Reconnecting on the Norton Rose Fulbright Podcast - A Deep Dive into "Transferability"

Tax Credit Insurance Helps Power Up Credit Transfers

Reprinted with permission from Tax Notes - Volume 182 | January 1, 2024

By Marie Sapirie

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The market for tax insurance has evolved alongside the market for credit transfers. At the opening of the new year, it’s likely on the cusp of a further expansion as more transfers are completed, with even more expected in the coming months.

Tax insurance has a long history and applications across many different types of transactions, but a new avenue for growth opened when the Inflation Reduction Act made transfers of renewable energy tax credits possible. Because tax insurance covers known risks, insurers want opinions or well-supported memoranda from outside counsel that offer a strong level of confidence about the credit, said Mark McTigue of Marsh. That generally means a “more likely than not” or should-level opinion or advice.

Even before the IRA, interest in tax insurance had steadily grown over the last 10 years, said Keith Martin of Norton Rose Fulbright US LLP. As more tax credit sales are completed, the demand for insurance will likely grow even more. Martin said that his firm had closed 11 sales of tax credits and has another 20 in documentation.

"The market for tax insurance has evolved alongside the market for credit transfers."

Investment tax credit buyers have so far almost universally required comprehensive risk mitigation, said Billy Lee of Reunion, an energy tax credit marketplace. “They either require a highly creditworthy seller (or guarantor) or tax credit insurance so there is a strong balance sheet that will make them whole for any reduction or loss of credits,” he said.

Credit buyers seeking a high degree of reassurance, particularly on recapture risk, are flocking to tax credit insurance. “If you’re buying a $100 million ITC and there is a possibility that in year 3 there is recapture because of a casualty that knocks the project permanently out of service, that’s a big tax bill,” said Lauren Collins of Vinson & Elkins LLP. Even sellers may prefer to get insurance instead of having to indemnify the buyer, she said.

But prospective credit sellers with smaller credit amounts may have difficulty offering, or be unable to offer, guarantees to buyers. And they might find it challenging to acquire insurance, too, although finding solutions to make the transfers of credits worth less than approximately $5 million is a focus for both tax credit marketplaces and insurers.

New buyers

Historically, insurance provided tax equity investors with reassurance that the credits were good and provided a backstop when a developer lacked a strong balance sheet, said Antony Joyce of Marsh. The transfer market is similar.

There are two types of tax credit buyers in the market, Martin said. The traditional tax equity investors were more likely to be satisfied with the types of indemnities they’re used to having in tax equity financing transactions, but are now starting to shift to all-events indemnities as they see less-sophisticated buyers get them. The other set of buyers expect to be compensated if anything goes wrong with the credit, and they’re less familiar with the risks they’re taking. The latter group is more likely to be a corporation not previously involved in tax equity or renewable energy that wants to buy credits to offset tax liability or as a revenue item. Such buyers tend to want a full scope of coverage, including basis risk, ITC rate computation risk, prevailing wage and apprenticeship risk, and risks connected to the bonus credits for domestic content and energy communities, Joyce said. They’re seeking protection that the credit and the transfer are good, he said.

Joyce said that traditional tax equity investors typically seek insurance for the riskier piece of the credits, rather than attempting to insure 100 percent or more of the credit, as some of the new post-IRA buyers do. “From an insurer’s perspective, the risk that’s being underwritten has the traditional riskier component and has insurance covering components of the credit that were not traditionally thought of as being riskier,” he said. That’s a new phenomenon brought about by the transfer market, and it affects the pricing, Joyce added.

In addition to the two types of buyers, there are also two types of transfers, Joyce said. Many transfers don’t include the step-up in basis typical of tax equity transactions, but a pool of transactions does include it. In those deals is a completed tax equity transaction that includes an embedded step-up in basis in the ITC, and the partnership is selling the credits. For all buyers and transactions, acquiring insurance is currently a bespoke process. “Every project and risk is different,” McTigue said.

Risks in transfers

Recapture is one of the chief risks that buyers of ITCs seek to have insured. “It’s low probability, but high consequence,” Lee said. Recapture insurance also provides a sort of backstop for property and casualty insurance, which most projects already have to cover the investment, he said. There are recapture scenarios that insurance typically won’t cover, however, including if the seller intentionally sells the project or converts it into a facility that no longer qualifies for the ITC.

"Recapture is one of the chief risks that buyers of ITCs seek to have insured."

