

PFR:          We’ve arrived at the point where a project is contracted, it’s been financed, and it’s operational. What have you seen in the market for operational wind and solar projects in the US? As competitive as ever?

Redinger:  Yes, this part of the market tends to be the most competitive. Current investors look at both the returns achieved through the contracted period and then the returns achieved at the end of the asset's useful life (year 30 or 35). Assuming a project with a 20-year PPA, we have seen assets trade in the 0% to 5% IRR range at the end of the contracted period.  Assets with PPAs shorter than 20 years will trade inside of this. Although many like to quote returns at the end of the asset’s useful life, we believe this is much less an important gauge on the value, given the 15 years plus of assumptions that need to be estimated 20 years from now.

PFR:          Given what you’ve said, do you think it’s possible that the market could be a little overheated?

Redinger:  I may have said that pre-Covid, but given how this asset class has performed in a worldwide pandemic, I think there’s a case to be made that it’s not. In fact, in some of these asset classes within the renewable space, I may argue that there’s still a lot of bang for the buck, given how these asset classes have performed in a national shutdown.

PFR:          Can you point to specific areas where you think that value can be found still?

Redinger:  We still believe that residential solar has a lot of bang for the buck. The returns that are available in residential solar are significantly higher than wind or other C&I or utility-scale solar projects.

Brown:      As a point of reference, if you go back to January 2019, you had a 30-year Treasury at about 3%, and a 10-year Treasury at about 2.5%. The 30-year’s now at 1.5%, the 10-year is sub-1%, so even if equity returns are about the same or a little bit inside of where they were before, on a risk-free rate basis, you may actually be better off in renewables than you thought you were if you invested a year or so ago. If the thesis is that you’re getting pretty airtight contracted cash flows for a period of time, with a view on some merchant exit value thereafter, I think you’re still doing pretty well across the entire asset class.

PFR:          It was interesting, Andy, what you were saying about residential solar. The market for US renewables in general is very international. There are European funds, strategic investors from Asia, all kinds of different international investors coming and investing in solar and wind in the US, but I wonder if that is perhaps not so much the case in residential solar. Can you talk a little bit about the ecosystem of who is owning and investing in residential solar assets in the US?

Redinger:  Yes, I think that’s a true statement, but let’s talk at the end of the year. We’re starting to see some international players come in, but it’s a relatively newer space, so it’s going to take some time. It feels like residential solar has just gained enough critical mass and the track record to begin to attract more international investors. The other asset classes within renewables have just had a bigger head start. With residential, there’s a lot more work involved in understanding it, because there’s a consumer component to it. Not only that, but there wasn’t a critical mass yet in the US, which is getting sizeable now. I suspect that going forward, resi will follow a similar path to the other asset classes in our space, and we are starting to see that. Money finds opportunity, and money’s starting to find the residential component, including some interest from overseas investors.

PFR:          That would be interesting to see. I’d like to move on to sources of financing now. How has the cost of debt played into the market for US renewables recently?

Brown:      When Covid first hit, there was some disruption, as every bank tried to assess what their funding costs would be on a go-forward basis. There was certainly some confusion for a 30-day period or so. But the market is pretty much back. On a spread basis, it might be 25 bp, plus or minus, wider than it was before, but going back and just thinking about the underlying risk-free rate, Libor has fallen pretty precipitously, so if you’re a developer, your overall absolute cost of debt is probably pretty much around the same level as it was before. It might have just been constituted differently between the risk-free rate and the spread.

                   There were certain institutions that were unsure about their level of engagement in the market on a go-forward basis. It might have been some of the European investors. But I don’t think that’s true, necessarily, anymore. If you’re a developer and you have a strong project, I don’t think you’re going to have any difficultly filling out the debt portion of the capital stack.

PFR:          Does that include developers of distributed generation?

Brown:      There may be a smaller pool of banks that are in that space, but we’re one of them and we don’t think that there are developers that are having issues finding financing in that sector either. So whether it’s residential, whether it’s distributed, or C&I or utility-scale, there’s capital available.

