ASF Journal, 2010 - Financing Renewable Energy


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Financing Renewable Energy with application of Structured Finance Technology

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ASF Journal, 2010 - Financing Renewable Energy

  1. 1. By John Joshi FAs much as $10.3 trillion inancing renew- able energy haswill be needed to fund never been more important. Around thealternative energy projects globe, from the United States to China to Bra-over the next two decades. zil, energy needs are growing at an ever fast-As the bank market starts to er rate while the tradi- tional carbon-based en-shrink, capital markets and ergy complex is under a great deal of strain.securitization ought to be Global warming is a key issue that needs toideally placed to step up and be addressed. And the need and desire to en-help reach that target. But sure energy security is of paramount concernthey need some help. for many nations. Renewable energy can provide many of the solutions: it’s kind- er on the environment, To prevent more of this... Shutterstock is sustainable and because it’s local it removes the need to import energy sources from politically unstable or unfriendly nations. But there’s a problem: funding infrastructure Energy projects is no easy task. The capital markets in general and securitization in particular could play a major role. But in the United States, at least, part of the issue stems from the fact that financing renewable projects is too dependent on cash grants and tax credits which have to be renewed every few years by Congress. The Investment Tax Credit, for Renewable example, is applied to a project immediately while the Production Tax Credit is based on the amount of energy produced. Being dependent on Congressional whim makes it hard to secure long-term funding. So I propose two solutions to channel capital towards long-term financing of renewable energy projects. A GSE for Renewables Financing First, I would argue that one crucial change needed is for the United States to establish an entity modeled after government sponsored entities like Fannie Mae and Freddie Mac to provide guarantees on loans, bonds and super-senior tranches of asset-backed securities. Let’s call it a renewable energy government sponsored entity, or REGSE. I know that calling for yet more government support after the financial crisis may 4
  2. 2. immediately strike many as unpalatable. So let me explain the exploit. The idea of a climate bond has been around for some reasoning. time. But securitization could play a large role, too. Both se- Financing alternative energy is already heavily dependent cured and unsecured bonds can be more appealing than bank on government support. One of the ways this happens is by loans thanks to the ability to offer longer maturity tenors, third- using so-called tax equity: selling, at a discount, tax credits that party credit enhancement and more flexible covenants. They stem from operating losses. Of course, to take advantage of in- also, of course, can tap into a much larger investing universe. vesting in tax credits, an entity has to have income to offset the And securitization offers both debt and equity financing tax credits and reduce its tax- of portfolio assets with lower able income. Unsurprisingly, correlation and increased di- the economic downturn hit versity and stronger credit that market hard: the Solar enhancement. The structures Energy Industries Associa- can be more efficient and of- tion reckons the number of fer better leverage for equity tax-equity buyers has shrunk investors. Credit risk can be from around 30 to just seven delinked from the asset origi- or eight. nators and the structure can The 2009 American Re- isolate the assets in a bank- covery and Investment Act ruptcy remote vehicle to pro- helped out by providing cash tect against the originators grants instead. Most projects defaulting. since have used the cash grant Of course, securitization Shutterstock to source investor capital. And ...securitization could help finance more of these has its own challenges. Regu- they allowed more investors to participate in renewable energy lators around the world, including the Securities and Exchange projects: hedge funds, for example, have been active lenders, re- Commission, are weighing how to impose mandatory risk re- ceiving the cash grant within 60 days of a project starting. At tention rules on originators securitizing their assets. If the final the end of last year, Congress renewed the grants for another rules require lenders to keep a 5% vertical slice, it might be rela- two years. tively manageable. But if regulators decide that keeping 5% of But replacing such stop-gap and ad hoc measures with a the first-loss position is preferable, banks would have to set aside more robust debt guarantee program, with proper oversight of up to 10 times as much capital, which is bound to be prohibitive. course, would be a marked improvement. Consider just how much investment globally is needed. The A Role, at Last, for Covered Bonds? International Energy Agency estimates that $10.3 trillion will The second solution I propose is to combine REGSE support be required to fund