A primary use of tax credit insurance is when the project’s financing includes debt, Lee said. If the project is performing worse than expected and the borrower defaults, the bank could foreclose, which would cause a recapture if the bank has the first priority lien on the equipment. “Some insurers will require the lender to enter a forbearance agreement to agree not to foreclose in the five-year recapture period,” Lee noted. He said that insurance brokers should push more of the markets to cover recapture from foreclosures without such agreements. “Doing that would remove a big hassle factor and create a lot of value for sponsors because that lender negotiation can be very difficult and time-consuming,” Lee said.

Tax insurance has typically been used in the traditional tax equity market for situations when the project developer relies on the physical work test to show when construction began, Martin said. That date used to be important to lock in tax credit rates during the period tax when credits were phasing out, and it remains important today for the application of the prevailing wage and apprenticeship rules and the energy community bonus credit.

Another risk that buyers think about is the possibility that the IRS disallows a portion of the credit that is claimed by a seller and sold to a buyer. Those situations — such as a sale of a $10 million credit that the IRS values at only $9 million — can be caused by numerous factors, including challenges to the appropriate amount of developer margin or the inclusion of ITC-ineligible costs, such as fences and roads. Disallowance is more likely than recapture but is generally less consequential, and still remains an important concern for buyers, Lee said.

The domestic content bonus credit is another area in which credit buyers seek the reassurance of insurance, in part because there is still considerable uncertainty in the application of the rules. In light of that uncertainty, a will-level tax opinion is hard for outside counsel to give, Collins said. The alternative is for taxpayers to get a should-level opinion and tax insurance, she said. Martin said that as the domestic content bonus credit gains traction, insurance to cover that risk will likely become more prevalent. But so far, there has only been one deal in which the market was willing to price domestic content into the financing, he said.

Insurance has been used in the traditional tax equity market in repowering wind projects. When a wind project is repowered with an expectation that it will generate another 10 years of credits, the tax equity market has been careful, Martin said, noting that some tax equity investors have required two appraisals to show that the 80/20 test was passed.

Tax credit insurance could also be a creative mechanism for covering registration and reporting risk for transfers, Collins said. Because that risk is all or nothing, foot faults like failing to timely obtain the registration number could have disastrous consequences, she noted. Similarly, if a seller fails to appropriately report the sale, the buyer could lose the money they paid for the credit without some type of risk mitigation.

Smaller credits

Although tax credit insurance is widely available, it comes at a price, and for smaller credits, the cost can be too high. Insurers’ minimum premiums may mean that insurance isn’t available. It can also be cumbersome, because insurers do extensive due diligence before writing a policy, and scale and simplicity are important factors in their decision to underwrite a contract. Consequently, projects that offer credits under about $5 million or have significant complexities can be hard to insure, and therefore hard to find buyers for, Lee said. But smaller projects may sometime soon be packaged into portfolios and sold collectively, and that bundling may open up insurance options for those credits, he said. The availability of insurance should make it easier for projects such as commercial and industrial solar and newer technologies to receive more bids from buyers, but for now, there are a lot of “orphan credits” because most buyers want full risk mitigation, Lee said, adding, “It’s a definite market inefficiency and an area we’re really focused on because the whole point of transferability is to make it easier for projects to get their credits monetized.”

"Although tax credit insurance is widely available, it comes at a price, and for smaller credits, the cost can be too high."

McTigue said that acquiring insurance on $2 million in credits, for example, is trickier because of the typical minimum premiums and the limits the insurance market is willing to entertain. “As much as it’s grown, it’s a fairly under-resourced space,” he said, but added that pooling credits by wrapping in other projects can be a creative way to overcome existing obstacles. “We say $5 million is the minimum limit on insurance, but there is some flexibility there,” McTigue said.

Advanced Power Announces Investment Tax Credit Purchase

Purchase demonstrates commitment to a sustainable energy future

Provided by Advanced Power

January 3, 2024

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BOSTON, January 3, 2024 – Advanced Power continues to show its commitment to advancing a sustainable energy future with its purchase of renewable energy investment tax credits (ITC). The credits were made available through the development of rooftop solar facilities offered for sale by a third party.

“Advancing a sustainable energy future drives our actions,” said Advanced Power’s CEO Tom Spang. “We are pleased to close this latest transaction, which supports our vision of a clean, reliable energy future.”  

