America’s biggest banks are predicting a “very dynamic” tax credit transfer market for renewables in 2024. That means more corporate participants and more credit suppliers than the market, which started to take off at the end of last year, has yet to see.
- The top line: Clean energy tax equity deals are starting to include a feature that gives the lender the right to direct the project to sell tax credits, in what’s being dubbed a “hybrid” model. But uncertainty about the growth of the tax credit transfer market and changing tax equity requirements is impacting the volume of tax equity commitments made so far this year, bankers said in a webinar with Norton Rose Fulbright last week.
- The market context: JP Morgan Chase and Bank of America, which account for over half of tax equity deals for renewables, estimate that around $4 billion in credit transfers were completed in 2023 — not including hybrid tax equity deals.
- The current take: When Bank of America first started considering hybrid transactions, they were presented as much easier to pull off than tax equity deals, managing director and head of tax equity origination Jack Cargas said. “But the diligence factor is surprisingly voluminous,” he added. ”Tax credit buyers are looking for a whole lot of information, and insurers are looking for a whole lot of information.”
Investor appetite for tax equity is growing, though at a smaller pace than market demand, said Rubiao Song, managing director and head of energy investments at JP Morgan. But the rise of hybrid transactions means that tax credit transfers are increasingly being built into the tax equity deal, Song added. “We believe it’s a very good model to expand the tax equity monetization market,” he said.
However, while these hybrid deals are on the rise, they’re complicated by the fact that there’s no market standard for their structure, said Cargas: “They’re all being negotiated on unique bases,” he said.
Given the number of these deals expected in the coming year, Cargas said Bank of America anticipates the hybrid structure will “settle into a less bespoke and more standardized product.”
Many projects have an additional complication: non-equity debt.
“If there is project level debt, or more commonly back leverage debt in place, the transaction is likely to require some kind of consent for a tax credit purchase agreement to be negotiated,” Cargas said, adding that getting that consent can be challenging.
Lender receptivity to proposed hybrid deals has varied, and many have concerns regarding contest rights, Cargas said. That’s been a challenge as the market adapts, he added.
The elephant in the deal room
Big banks may be anticipating a lift to the tax credit transfer market, but they aren’t sure just how quickly it will grow.
In part because of that uncertainty, Cargas said Bank of America has had a slightly slow start to the year: while the bank usually has around 80% of its expected tax equity investments committed by mid January, this year they’re currently at between 50 and 60%.
“It’s hard to really state exactly what we think we’re going to do this year,” he said. “The tax credit transfer market is important, it could be impactful, we’re not sure.”
Several of the bank’s commitments from prior years have “rolled over” into 2024, whether by deal design or due to construction delays, Cargas added. Interest in tax equity is still high, he said, but as far as what the bank will commit to this year, “it’s a little nebulous.”
The elephant in the room is the looming implementation of banking rules that might make tax equity financing for clean energy projects more expensive, said Song. The final set of rules to be implemented under international banking regulations known as Basel III could require that, starting in 2025, banks maintain a 400% financial cushion for tax equity deals — four times more than today’s requirement. Song said he’s seeing “encouraging signs” that regulators are acknowledging the unintended impact of the proposed rule, but timing is crucial.
“As of now, there’s a significant amount of uncertainty around how the final rules will come out,” he said, pointing to industry efforts to convince regulators to reconsider.
“We are proceeding very cautiously,” Song added. “If we do not see any good resolution by mid year, I would expect major bank investors will take a pause in issuing new commitments.”