PFR:          You mentioned residential solar again. That is an area where there is an increasingly wide range of financing options available.

Redinger:  Yes, up and down the capital stack. The ABS market is wide open, and each new deal helps to educate and bring new investors into the residential solar space. We are seeing terms and structures tighten, so that’s also a great sign. In addition, we see more interest from banks and an increased willingness to provide credit to residential solar. It seems to be going a bit slower than the ABS space. But, I suspect that’s going to start accelerating as banks get comfortable with the consumer component.

PFR:          When an investor buys renewable energy assets in the US, perhaps from a developer or another investor, is there much scope to refinance them on more favourable terms, if they already had financing in place?

Brown:      That’s a very case-by-case question. Depending on when the financing was put in place, it might be possible. It may not be. It probably depends on the incumbent sponsor.

PFR:          Do you see much refinancing activity generally, in renewable energy?

Redinger:  We used to. Over the last year or two, there was a lot of it. The market, a couple of years ago, was significantly different from the market today. A lot of our clients – a lot of sponsors generally – took advantage of the refinancing market over the last couple of years. But this year, compared to the previous two, I’ve seen very little.

Brown:      There are some cases where there are some older-vintage portfolios that were not previously levered, that are running off tax equity, and those sponsors are running processes. These are some of the large European utility holding companies. There might also be a case where people call about acquisition financing. But it’s not usually a case of restructuring what is already in place. The whole capital structure is changing as tax equity is rolling off. We’ve seen some of that, but we’ve had very few calls about shaving a quarter of a point off the margin, for instance.

PFR:          Speaking of tax equity, you’ve mentioned already that you expect there to be slightly less availability of tax equity, given what is happening in the economy more generally. Corporate profits, presumably, will not be as high as previously expected. How does having secured tax equity already impact the attractiveness of a project to investors?

Brown:      It’s a pretty significant de-risking milestone. There are funds who want to invest in this asset class, but don’t have either the manpower or the ability to go and source that tax equity themselves, so that is a huge driver of value.

                   If you’re a developer, you’re probably either selling pretty early, before any of those conversations start, or you’re waiting and structuring that tax equity on your own and going from there. Given the feedback that we are hearing from sponsors about the relative challenge of finding 2021 tax equity versus 2020, that will become even more relevant.

PFR:          Will developers and other investors try to get more creative around finding tax equity partners, rather than going to the usual suspects?

Redinger:  For the newer entrants that don’t have established tax equity relationships, they’re going to have to get creative. There are probably more projects than there is tax equity, but we’ll have to see if that’s the case. Tax equity investors don’t say that’s the case, but I know there are going to be less corporate profits next year, which means there will be less tax capacity. The newer entrants, the ones that have not done tax equity deals before, they’re the ones that will have a hard time finding tax equity, and they will probably have to be more creative.

PFR:          Given the Covid-19 pandemic, which has been a defining event of this year, how active has the market for US renewable assets been in the first six months?

Redinger:  Today, I don’t see that there’s a difference. There’s the same amount of capital chasing the projects as there was in January. Maybe in March and early April there was a little bit of a blip, but it’s business as usual as far as I’m concerned.

PFR:          Have lockdown measures affected the way sale processes are conducted? How are investors carrying out due diligence, for example?

Redinger:  We’ve worked around the due diligence issues and site visits and those types of things. Maybe some deals were delayed a week or two because of that, but the market is finding a way around them to get these deals closed.

Brown:      Pretty much everywhere in the country, renewables were considered an essential asset class, and so people had access to go to sites. We are aware that IEs are starting to visit sites, so that’s not an impediment. People make a lot of sponsors potentially going to site visits, but, depending on where you are in terms of construction, I’m not sure I’ve ever seen a site visit make or break a deal, or someone walk away based on what they saw on the site. As a result, we really haven’t seen much, if any, impact.

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