The 2022 Inflation Reduction Act (IRA) made the transfer of renewable energy tax credits possible. The IRA aims to accelerate the transition to a clean energy economy and drive increased deployment of new, clean electricity resources. Section 6418 of the Internal Revenue Code allows for the transfer (sale) of certain renewable energy tax credits from renewable energy project developers to a qualified third party.

“Advanced Power is a developer, owner, and asset manager of modern power infrastructure and has now made a tax equity investment and completed a tax credit transfer transaction. We are positioned to execute similar transactions soon,” added Spang.

Reunion, a technology-enabled finance company that helps guide corporate tax teams through the clean energy tax credit transaction process, originated the opportunity for Advanced Power and facilitated the transaction between the parties.

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Advanced Power focusing on further U.S. renewables development

Advanced Power manages all aspects of an energy project's life cycle, including development, construction, financial structuring, and operations. A robust renewables pipeline across Desert Southwest, ERCOT, PJM, and MISO is underway. Late-stage projects in the pipeline include:

• ‍Eldora Energy – 240 MWdc solar with an additional 200MW/400MWh battery storage facility
• ‍Alina Energy – 220 MWdc solar with an additional 200MW/400MWh battery storage facility
• ‍Elio Energy – 300MW/600MWh battery storage facility
• ‍Rock Rose Energy – 200MW/400MWh battery storage facility

For more information about Advanced Power, its energy projects, and its expertise in development, financial structuring, and asset management, please visit www.advanced-power.com.

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About Advanced Power

Advanced Power is a privately owned global developer, manager, and owner of modern power infrastructure. The company develops low-carbon and renewable electric generating projects as an independent power producer. Advanced Power’s successes include 11 gigawatts in development or operations in the United States and Europe. The company has offices in Boston and Houston, with a registered office in Zug, Switzerland.

Founded in 2000, Advanced Power is focused on advancing a sustainable energy future, bringing reliable energy to places that need it, and providing economic benefits plus jobs to communities while making massive contributions to reducing CO₂ emissions.

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To Market, To Market: Tax Credit Transfers Start Rolling Along

Reprinted with permission from Tax Notes - Volume 181 | October 30, 2023

By Marie Sapirie

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The Inflation Reduction Act opened the market for buying and selling energy tax credits by creating a new asset class. One result of that innovation was the launch of new marketplaces in which buyers and sellers can transact. A novelty in the federal tax area, tax credit marketplaces are working to establish themselves as a key aspect of the implementation of both the new and the dramatically revised energy credits.

The objective of the marketplaces is to facilitate credit transfer transactions by bringing buyers and sellers together and helping them complete their deals efficiently. The early deals appear to be mostly dominated by established participants in the traditional tax equity market, but the founders of the new marketplaces see a chance to both assist in those transactions and turn the untapped potential of smaller projects and new credit purchasers into completed deals.

New market, new marketplaces

As the recent spate of announcements has heralded, the market for credit transfers is taking off. “There are very few tax planning strategies that can have as large an impact as this can have for a single transaction, but it’s all based on scale,” Gabe Rubio of BDO USA LLP said. Where marketplaces fit within the credit transfer market is still being determined, but there are indications that they’ll play an important role.

“There has been an awesome amount of demand from clean energy project developers,” said Andy Moon of Reunion, an energy tax credit marketplace that launched this year. His company currently has $3 billion in credits from hundreds of developers on its platform from leading solar, wind, and other project developers. Moon said that because of the shortage of available tax equity and the complexity involved in tax equity partnership structures, there is a growing realization that transfers will be an important part of the financing toolkit for all developers.

One of the challenges is that the population of sellers is reasonably well defined, but the population of potential buyers is not. “People are interested and are feeling out the market but are trying to figure out how the process works and figuring out what they need in order to be able to transact,” said Seth Feuerstein of Atheva, another credit marketplace. For the sellers’ part, they’re often learning what buyers want, he said. That learning process will continue as the market matures.

By educating buyers and sellers and making transactions significantly less onerous than tax equity deals, the marketplaces hope to help the market mature faster. Moon said Reunion is focused on educating market participants and ensuring that transactions are done properly and are good experiences for buyers and sellers. “Part of why we’re interested in providing our knowledge to the market, including to our competitors, is that if there is fraud or recapture, that’s bad for us too,” he said.