alternative energy projects over the next with a covered bond market mechanism to provide additional two decades just to maintain the climate stabilization target of liquidity for banks to recycle their capital and access the struc- not allowing temperatures to rise by more than 2 degrees Celsius. tured finance markets for renewable energy projects. If originators have to retain risk, a covered bond market Investment Shortfall; Capital Markets Opportunity would allow the balance sheet capital provider to recycle the Yet in 2009 just $162 billion was invested, according to Bloom- capital after a project is out of the build-out phase and has berg. That’s less than a third of the IEA’s average annual base achieved a certain amount of seasoning in power generation andEnergy case estimate and 7% low- revenues before securing er than the year before. The International Energy Agency estimates permanent financing from Virtually all the capital the securitization market. came either from com- that $10.3 trillion will be required to Access to the coveredRenewable panies tapping their own bond market would allow balance sheets or from the fund alternative energy projects over the banks to recycle their cap- bank loan market. And next two decades ital efficiently and allow both sources are limited. investors to participate Moreover, the bank market is likely to shrink further thanks in high quality renewable energy projects. The flow of capital to regulatory changes such as the Basel III rules that require would increase substantially to the sector. The ratings on the financial institutions to hold more short- and long-term liquid- projects could be enhanced via GSE support on the senior partFinancing ity and more Tier 1 capital in general and even more capital in of the structure. The capital ratios for banks could benefit by particular against lower-rated loans and securities they hold. So reducing the overall risk with REGSE support. even as the economy recovers, banks will be taking risk off their A GSE-style guarantee, though, would render some of books. the challenges moot, assuming renewable energy loans were That ought to be an opportunity for the capital markets to granted the same risk-retention exemption as qualifying4
  3. 3. mortgages look set to get. would not be subject to congressional appropriations. The It’s not a new idea. The Coalition for Green Capital (CGC), House passed the bill in June 2009 but it is still stuck on thea non-profit organization in Washington, DC, has been push- Senate Legislative for the government to establish a Green Bank that can cul- These aren’t ideal proposals, but they do demonstrate thattivate “a stable, long-term investment environment, lasting for a Congress recognizes the viability of and need for securitizationdecade, to encourage profitable business deployment of sustain- as a key financing tool for the renewable energy energy.” CGC’s proposal includes creating an Energy Inde- But more is needed. A GSE-style guarantee would allowpendence Trust — a non-profit company run by the private sec- the financing of longer dated maturities of debt as well pro-tor as a federal corporation along the lines of a GSE entity that vide cheaper debt financing and equity leverage for projects. Awould provide low-cost, long-term financing for energy projects. combination of regulatory policy initiatives similar to CEDA, Congress has been mulling similar plans, too. The Ameri- development of a Green Bank and the covered bond market,can Clean Energy and Security Act (H.R.2454) seeks to estab- and government guarantees may allow us to create the appropri-lish a new Clean Energy Deployment Administration (CEDA) ate securitization structures which, in turn, and with the right“to promote access to affordable financing for accelerated and combination of leverage, would enable a significantly lowerwidespread deployment” of clean energy, energy infrastructure, cost of capital for energy infrastructure projects. Investors andenergy efficiency and manufacturing technologies. The House our society will benefit from access to a new asset class.version of the bill has provisions that allow CEDA to guarantee The views expressed are those of the author and do not necessarily represent thetax-equity deals and power purchase agreements. The bill also views of ASF.allows CEDA to provide credit support to a portfolio of taxable John Joshi is a managing director at CapitalFusion Part-debt obligations for energy efficiency and to install renewable ners LLC, FinCap Solutions LLC and a senior advisor atenergy capacity, though it’s limited to two megawatts. The Sen- SeaCrest Investment Management. At CapitalFusion Part-ate version of the bill allows CEDA to use financial mechanisms ners and FinCap Solutions he has responsibilities in businessincluding securitization, indirect credit support, other means of development and oversight of all strategic business enhancement and secondary market support through lend- At SeaCrest he is responsible for Sustainable Investment Research and the portfolio management team for the Cleaning on the security of debt for clean energy technology. Funding Earth Fund Strategy.for CEDA would come directly from the U.S. Treasury and