Christopher Lord, Managing Director of CapIron, Inc. and an instructor with HeatSpring, recently interviewed Andre Zaffuto, a lending officer focused on solar and other renewable energy opportunities for Bridge Bank. Lord talked with Zaffuto about bank lending in today’s solar climate.
- Leverage on solar projects can greatly enhance the ability of sponsors to stretch their capital and do more with finite resources.
- It’s a good year for solar lending – rates are expected to stay low
- There’s a wider acceptance of solar as an asset class and an understanding of its risk (all based on years of operating data)
- Senate Democrats are already trying to pass an ITC extension, but the outcome is far from clear. In the absence of such an extension now or before the end of 2016, Zaffuto speculates that lenders will try to fill the void in the capital stack with an increase in lending, but that would also require lenders to take on more risk
- Factors that make a solar project attractive: major contracts executed or in very late stage drafting, including: PPA and or SREC contracts, interconnection agreements, EPC contracts and, of course, a ground lease. Permits should also be in place or ready to issue. A strong balance sheet. An investment grade rating is always a big plus but not necessarily a requirement.
- Sponsors should look at a lender’s execution ability, including their speed to funding, and their experience/technical knowledge of solar. These items all have a direct impact on the due diligence process and closing or transaction costs.
ABOUT ANDRE, LENDING OFFICER AT BRIDGE BANK
Andre Zaffuto has been with Bridge Bank since 2014, after pursuing opportunities in energy efficiency and commercialization of green technologies. His career included an MBA from UC Davis (where he was an energy efficiency fellow), and stints with Solar Power Partners and NRG. As a Vice President and Relationship Manager with Bridge Bank, he focuses on C&I and Utility scale solar lending.
LENDING SERVICES FOR SOLAR DEVELOPERS
Lord began the interview by asking Zaffuto about Bridge Bank, and his role with the Bank. Zaffuto responded that Bridge Bank began its history as a business lender to early stage players in different technology fields including energy. In fact, one of the Bank’s early clients was SolarCity. The Bank was recently acquired by Western Alliance Bancorp, a $15 billion banking organization, giving the Bank access to greater resources. Today the bank provides a variety of traditional banking services, but Zaffuto’s focus is on lending services for solar developers, including term loans and construction loans. Zaffuto is also exploring for the Bank new lending opportunities in storage, bio-fuels and wind.
IT’S A GOOD YEAR FOR SOLAR LENDING
Lord asked Zaffuto why solar lending is so important to projects today. Zaffuto explained how leverage on solar projects could greatly enhance the ability of sponsors to stretch their capital and do more with finite resources. A lender can contribute up to 80 cents of every dollar invested by a sponsor, and the cost of that capital is typically lower than the cost of a sponsor’s equity. That’s a powerful multiplier.
In response to a question about trends in the C&I market from Lord, Zaffuto thought it would be a good year for solar lending. He expects rates to remain very low for now and the near future. Zaffuto also thought that the market would see more involvement from regional banks, particularly in Colorado and the northeast. This growing involvement points to wider acceptance of solar as an asset class and an understanding of its risk (all based on years of operating data). Zaffuto also saw a growing movement for securitization of solar lending, not just in residential but also in the C&I market. Back leverage is also growing in importance, as sponsors move away from project level debt and look to borrow against their share of the residual cash flows from one or more projects. This reduces the importance of collateral and increases the focus on the health of project cash flows. Zaffuto also compared back-leverage to traditional project level senior debt, including the importance of a sponsor having enough cash flow – from one or more projects – to make it worth leveraging. Coverage ratios have not changed much – direct project debt typically sees the same as a back leverage deal, about 1.25x to 1.35x for commercial, and maybe a little higher for residential portfolios.
ITC DROPPING IN DECEMBER – IMPACT ON SOLAR LENDING?
