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ITC Equity Market Remains Active Amid COVID-19 Pandemic
Like so many other industries across the world, the solar investment tax credit (ITC) equity market is affected by the COVID-19 pandemic.
However, ITC investors and syndicators are moving forward on existing developments and continuing to make new investments.
“In the immediate COVID-19 market shock, we saw the large players that define the tax equity market stand by their commitments,” said Jessica Robbins, senior director of structured finance at Sol Systems. “Their consistency helped greatly to calm the market.”
“Our forecast for the year is unchanged and, of course, [we are] honoring all our commitments,” said Darren Van’t Hof, managing director of environmental and community capital at U.S. Bancorp Community Development Corporation (USBCDC).
However, the pandemic is affecting investors’ appetite for ITCs.
“Our budget is a little smaller than expected coming into this year given the impact of COVID-19,” said Eric Heintz, director of energy finance at M&T Bank. “My perception of the industry is that investors will fulfill their 2020 commitments. From there, I expect most investors to proceed cautiously.”
“It certainly has an impact. Some investors have indicated reduced tax capacity this year,” said Tom Bitting, principal at Advantage Capital. “They are still interested in projects, but some have a lower tax appetite and some are taking a more general pause due to the overall level of economic uncertainty.”
That being said, investors are still closing transactions during the pandemic.
Heintz said M&T Bank is still cautiously moving forward and committed to a transaction in late May for 2021.
“This is still an appealing credit for investors. Those with capital want to continue to invest,” said Bitting. “For us specifically, we are definitely still active. We are out evaluating transactions, negotiating term sheets and pressing forward. We are still closing deals, but are a little behind on the calendar. Deals that would have closed [in early June] are closing in late July or August.”
Van’t Hof said this cautious outlook may remain for a bit moving forward.
“We have seen some uneasiness about new commitments, particularly for 2021,” said Van’t Hof. “People are being less generous in making 2021 commitments. [Investors] are less willing to write term sheets.”
“Banks are setting aside substantial reserves for anticipated credit losses due to the impact of COVID-19,” said Heintz.
ITC Equity Pricing
ITC equity pricing has dipped recently.
“Pricing for ITCs is going to come down and yields are likely going to go up,” said Van’t Hof. “This change in pricing is not entirely a result of COVID-19. Because of the credit stepdown and the safe harbor [provision], there is some acceleration of activity. Pricing is favorable to investors because of the supply and demand.” Van’t Hof added that the price per credit for the ITC is lower now than it was five years ago.
“I haven’t seen an immediate change in pricing because of COVID-19,” said Robbins. “What moves tax credit pricing is the return an investor requires to do the deal. That hurdle may go up in the coming months. However, there is relative inelasticity in investor demand for tax credits–once an investor has exhausted their tax appetite, they’re going to stop doing deals regardless of pricing.”
“We don’t price on a dollar per credit basis. Each deal is unique. Sponsors have different objectives and desired cash profiles for their transactions and we try to be accommodating,” said Heintz. “We focus more on yields. Given the contraction of capital in the marketplace, I expect to see yield premiums for 2020 and 2021 transactions compared to the pre-COVID-19 market, barring any legislative changes.”
Bitting added that the stepdown of the ITC is also affecting the ITC equity market.
The ITC stepped down from a 30 percent credit in 2019 to a 26 percent credit for facilities that begin construction in 2020. The ITC will step down once again to a 22 percent credit for those beginning construction in 2021 before it becomes permanently 10 percent in 2022.
“The stepdown of the ITC plays a role in terms of capital available,” said Bitting. “It is an unwelcome hit in a time of larger uncertainty.”
For the ITC, equity pricing isn’t the only factor to consider.
“There are three major components to ITC pricing: the price per credit, preferred returns and the buyout price,” said Bitting of Advantage Capital, which also invests in state low-income housing tax credits and both federal and state new markets tax credits. “We have seen pricing come down across the board. Though we have seen material movements in price for both low-income housing and new markets, we haven’t seen as much of a decline–yet. There hasn’t been overly material movement [in ITC equity pricing] this year, which somewhat surprises me.”
ITC equity market participants said the Great Recession was quite different from the economic impacts of the COVID-19 pandemic.
“This is a very different crisis from the Great Recession,” said Heintz. “I think the banking industry is considerably more capitalized and has a greater amount of liquidity than it did during the Great Recession.”
“In 2008 and 2009 there were liquidity issues,” said Van’t Hof. “In this case with COVID-19, you don’t have that. Now, there is liquidity and access to capital. This is not a capital crisis, but there is anxiety out there.”
“There are so many differences between the Great Recession and this [economic crisis]. The Great Recession was a housing and financial market crisis,” said Bitting. “These are uncharted waters. In this recession, unemployment spiked so fast and so high–and until that comes back in line, I think there will continue to be a lot of uncertainty, regardless of what the stock market is doing.”
During the Great Recession, the Section 1603 program was created through the American Recovery and Reinvestment Act of 2009 to attract ITC investments. Under this program, the Department of the Treasury made payments in lieu of the ITC to eligible applicants for specified energy property, including solar.
“The 1603 grant program was put in place because of the industry’s constrained tax capacity,” said Heintz.
“Back then with the 1603 program, you had a 30 percent grant that projects could get,” said Van’t Hof.
“A return to the cash grant would provide significantly more certainty in the market,” said Robbins.
Van’t Hof said industry participants have inquired about bringing the Section 1603 program back to help the COVID-19 market rebound, but he isn’t sure that is the best option.
“We are seeing people asking for refundability. It would amount to a new program with rule writing,” said Van’t Hof. “By the time you get through that, you could have made a tweak to the carry-back rule and plug significant gaps.”
However, ITC equity participants believe this pandemic will bring out high quality developments.
“You might see a flight to quality in renewables coming out of this,” said Van’t Hof.
“People will invest in high quality projects with fewer risks,” said Robbins. “Investment grade, simple projects on good sites will do well while projects in newer markets with more risk will be more challenging.”
Bitting sees two potential paths the ITC equity market could take because of COVID-19.
“If we don’t rebound quickly then the declining value of the ITC will be even more painful,” said Bitting. “Or, if we rebound quickly how do we catch up with so much pent-up demand?”