Alarm bells are ringing. Rates are rising. But what does that mean for renewable energy development?
Rates have been de minimis since 2010
According to SEIA, cumulative solar deployment in the United States surpassed 121 gigawatts in 2021.[1] 90%+ of this deployment occurred post The Great Recession. This means that a vast majority of the solar deployment to date occurred during a near-zero interest rate environment. So how may rising rates impact solar development?
Changes in rates are a reflection of economic conditions during a time period. In recent recessionary periods, short-term base rates (treasury rates, LIBOR/SOFR rates, FED Funds rates, saving interest rates) have fallen dramatically while credit spreads (the risk premium for an applicable credit risk) rise precipitously.
Consider a BB rated counterparty with a rate of 10YR Treasury + Credit Spread. In October 2020, the 10YR Treasury was 0.841% and the ICE BofA BB High Yield Index Spread was 3.85%. This implies that a BB rated counterparty’s cost of borrowing from a lender in October 2020 would’ve been estimated around 4.69%. Fast forward to March 2022, the 10YR Treasury is at 2.48% with the ICE BofA BB High Yield Index Spread at 2.37% implying a rate of 4.85%. So, while the base rate (10YR Treasury) rose significantly due to inflationary pressure, the credit spread has compressed, implying less concern in the markets regarding credit risk. In an environment where inflation persists (rising base rates) and economic activity becomes a concern, you could expect to see base rates and credit spreads move in the same direction.
Expected default is increasing
While bankruptcies in Q1 2022 were the lowest in 13 years, the market is signaling the expected 1-year probability of default has increased for most sectors throughout the U.S. according to an April 2022 report from S&P Global Market Intelligence. With future expected default rates rising, there is a degree of likelihood that credit spreads for sub-investment grade or unrated entities may widen.
Cheap Debt (< 4%) is increasingly rare
We continue to hear from our development partners and throughout the conference circuit that between rising EPC costs and rising interest rates, deals that were getting done on paper 6-12 months ago are no longer penciling in today’s environment. While rates are rising, the abundance of capital in the market remains, and developers who have strong banking relationships will be better positioned. Developers that signed PPA agreements 8-12+ months ago are having required, but difficult conversations with offtakers; they are amending prior contract terms to make projects viable. In an economic environment where The Federal Reserve has recently pledged to consider multiple 50bps+ hikes, and supply chain pressures impact small and medium businesses, financing may begin to tighten.
So what does this mean for solar development project finance?
Rising rates have the potential to significantly impact project finance economics. In an illustrative project below, we depict the sensitivity impact on levered IRR (L-IRR) of amortization and interest rate sensitivity for a 2MW project. Based on Energetic Insurance’s view of the market, a 20-year amortization is commonplace and only a 200bps rise in debt interest rates could result in up to a ~11.4% reduction in levered IRR for the developer in this example.
Energetic Insurance is actively working with asset owners and developers who seek to utilize the EneRate Credit Cover to proactively de-risk operating and new construction assets to compete for the best financing terms in a rising rate environment.
Questions? Pose them in the comments below or reach out here to learn more.
This does not constitute and is not intended by Energetic Insurance to constitute a solicitation for any insurance business.
[1] https://www.seia.org/solar-industry-research-data