The latest on Energetic and renewable energy trends.

In the energy sector, projects that don't fall under utility-scale or residential categories are typically classified under the catch-all segment of commercial and industrial (C&I). This broad classification can obscure the nuanced differences within the segment. In prior blog posts, we explore the shift to "true C&I" and the various challenges in financing these projects. Developers must collaborate with financing partners who understand the nuances of C&I. Rigid underwriting in C&I financing overlooks the unique aspects of each project, often disregarding potential revenue streams and resulting in sub-optimal financing terms for sponsors.

Financiers determine how much to lend based on the Cash Flow Available for Debt Service (CFADS) after a project has covered all relevant operating expenses and senior investors, like tax equity. They apply a Debt Service Coverage Ratio (DSCR) to decide the amount to advance against expected CFADS, a process often referred to as "Debt Sizing."

Determining CFADS & Debt Service Payments

Inputs:

• Revenue  
• Expenses (including any Tax Equity Distributions)
• Debt Service Coverage Ratio (“DSCR”)

Formula (annual figures):                                              

CFADS = sum(revenue) minus sum(expenses)

Debt Service = CFADS / DSCR

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Key Inputs to Determine Total Proceeds 

1. Amortization Period: The total length of time it takes to repay a loan in full through regular payments.  
2. Interest rate: The cost of your loan as proposed by your Financier.
3. Term: The length of time until the loan is due and must be fully repaid.*  
4. Debt Service Payments: The amount of money required to cover the repayment of interest and principal on a debt over a specific period.

*In the event the Term is shorter than the Amortization Period, this is typically called a “Mini-Perm” structure where a balloon payment would become due.

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When determining a project’s expected CFADS, financiers have discretion over what qualifies as "eligible revenue." For example, some lenders may exclude revenue from storage assets due to concerns about battery performance risks. This practice reduces the revenue a sponsor can use to repay debt, limiting total proceeds. Additionally, debt proceeds are impacted by financing terms. Some lenders arbitrarily limit amortization periods, meaning contracted revenue sources may not be fully accounted for, regardless of their contracted term.

Consider a project that includes installing electric vehicle (EV) charging stations. Traditional lenders might disregard cash flows from these charging stations as repayment sources because they lack long-term contracts. However, the rising demand for EVs and increased usage of charging stations indicate significant revenue potential over time. If financiers were to credit even a small portion of this revenue stream — using a Debt Service Coverage Ratio (DSCR) of 2.0x, for example — it could substantially boost the proceeds available to the project sponsor. This additional credit could be the deciding factor between the project's success or failure due to insufficient funds.

Standard underwriting for C&I solar projects often follows a checklist approach with predetermined values or assumptions for the inputs above. Rigid underwriting reduces debt proceeds by not considering each project's unique aspects, leading to suboptimal financing outcomes due to a lack of risk-adjusted flexibility and a one-size-fits-all approach that overlooks specific project variables.

To illustrate this, let's consider Donnie the Developer, who is working on a project that includes solar, storage, and EV charging. While the solar and battery assets are fully contracted for 20 years, the EV charging revenue is not contracted. The financing parties, constrained by their underwriting manual, set amortization at "the lesser of 15 years or 80% of the contract term," which arbitrarily results in a 15-year amortization period. Additionally, the lender excludes any revenue from EV charging.

Donnie’s proceeds are significantly limited by these rigid practices. Adopting a more nuanced approach would substantially increases his proceeds. First, amortization could be allowed for the full contracted term, considering that the useful life of these assets exceeds 20 years. Additionally, financing parties could apply a more conservative DSCR of, say, 2.0x specifically for EV charging revenues, providing some credit for this cash flow. As a result, Donnie could see a significant increase in total debt, potentially by 10% or more.

This flexibility enhances financial outcomes for Donnie by increasing project feasibility and attracting broader access to capital. By tailoring financing terms to the unique aspects of each project, Energetic Capital ensures developers like Donnie can optimize their projects, secure necessary funding, and contribute to the growth of sustainable energy solutions.

Small to mid-size C&I projects have always struggled to obtain financing from tax equity.  Utility-scale projects have historically utilized the partnership flip structure, and in recent years have started to explore inverted lease structures more. Residential rooftop portfolios have almost exclusively used partnership flips and inverted lease as the preferred form of structure to raise tax equity. On a stand-alone basis, however, small to mid-size C&I projects cannot support the transaction costs that these more complicated structures carry.  This often results in developers aggregating projects into a portfolio and selling them into a single tax equity partnership or utilizing a sale leaseback structure for individual projects. In this post we outline the pros and cons of the prevailing tax equity structures and the emergence of transferability in an attempt to surface the reasons for a perceived bottleneck in tax advantaged capital in C&I projects.

