Project Finance International September 20 202364
FEATURES
Most US wind and solar projects qualify for
either an investment tax credit (ITC), which
is available when a project is completed, or a
production tax credit (PTC), which is generated
over a ten-year period starting when the
project rst becomes operational. The IRA
introduced signicant changes to accelerate the
energy transition, including extending existing
tax credits through the next decade, creating
new tax credit bonuses for projects in fossil
fuel communities and those that use domestic
components, and creating new tax credits for
emerging technologies, such as battery storage
and hydrogen projects.
But by far the most fundamental of the
changes that the IRA introduced is the right of
project owners to sell their tax credits freely in
the open market. Prior to the IRA, tax credits
could not be bought and sold. Instead, they could
be shared only by equity owners of projects
through structured joint ventures known as tax
equity partnerships. Now, most tax credits may
be sold in the market under a tax credit transfer
programme. This change and a detailed set of
regulations that the Internal Revenue Service
(IRS) released in June 2023 are shaping the
renewable energy project nance market in
the US.
Navigating the tax credit sale rules
Financing projects that will sell tax credits
involves new considerations and opportunities.
The rst is how best to structure bridge nancing
against the future sale of a project’s tax credits.
A second consideration is how project owners
can protect against the risk of ITC recapture,
as described below, which could result from a
lender foreclosure at any time in the ve-year
period after an ITC is claimed.
• Payment limitations – Buyers and sellers of tax
credits must follow two specic payment rules.
First, the payment must be made in cash. Second,
the payment must be made in a window of time
starting at the beginning of the year in which
the credit is generated and ending on the date
the tax return is led for the credit. For example,
if a ling is made to extend the tax return ling
deadline, the buyer is able to pay from January
of a given year up to midsummer (or later) of the
following year.
The inability of buyers to prepay for
credits effectively means that tax credit
buyers cannot provide bridge capital to
developers that have not yet earned their tax
credits. Project owners, therefore, turn to
banks or other capital sources to bridge to a
tax credit purchase commitment. In the case
of a sale of PTCs, the purchase commitment
will likely call for payment instalments to be
made over a period that could be as long as
ten years.
• ITC recapture – Although an ITC is claimed
in full when a project is completed, the credit
vests over a ve-year period, in equal 20%
instalments per year. If a project loses its tax
credit qualication status at any point during
this ve-year period, the unvested part of the
credit is recaptured and must be repaid to the
IRS. This rule applies not only to ITCs claimed by
project owners but also to ITCs purchased by tax
credit buyers in the open market. Recapture is
most commonly caused by a casualty event that
destroys the project, a systemic design failure
AFTER THE IRA – A NEW
FINANCING LANDSCAPE
AS WE PASS THE FIRST ANNIVERSARY OF THE INFLATION REDUCTION ACT, THE PROJECT FINANCE MARKETS
ARE BEGINNING TO COALESCE AROUND NOVEL FINANCING STRUCTURES DESIGNED TO MAKE OPTIMAL USE
OF THE NEW TAX CREDIT SUBSIDIES THAT THE US CONGRESS ENACTED. THIS ARTICLE EXAMINES SOME OF THE
KEY STRUCTURAL CHANGES IMPLEMENTED UNDER THE IRA, WITH A FOCUS ON HOW THESE CHANGES ARE
SHAPING THE WAY US RENEWABLE ENERGY AND ENERGY TRANSITION PROJECTS ARE CAPITALISED, AND THE
WAY PROJECT FINANCING FOR THESE PROJECTS IS EVOLVING. BY KELLY CATALDO, PARTNER, AND ELI KATZ,
PARTNER AND VICE-CHAIR, ENERGY & INFRASTRUCTURE INDUSTRY GROUP, LATHAM & WATKINS LLP.
FIGURE 1 - TAX EQUITY BRIDGE LOAN STRUCTURE
ECCA
Construction
loans
Tax equity
bridge loans
Sponsor
Parent
Class B Member
Tax equity
partnership
Tax equity
Investor
Lenders
Project company
(Borrower)
Project
Collatera
l
package
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Project Finance International September 20 2023 65
IRA FINANCING LANDSCAPE
that renders the project inoperable, or a sale of
the project assets or equity during the ve-year
recapture period.
Historical structures
Historically, to raise capital for the construction
of projects, sponsors have obtained loans from
lenders and binding commitments from tax
equity investors. Tax equity investors typically
do not take construction risk and fund their
commitments only once the project has achieved
specied completion milestones. Tax equity
bridge loan (TEBL) facilities have become a
commonly used technique to raise capital against
a future tax equity commitment. The structure of
a typical TEBL facility is depicted in Figure 1.
