Editor’s Note: This article is the second in a bi-monthly Solar Power World series on U.S. solar financing to help our readers understand the current states of play in the U.S. solar financing markets. We’d like to thank Robert Sternthal, president of Reznick Capital Markets Securities, for working with us to produce this series.
By Robert Sternthal
In the first article, I tried to distinguish amongst the three viable U.S. markets for solar, as follows:
- Residential Solar
- Small-Scale Commercial
- Large-Scale Commercial/Utility-Scale
In this article, I will attempt to provide additional insight — and hopefully some foresight — into the small-scale commercial market.
How The Small-Scale Market Is Defined
Most people in the solar industry would define the small-scale market as anywhere from 500 KW to 5 MW. I would argue that you probably need to get to at least 10 MW before you could create a single financing mechanism for a project, so even deals less than 10MW should be considered small-scale.
Small-Scale Market Challenges
Of all the issues in the small-scale market, nearly all of them boil down to the classic chicken-egg theory. A majority of transactions are put together by sponsors, developers or engineering, procurement and construction (EPCs) companies without either:
- a financing strategy;
- or an exit strategy.
Even when sponsors believe that they have both of those, they are usually proven wrong. Why?
In a typical sale, sponsors often get the following wrong. They assume:
- an after-tax yield that is lower than market. Market pricing depends upon more than just economics, e.g, location, size, technology, ITC vs. 1603 grant, etc., are also important factors;
- that only after-tax yield matters without looking at a cash-on-cash yield. No, a 4% cash-on-cash return does not work;
- all buyers will take bonus depreciation. Most do not;
- all power-purchase agreements (PPAs) are financeable. Many need to be amended or revised in some manner;
- leverage/debt that does not reflect market. Even high priced offtakes require equity to keep “skin in the game”;
- S-RECs at inflated or market pricing. Only equity owners can take an aggressive view of S-RECs, while all others take the most conservative approach;
- state credits are easily saleable (particular to North Carolina). There is a very limited market for state credits or those markets would be similar to New Jersey or California; or
- my off-taker is bankable. Without an investment-grade rating, financing is not a given.
Not Enough Equity Capital
Solar projects are capital intensive. Even the best projects require 15% to 20% equity capital, balance sheets to support investment tax credits (ITC), recapture indemnities, environmental indemnities, debt support, PPA support (L/Cs) and cross-guarantees, among others.
To develop, build and own 50 MW of deals, a good sponsor might be required to have $50 million of capital with more than $25 million of it being liquid. How many sponsors do you know with $50 million in the small-scale commercial space? Can you get further than counting on one hand?
What Does This Mean To Contractors
You must know what your exit strategy is. Are you a seller? Do you want to develop your projects with a view to sell them and cash out once your project is shovel-ready? Or do you want to own your projects long-term, in which case, you’d better start shopping for a capital source.
If you are a seller, you need to understand your market. How do potential buyers in my market value solar deals? How do they view the tax benefits? SRECs? State tax credits? Panels with warranties?
If you are a long-term owner, you need to fully understand the tax equity and debt providers in your market. How will they view your projects? How is your balance sheet and wherewithal to support your projects? How is your track record? What financing structure will I use, and how will such structure affect my returns?
What Does All This Mean For The Market?
Few will survive. Many sponsors have gone up in flames, and with the changeover from the grant to the ITC, there will be less room for sponsors to make mistakes in their assumptions. Today, we’re already seeing large sponsors that have aggregated anywhere from 100 MW to 2 GW, selling portions or all of their portfolios or their companies even, to secure the capital necessary to develop their pipelines, while many of the deals in those pipelines are virtually worthless to potential buyers because of the common mistakes discussed in this article.
Whether sponsors are consolidated into only a few or not, the deals themselves will ultimately consolidate into a few large owners — with tax capacity at first — and then most likely into some form of real-estate investment trust structure that develops such that the institutional and retail markets will own the cash flows from large portfolios of solar and other renewable projects.
Sternthal is president of Reznick Capital Markets Securities and has extensive experience in financing renewable energy transactions, whether they are in the wind, solar or biomass sectors. Working alongside Reznick Group and Reznick Think Energy, Reznick Capital Markets Securities offers one of the most comprehensive financial advisory platforms in the industry.