When comparing the three structures, each has its advantages and disadvantages:

All three cases present unique challenges for C&I developers, but at the root are two main issues: size and standards.

There is not enough juice in the squeeze. Smaller projects cannot sustain the costs of setting up and administering complex tax equity structures like P-Flips or inverted leases. Sale lease backs present an interesting opportunity, but most of the banks with tax capacity and the capability to underwrite project finance have minimum size and sponsor standards that preclude many C&I developers.  

Underwriting standards are high. The stakeholders making tax investments are generally risk averse. The majority of tax equity transactions are underpinned by investment grade rated offtakers. In some ways this is a product of complexity; having a credit counterparty that is perceived as a strong credit “simplifies” an otherwise complex process. However, most C&I offtakers do not meet this credit standard.  

The complexities of various tax equity structures have led many developers to sell tax credits generated by the project. Contractually this is a simple approach, but it does not allow for a fair market value step-up nor does it confer any depreciation benefits on the purchaser. Some projects are pursuing hybrid structures (known as “T-flips”), but the real issue is a supply-demand mismatch: there are more projects than tax advantaged capital can support. This causes a flight to simplicity and perceived quality... in other words: size and standards!  

The solar energy industry has experienced rapid growth in recent years, fueled by both the increasing demand for sustainable energy sources and financial incentives like the Inflation Reduction Act. However, solar developers often encounter a significant pain point: their businesses outgrow the financing capacity of the local and regional banks that provided their initial capital. The mismatch between the pace of project development and the availability of financing is causing developers to focus on shopping for financing rather than developing pipeline, which is hindering the industry's overall progress and impacting the developers’ bottom line.

For example, one solar developer we’ve spoken with is expanding nationally and its current pipeline is more than twice the MW in its current portfolio.  This developer is struggling to find new financing partners that can scale with it. We’ve also recently spoken with another developer in search of new financing for a similar reason: its growing portfolio of projects is approaching the legal lending limit from a regional bank to a single sponsor. Without sufficient capital reserves or access to alternative funding sources, developers may be forced to accept less favorable financing terms from larger banks.

Energetic Capital offers financing solutions to overcome challenges like these. Energetic’s loans can start as low as $5M and scale to $50M or even $100M over time, empowering developers to scale with a single source of capital while owning their projects. We offer time-based facility structures that allow for flexible draw periods with terms that can improve with time and scale.  Energetic Capital will work with developers to ensure that they can grow their portfolio without having to sell projects for the liquidity needed to scale.

Development platforms that hold on to projects can multiply enterprise value by up to 12x!

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Earlier this year, we published a post detailing some of the challenges commercial solar developers face, and how these challenges often force these developers to sell. As we approach the middle of the second quarter, this phenomenon persists. C&I developers often face a tough choice: sell projects for immediate liquidity or hold them to build long-term enterprise value. In this post, we reconnect with our friend Donnie the Developer to explore the pros and cons of this decision.

Developers that sell projects are able to capture a material gain on their work. Purchasers are typically willing to pay a 20% premium to EPC costs (sometimes called a development fee or market-up) to acquire projects. This provides originating developers with a major liquidity event, clearing any development financing and ideally creating a dividend for the developer. This is an attractive option in the short-term. However, this approach is less accretive to long-term enterprise value. When developers hold onto their projects, they create enterprise value by building a portfolio of long-term, revenue generating assets on their balance sheet. Depending solely on the income from selling projects makes a development platform vulnerable to market fluctuations. While the market may be favorable today for PPAs that you negotiated over the last 8 months, it may not be true for PPAs that you’re negotiating today and plan to sell 8-12 months from now.

Donnie Developer has historically focused on selling projects, favoring the influx of liquidity that can rapidly be recycled into new projects. However, rising interest rates, cost inflation and other market influences are making it harder to find buyers. This is straining Donnie’s balance sheet, as maturities come due amounts borrowed to fund development.

If Donnie Developer shifts to holding onto projects, he could create significant enterprise value. Green Energy companies see EBITDA valuation multiples of approximately 12x This means that each $1 in project (or portfolio) free cash flow creates up to $12 in enterprise value for the sponsor. There is an added benefit: the more proejcts that Donnie chooses to own, the stronger his balance sheet becomes, reducing friction in securing new financing.

In the current market, choosing a balanced strategy enables developers to enjoy stable, recurring cash flows while also capitalizing on market opportunities, ensuring they don't sell their future short. Sponsors should evaluate their access to flexible, commercial financing that will enable them to own their projects. Energetic has helped many sponors navigate the complex web of possible liquidity solutions – reach out to learn more.

On its face, renewable energy project finance should be very simple: projects sign a long-term power purchase agreement (“PPA”) selling electricity to an offtaker, and developers then borrow funds against that known, future revenue stream to build the project.

