Why use a yield co to raise capital for solar projects?

This blog post extracts some interesting parts related to the benefits and challenges of using a yield co to raise capital for solar projects based on an article titled "New Horizons In Solar Financing" published on Law360 on 15 May 2014 by Freedman and McFayden - partners at Shearman and Sterling LLP. They noted that alongside public debt markets and crowdfunding, yield co can be helpful in financing solar projects.

What is a yield co?

Historically, developers raised equity at a parent level, requiring investors to optimally value an entire pipeline of projects in various stages of development and even (in some cases) non-development businesses. Recently, developers have shown growing interest in an alternative.

A yield co is a special purpose vehicle created to hold a portfolio of de-risked operating assets and monetize a portion of its value through the sale of equity on a public exchange.

The yield co distributes some or all of the projects’ revenues as dividends. The parent company may use the cash raised from the initial sale of shares and from ongoing dividends to develop additional assets to sell to the yield co or for general corporate purposes.

Any cash retained by the yield co may be used for operations and maintenance and to acquire additional projects.

Projects may be acquired from the parent or an affiliate, which may also be involved in managing the company, or from third parties.

The company may be established around a portfolio of identified projects, or it may be established as a blind pool of capital, with management exercising discretion to acquire projects opportunistically.

Benefits

First, in a yield co, the tax attributes of renewable generation can offset the tax obligations of other projects in the portfolio. In order for the yield co to utilize all of its tax benefits, some of the projects in the portfolio must have net profits resulting in tax liabilities, either because they are conventional generation assets or because they are older renewables projects that have already exhausted their tax benefits. The yield co’s ability to shelter its own tax obligations eliminates the need to access a potentially constrained pool of tax equity investors.

Second, a yield co may allow a parent to finance its corporate operations (and potentially its further project development activities) more cheaply than selling equity at the corporate level, if investors have not appropriately valued the assets’ potential as part of the parent or if investors will pay a premium for the high, stable yields of operating assets in isolation.

Third, selling assets into a yield co may provide certain tax benefits — the parent company can realize the tax value of net operating losses from retained operations immediately rather than over the several years of project cash flows; and the yield co’s investors enjoy the benefits of tax-free distributions (as return of basis — for as long as the yield co does not generate earnings and profits) and a tax shield resulting from incremental depreciation.

Challenges

Several challenges must be addressed in order to effectively use a yield co to monetize solar projects.

First, the yield co must have a large enough portfolio to justify the expense of a public offering.

Second, it must continue to acquire new projects to maintain its favorable tax position and to generate the growth that investors seek.

Third, affiliated entities (such as developer-managers) may incur high costs to protect against potential conflicts of interest when they want to sell assets to the yield co, a risk highlighted by ratings agency reports in connection with the NRG Yield offering.

Fourth, the portfolio must be carefully selected and marketed to match the risk appetite of the target investors, and the market’s lack of familiarity with either the technology or the applicable regulatory regimes can lead to underpriced or failed offerings. For example, in 2013 ,when AES Corp. withdrew its IPO of Silver Ridge Power, a solar yield co, reports attributed the offering’s failure to investor uncertainty about the applicable international regulatory regimes.


http://www.shearman.com/~/media/Files/NewsInsights/Publications/2014/05/New-Horizons-In-Solar-Financing-Freedman-McFadyen-Lamb-051614.pdf

What is New Markets Tax Credit (NMTC) Program?

About The New Markets Tax Credit Program (NMTC) 

NMTC is a federal community development program designed to stimulate the flow of investment capital in underserved communities. 

Taxpayers that make qualified equity investments in designated Community Development Entities (CDEs) receive a tax credit that is claimed over a multi-year credit allowance period. 

Substantially all of the qualified equity investment must in turn be used by the CDE to provide investments and job creation in low-income communities.

Mini-bonds: Overview and examples

Mini-bonds and retail bonds

Similarity

• They are not covered by the Financial Services Compensation Scheme and considered as risky investments. (Hargreaves Lansdown investment expert Adrian Lowcock)
• They are smaller in size compared with corporate bonds or government bonds and are issued by smaller firms.

Differences

• Mini-bonds are not listed on the stock exchange, or on any other platform, while retail bonds are listed on the London Stock Exchange’s Order Book for Retail Bonds.
• Mini-bonds need to be held until expiry some years later while retail bonds on the ORB can be bought and sold during normal market hours, allowing investors the opportunity to both value and sell the bond.

These are also the risks associated with investing in mini-bonds and, in exchange, the mini-bond yield is higher than retail bonds.

A few examples of mini-bonds in the UK renewable energy sector

October 2010 Ecotricity

Ecotricity, a UK-based provider of electricity through renewable energy, raised £10 million through the launch of “EcoBonds” to its 40,000 business customers including body shops, EMI and co-operative banks, small and medium sized businesses, organic food retailers, local authorities, and schools. These are four year bonds with an interest rate of 7% (Ecotricity customers qualify for an improved rate of 7.5%). Minimum investment was set at $500 to encourage small investors to participate. The £10 million raised will fund Ecotricity’s equity investment in 12 wind farms then in development in the UK. The total aggregate projects costs will be £25-£30 million. Ecotricity will fund the remainder through debt financing from the banks. The Ecobond funding will also go toward initial development of solar projects and research and development into tidal energy.