With the ITC dropping after December 31, 2015 from 30% to 10%, Lord asked Zaffuto how the market for solar lending might change. Zaffuto noted this is a hot topic, and the latest word is that Senate Democrats are already trying to pass an ITC extension, but the outcome is far from clear. In the absence of such an extension now or before the end of 2016, Zaffuto speculated that lenders would try to fill the void in the capital stack with an increase in lending, but that would also entail lenders taking on more risk. There clearly is a rush to finance projects this year and next. Tax equity is perceived to have a finite life. Zaffuto noted that a lot of tax equity appetite for 2016 has already been allocated by existing investors to specific projects and sponsors. This is creating an opening for new investors with tax appetite to enter the market, the downside of which will be higher transaction costs as these new investors go through their first round of transactions. All said and done, Zaffuto expects lenders to play a bigger role in solar project financing going forward, particularly in back-leveraging. He also noted that YieldCo’s are particularly big users of back leverage, and a reduction of the ITC will play to their inefficient use of tax benefits.
SOLAR PROJECTS THAT ARE ATTRACTIVE TO A PROSPECTIVE SOLAR LENDER
Lord then asked Zaffuto to explain what makes a project look attractive to a prospective solar lender. Zaffuto responded that he likes to see a project with major contracts executed or in very late stage drafting, including: PPA and or SREC contracts, interconnection agreements, EPC contracts and, of course, a ground lease. Permits should also be in place or ready to issue. Zaffuto likes off takers with a strong balance sheet. An investment grade rating is always a big plus, but not necessarily a requirement. In the absence of an investment grade rating, Zaffuto likes to see off takers with a few years of audited financials. Zaffuto also looks at an off take’s existing leverage, available cash, off-balance sheet commitments, management experience, etc. There are always ways to mitigate a lack of investment grade rating, whether that means an interest rate adjustment, a shorter term or a higher coverage ratio. Bridge Bank’s typical approach to a project with a 20-year PPA, is to calculate payments using a roughly equivalent amortization schedule, but structure it with a shorter term and a balloon payment. Bridge Bank does sculpt cash flows with cash sweeps where appropriate.
On the subject of construction loans, Zaffuto says he will do stand-alone construction lending but his preference is to see his construction loans convert into a term loan at COD. For the Bank to do a pure construction loan, it is important that the borrower demonstrate a solid and reliable take out for COD. Zaffuto says that there are a few key areas of risk for a lender in a construction loan. Questions he worries about include: will this project get built? On time? On budget? Are the EPC and sponsor well capitalized, do they have a track record? Zaffuto also looks to measure cash reserves, and checks on whether cost assumptions are realistic. He also analyzes financials, and once the loan is made, he will closely monitor construction progress.
Lord noted that there are a lot of outside or third-party costs involved for a Sponsor in connection with leverage, and asked if there are ways to manage those costs. Zaffuto noted that tax equity investors and lenders share a lot of common concerns, and so where possible a lender will piggyback off the tax equity investor’s experts, including independent engineer.
Once the loan is made, Zaffuto explained that the Bank will monitor the project very closely and compare its performance regularly to the pre-COD projections on which loan decisions were made. The bank must take a pro-active approach in order to head off problems early, if not before, they arise.
HOW TO SELECT A LENDING PARTNER
Lord concluded by asking Zaffuto how a sponsor should select a lending partner. Naturally people look to price and terms to distinguish among lenders, said Zaffuto, and those are important measures. But, sponsors should also look at a lender’s execution ability, including their speed to funding, and their experience/technical knowledge of solar. These items all have a direct impact on the due diligence process and closing or transaction costs. Another question that a sponsor should ask is whether the lender has worked with the project’s tax investor before. A lender’s geography footprint is also important, as well the lender’s legal lending limit. As a part of that analysis, a borrower should also take a long-term view and ask whether this lender will make a good program partner or one more suited to a one-off transaction. Finally, and most importantly, a borrower should not only ask for referrals from a prospective lender, but go meet with the referrals in person to get the most information possible.
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