Simple, right? Sadly no. Financiers determine how much they are willing to lend based on the Cash Flow Available for Debt Service (“CFADS”) after a project has paid all relevant operating expenses and senior investors (such as tax equity). Financiers apply a Debt Service Coverage Ratio (“DSCR”) to determine the amount they are willing to advance against expected CFADS (often referred to as “Debt Sizing”).

This becomes a complicated exercise after giving effect to all the ways a project can generate revenue. Unfortunately, most financiers take a binary view, often significantly discounting any source of revenue that is unfamiliar or that does not fit within their “credit manual”. The result is lower CFADS (at least as far as the lender is concerned), and lower debt proceeds to the sponsor.

The most common example of this is how financiers often treat contracted PPA revenue from sub-investment grade or unrated offtakers. Project sponsors have seen financiers applying a discount of 80% or more to these cashflows, cratering the economics for sponsors. Take the following example inspired by a transaction Energetic Capital worked on recently:

Donnie Developer executed a fixed price PPA at $0.15/kWh with an unrated, midsized private manufacturer with a strong financial profile. The project will generate 2.37M kWh in year 1, resulting in over $350K in revenue.  The lender discounted revenue under this contract by 50% due to the lack of a credit rating. With revenue cut in half, the loan amount offered by the lender fell by more than 60%.

Donnie reached out to see if Energetic Capital was able to devise a more palatable financing solution. Energetic Capital’s ability to look at the offtaker risk in context of the entire project enabled Donnie to receive full credit on the offtaker PPA. Ultimately, Energetic Capital’s financing solution resulted in a significant bump in the developer’s levered rate of return, increasing from 10% to 14%.

Flavors of this scenario are playing out constantly across the C&I segment. Before you give up on financing projects yourself, reach out to see whether there is more value in your project than traditional financiers are willing to concede.

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Boston, MA – April 8, 2024 – Energetic Capital (“Energetic”) announced its first ever binder for a credit insurance policy that will cover offtaker payment risk in a utility scale transaction. EneRate Credit Cover, a proprietary credit insurance policy offered by Energetic Capital, is an established solution for C&I developers seeking to make their projects more bankable. Application in a utility scale transaction is an important evolution that demonstrates the flexibility of Energetic’s underwriting capabilities. EneRate Credit Cover employs a novel risk-based pricing model that leverages proprietary market forecasting.  

This transaction also signals an important market shift. Historically, credit enhancement has not been required for large utility scale projects with large, regulated utilities as offtaker. Rising load requirements and ESG initiatives are causing more corporates and their suppliers to enter into bilateral agreements with generators, introducing counterparty credit challenges that were not relevant for utility scale transactions.Virtual and offsite PPAs are making renewable energy more accessible, but many investors are unwilling to lend to projects that rely on sub-investment grade or unrated offtake.  

“Renewable energy procurement is no longer limited to companies engaging in principled investment strategies. It now forms a cornerstone of the energy supply for large consumers. We are excited to be able to help facilitate this shift into a wider market The benefits of distributed energy resources should be more widely distributed. We are excited to expand  our thesis into large scale projects and enable more buyers to access clean energy.” said Jeff McAulay, CEO at Energetic.

The transaction is an important milestone for Energetic and for the industry as a whole as the industry moves meet clean energy targets and combat climate change. To learn more about Energetic’s products reach out!  

For media inquiries, please contact:  

Jeff McAulay - (617) 819-4332

jeff.mcaulay@energeticcapital.com  

NOTE: This Press Release does not constitute and is not intended by Energetic Capital or any of the entities mentioned in this release to constitute a solicitation for any insurance business.

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About Energetic Capital(www.energeticcapital.com)  

Energetic Capital is a specialty financing company with a novel, data-driven approach to develop new risk management products to unlock investment in the renewable energy industry. Our first product, EneRate Credit Cover®, unlocks renewable energy project financing for unrated and below investment grade counter parties by covering offtaker credit risk. The EneRate Credit Cover has been used on more than 1,200 renewable infrastructure projects. In 2023, Energetic added lending capabilities (construction and permanent financing) to provide more solutions for its development partners.

Headquartered in Boston, Energetic Capital was awarded a SunShot Prize from the US Department of Energy in 2017 and has received more than $7M in corporate financing to date. EneRate Credit Cover™ and other insurance policies are issued by RE3 Energetic Insurance Solutions, LLC, or SiKey Insurance Services, LLC in New York, wholly-owned subsidiaries of Energetic Insurance, Inc. d/b/a Energetic Capital.  Energetic Capital complies with all state-mandated regulations for surplus line insurance brokers and RE3 Energetic Insurance Solutions, LLC is licensed as a surplus lines broker in Massachusetts with License #: 2053916.