September 2013 A Shade Greener  

A similar offering came from UK-based A Shade Greener which is aiming to raise £10m from small investors (min. £1000) by offering 3 year retail bonds at 6% annual return, but with an interesting twist – all the interest paid upfront as a lump sum. The company will use the proceeds to install panels at no cost to the householder and collects the feed-in tariff payments. As with the CBD bond, this must be held for three years until maturity.

October 2013 Good Energy Group plc

Good Energy Group plc set out to raise £5 million through a retail bond offering to finance investment in solar and wind energy generation. Within three weeks, Good Energy easily met their target, closing the book at £15m three weeks ahead of schedule. The bond offers investors a coupon of 7.25% per annum, paid every half-year. It has an initial term of four years and investments can be executed in multiples of £500 with no upper limit.

December 2013 Secured Energy Bond

Australia-based CBD Energy offered a “Secured Energy Bond” to raise finance to install solar panels for chosen UK businesses at no cost to the business but with income derived from Feed-In Tariffs. The bond is secured against the assets of the company and also has a corporate guarantee from the parent company. It will pay an annual coupon of 6.5%. The minimum investment into the bond is £2,000 for a 3 year fixed term and as the bond is non-transferable, it has to be held to maturity in late 2016.

Sale-Leaseback & Inverted Lease

The two lease structures that are most commonly used to finance solar collection installations are the Sale-Leaseback Structure and the Inverted Lease Structure.

The Sale-Leaseback Structure

Under this structure, the system is sold by the Developer to the Investor and then leased back to the Developer, and the Developer delivers the power to the Off-taker via a Power Purchase Agreement (PPA). The Investor would be the owner, and would claim the tax depreciation and the Investment Tax Credit (ITC) Grant. In addition, the Developer would have a purchase option at the end of the lease term.

The advantages of a Sale-Leaseback Structure include:

• Common project finance structure
• Provides 100% financing for the system
• Transfers 100% of the tax benefits to the Investor
• Sale-Leaseback Structure can commence up to three months after the system has been placed into service
• ITC Grant based upon FMV rather than Developer’s cost

The disadvantages of a Sale-Leaseback Structure include:

• Generally not available for Production Tax Credit (PTC) because of ownership requirements
• Developer’s purchase option is more expensive
• Tax-exempt or government entities can’t be the Developer or Investor
• Lease must qualify as a true lease for U.S. federal tax purposes

The Inverted Lease Structure

Under this structure, the Developer leases the system to the Investor. The Off-taker receives the energy from the system via a PPA, and in turn pays the Investor for the energy produced. The Developer may operate the system on behalf of the Investor pursuant to an Operation & Maintenance (O&M) Agreement. The Developer (as owner) claims any tax depreciation, and can elect whether the Investor can claim the ITC Grant. The Investor (as lessee) claims any tax deductions for the lease payments. At the conclusion of the lease term, the system automatically reverts to the Developer.

The advantages of the Inverted Lease Structure include:

• Popularity and understanding of lease structures
• Developer retains the residual interest
• Easy exit for the Investor
• Developer may capture some upside during lease term under an O&M Agreement
• ITC Grant based upon FMV of the system rather than the Developer’s cost
• Achieves separation of ITC Grant and depreciation

The disadvantages of the Inverted Lease Structure include:

• Generally not available for PTC because of ownership requirements
• Investor recognizes income equal to 50% of ITC Grant over initial five years of lease term
• Tax-exempt or government entities can’t be Developer or Investor
• Lease must qualify for credit pass-through election
• Lease must qualify as a true lease for U.S. federal tax purposes

5 Basic Rules That Teach You 90% of Successful Investing

Written by Morgan Housel from The Motley Fool 

Everyone in my family except me works in health care, so dinnertime discussions around the holidays inevitably drift toward talk of antibiotics, appendectomies, and insulin.

I've listened to hours of family medical conversations for years, and I still know little about it. Medicine is really complicated. Even a basic level of competence requires years of specific training. If you're like me and don't have that training, you have no idea what everyone else at the dinner table is talking about, and you definitely shouldn't try to be a doctor.

My field -- finance -- is different. It's the opposite, actually.

Doing well in finance isn't about memorizing textbooks. It's more about patience and an even temperament. That's why people with no formal financial training can master investing. Doctors might require a decade of school to become competent, but I'd say 90% of successful investing can be summed up with just a handful of simple rules.

I spent a lot of time in 2013 writing about simple finance rules. Here are five of my favorites.