The transactions facilitated by the marketplaces still involve outside counsel for each party to the deal. Moon said that Reunion helps lower expenses for buyers and sellers by guiding the due diligence process and providing a starting point with standardized documents that the parties and their counsel can customize through negotiations. There are additional benefits to having a nonparty facilitator whose role is to efficiently move the transaction to closing, he noted. For example, he explained that while developers may seek higher-than-market sales prices initially, Reunion has been able to bring its market expertise to the table to help buyers and sellers achieve a price that makes sense. “The go-between role is important,” he said.

Moon said that the long-term vision for Reunion’s role in the market is to be a place where many buyers and sellers can transact regularly in an auction style and to offer buyers the ability to purchase a portfolio of many projects. “Right now, buyers want projects with scale, but by the time we get to the later part of 2024, one thing that we anticipate is more, smaller projects with larger discounts,” he said. The key to those deals will be risk mitigation.

The marketplaces might also carve out a niche as matchmakers between buyers and sellers who don’t already know each other by helping them to find the right deal partners. Rubio said that the marketplaces could provide a valuable service to clients that have very specific parameters.

Transfers on the rise

Both on and off of the marketplaces’ platforms, credit transfers have taken off. Rubio said his firm closed transfer agreements of just under $300 million in credits in September. “VPs of tax are starting to wake up to this, as are developers, and it is becoming a very relevant tax and cash planning strategy,” he said. That growing awareness is why the credit transfer market is on an upward trajectory.

Moon predicted that the rest of 2023 and early 2024 will continue to see bilateral transactions, as the process becomes more familiar to purchasers. “Once a company and their finance team get comfortable with the process, there’s no reason not to continue to transact at equal or larger volumes in future years,” he said.

The market is currently heavy on solar projects, probably because that technology is among the most prevalent and there are many small solar projects that drive up the numbers, said Feuerstein. He added that developers have shown a preference for selling investment tax credits because they generate more income for the seller, but production tax credits are actually easier to sell because of the lack of recapture risk. So far, there doesn’t appear to be much of a difference in sales price between ITCs and production tax credits.

Risk mitigation is one of the major focuses of the credit marketplaces. Treasury and the IRS stated in the proposed regulations that the risk of recapture should be on the buyer, with a few exceptions in the case of partnerships and S corporations, but they allowed transferors to indemnify transferees. The focus in deals is now on mitigating the recapture risk through insurance and guarantees that let buyers feel more secure about their purchases. “All of our agreements put the burden of recapture on the seller,” Feuerstein said.

No portal

The IRS says it expects to open a registration portal for credit transfers by the end of the year, the main missing link in the transfer process. Credits sold today still have to be registered. Uncertainty about what exactly that prerequisite will entail is causing some additional friction in the market, but it’s “more of a hurdle than a barrier,” Feuerstein said.

Pricing

The price range for credits is still fairly wide, but it’s starting to crystallize, and it will probably narrow over time. “The highest we’ve seen is 94 cents [on the dollar],” Feuerstein said. But sales in the low-80-cents range are also happening, and some sellers may even go into the 70s. “The pricing depends on the size of the credit and the creditworthiness and reputation of the seller, among other things,” he said.

Moon said that for the 2023 tax year, current production tax credits sell in the mid-90s, and ITCs from established solar, wind, and battery storage developers are in the low 90s. Technologies that now have a smaller pool of buyers, such as biogas, are trading around 90 cents or in the high 80s, he said. “Smaller projects, projects from newer developers, or projects with more risk or complexity may have a discount in the mid-80s,” Moon said. Looking forward to 2024, the options will increase with additional technologies, such as carbon capture, and new structures. For example, buyers could lock in a larger discount by committing to purchase tax credits for projects that will be placed into service at least 12 months in the future.

The proposed regulations established that the discount at which credits sell isn’t taxable income to purchasers, which has caused sales prices to rise. Moon noted that from the standpoint of the internal rate of return, the returns on purchases are quite healthy because the credits can be used to offset quarterly estimated payments.

The successful completion of the initial credit sales is likely to serve as a proving ground for the process. Buyers and sellers of smaller credits in particular may be the beneficiaries of the collective knowledge and eventually more standardized processes that follow on the heels of the initial transactions. “It’s harder to justify the transactional expense necessary for a smaller transaction,” Rubio said. He said that he hasn’t seen a completed sale of a credit under $5 million so far, but that is likely to change as the market develops.