1. Wealth takes time.

Charlie Munger, Warren Buffett's investing partner, put it best: "You don't have to be brilliant, only a little bit wiser than the other guys, on average, for a long, long time."

Warren Buffett is a great investor, but what makes him rich is that he's been a great investor for seven decades. Of his current $60 billion net worth, $59.7 billion was added after his 50th birthday, and $57 billion came after his 60th. If Buffett started saving in his 30s and retired in his 60s, you would have never heard of him. His skill is investing, but his secret is time.

Understanding the value of time is the most important lesson in all of finance. The single best thing we can do to improve the financial state of Americans is encourage people to save from as early an age as possible.

2. Most financial problems are caused by debt.

I have a family friend who earned several hundred thousand dollars a year as a specialist in an advanced field. He went bankrupt a few years ago and will probably need to work for the rest of his life. I know another who never earned more than $50,000 a year but retired comfortably on his own terms.

The only real difference between these two friends is that one used debt to live beyond his means while the other avoided it and accepted a realistic standard of living.

Just as saving gives you options in the future, debt takes options away. Not having the option of flexibility is the root of most financial problems. You can be a brilliant worker (or investor) and find yourself in financial ruin if you don't respect the power of debt. Income, wealth, and standard of living aren't as correlated as people think.

3. Forecasting market returns is close to impossible. Worse, it's dangerous. 

A stock's future returns will equal its dividend yield, plus its earnings growth, plus or minus changes in valuations (earnings multiples). That's really all there is to it.

Dividends and earnings growth for many companies can be reasonably projected.

But what about the change in valuations? There's no way we could possibly know that.

Stock market valuations reflect people's feelings about the future, swinging between optimism and fear. And there's just no way to know what people are going to think about the future in the future. How could you?

If someone said, "I think most people will be in a 9.26% better mood in the year 2024," we'd call them delusional. When someone does the same thing by projecting 10-year market returns, we call them Wall Street analysts.

We know a group of high-quality companies will build wealth for their shareholders over time. But we can never be specific when trying to guess what the stock market might do going forward. Assuming we can predict exactly what stocks will do in the future makes us blind to risk and uncertainty. Coming to terms with an unpredictable future forces us to be nimble and prepared. You can guess which group does better.

4. Simple can be better than smart.

Someone who bought a low-cost S&P 500 index fund in 2003 and left it alone earned a 97% return by the end of 2012. That's great! And they could have spent the last 10 years at the beach, or hanging out with their kids.

Meanwhile, the average fancy professional market-neutral hedge fund -- many of which are staffed with PhDs and some of the world's fastest computers -- lost 4.7% over the same period, according to data from Dow Jones Credit Suisse Hedge Fund Indices. The average stock-trading equity hedge fund produced a 96% total return -- still short of a simple index fund.

There are no points awarded for difficulty in investing. Smart people who devote their entire lives to investing can (and often do) fail, while some of the simplest investing techniques you can think of are wildly successful. Good businesses run by good people purchased at good prices held for as long as possible. That's it.

5. The odds of experiencing stock market volatility are exactly 100%.

Most investors understand that stocks produce superior long-term returns, but at the cost of higher volatility. Yet every time there's even a whiff of volatility in the stock market, the same cry is heard from investors around the world: "What the heck is going on?!"

The majority of the time, the honest and correct answer is the same: Nothing is going on. This is normal and just what stocks do.

Since 1900 the S&P 500 has returned about 6% per year, but the average difference between any year's highest close and lowest close is 23%. Volatility, even really severe swings, is perfectly normal and shouldn't be feared.

Accepting market volatility as normal and focusing on the businesses I own is a lesson I've learned from Motley Fool co-founder David Gardner. David is one of the brightest investors I know, and has one of the best track records in the industry. His ability to remain steadfast in the face of market volatility is astounding. David's service, Supernova, is about to open to new investors for the first time in months.Click here if you're interested in how he does it.

As we head into 2014, one of the best things you can do to improve your experience as an investor is remind yourself that investing may not be easy, but it's not difficult or complicated. Professional investors and pundits make it seem complicated because they think of it like medicine, complex and dependent on detailed knowledge. It's not. This isn't brain surgery. All we're doing is spending less than we earn, saving the difference, investing it, and waiting. 

Differences between bills, notes and bonds?

Treasury bills (T-Bills), notes and bonds are marketable securities the U.S. government sells in order to pay off maturing debt and to raise the cash needed to run the federal government. When you buy one of these securities, you are lending your money to the government of the United States. 

Frequency of interst paid

• T-bills: Because they are sold at a discount from face value, they do not pay interest before maturity. The interest is the difference between the purchase price and the price paid either at maturity (face value) or the price of the bill if sold prior to maturity.
• Notes and bonds: They have a stated interest rate that is paid semi-annually until maturity. 

Terms to maturity

• T-bills are short-term obligations issued with a term of one year or less
• Notes are issued in two-, three-, five- and 10-year terms. 
• Bonds are issued in more-than-10-year terms.

Edited from investopedia