Like a construction loan, a TEBL is drawn
during construction, used to pay project costs as
incurred and secured by all assets of and equity
in the project company. The TEBL is sized off of,
and repaid with the proceeds of, the tax equity
investor’s future funding commitment. As a
result, lenders focus on the credit quality of the
tax equity investor and any conditions to its
funding obligations.
Generally, a tax equity investor memorialises
its commitment in an equity capital contribution
agreement, which is signed concurrently with
or shortly after the closing of the loan facilities.
Once the project is operational, the tax equity
investor funds its commitment and repays the
TEBL. Any remaining construction loans are then
typically repaid with proceeds of a term loan, the
“term conversion”.
Tax equity investors generally do not permit
the tax equity partnership to have secured debt.
Accordingly, asset level liens are released at term
conversion. The term loan is secured by assets of
and equity in the term borrower, and the term
lenders are structurally subordinated to the tax
equity partnership. This structure is known as a
back-leverage loan, and the associated collateral
package is depicted in Figure 2.
Bridging to tax credit sales
• Bridge loans – Bridge nancing structures for
tax credits sales borrow heavily from TEBL
structures, but with signicant differences and
new considerations. Like the timing mismatch
that created the need for a TEBL, project owners
require signicant capital for construction before
tax credit buyers are permitted to pay for the
credits. Tax credit transfer bridge loan (TRABL)
facilities, which are sized based on the projected
sale price of the tax credits, can be used to bridge
this gap.
TRABL facilities for ITC transactions are
structurally similar to TEBL facilities, with loans
during the construction period repaid on a
lump-sum basis with the proceeds of the sale of
ITCs. Because the sale is not tied to construction
completion milestones, the repayment of the
TRABL, which depends on when the tax credit
buyer agrees to pay for the credits, may be
misaligned with when term conversion can
otherwise be achieved.
In contrast, repayments under PTC TRABLs
are likely to occur over a multi-year period
as the PTCs are generated and sold. Loans
will be sized against the projected aggregate
payments from the sale of credits, and repaid
on an amortisation schedule sculpted to
the PTC instalment payments under the tax
credit purchase agreement. Similar to ITC
sales, there will be a mismatch between term
conversion and repayment of the TRABL
facility for PTCs.
The lenders in tax credit sale transactions will
evaluate the creditworthiness of the buyer given
that they are bridging to its commitment to buy
the credits. The credit analysis for PTC sales will
be even more important given the long tenor of
the TRABL bridge. Lenders may insist on nancial
covenants and credit support to ensure their
source of repayment will remain creditworthy
over the purchase agreement term.
FIGURE 2 - BACKLEVERAGE LOAN STRUCTURE
Bank-levered
loans
Bank-levered
Lenders
Class B
Membership
Interest
Class B Member
(Back-leverage
borrower)
Class A
Membership
Interest
Class A
(Tax Equity
Investor)
Tax Equity
Partnership
Project
Company
Project
LLCA
Sponsor
Parent
Collateral
package
FIGURE 3 - PROJECT FINANCE VARIATION
Construction Collateral Package
Class A
Interest
Class B
Interest
Borrower Affiliate Partner
Project Company
Tax Equity Partnership
Lenders
Tax Credit
Purchaser
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Project Finance International September 20 202366
While the mature TEBL market has settled
around a 95% to 100% advance rate against
a tax equity commitment, debt sizing in
the nascent TRABL market continues to
evolve. Debt sizing for PTC sales is further
complicated by the longer-term repayment
period, and the fact that PTCs – and therefore
the corresponding payments from a tax
credit buyer – uctuate based on a project’s
generation prole.
Some near-term projects may not have
arranged tax credit sale agreements at
nancial close, as the demand for construction
nancing is outpacing the ability of project
developers to source tax credit buyers on
attractive terms. Some lenders are advancing
TRABL commitments against the value of
uncommitted credits, at advance rates that
range from 50% to 75% of expected credit
value. Other lenders are requiring full
or partial sponsor credit support during
the period before a tax credit purchase
commitment is executed.
Structure and recapture – There are at least
two key variations on the conventional project
nancing structures discussed in the historical
structures section. The rst, depicted in Figure 3,
is similar to a conventional tax equity partnership
and is designed to avoid a recapture event if the
lenders foreclose.
Lender foreclosure on the assets of or equity in
the project company during the ve-year period
after a project is placed in service may result in
a recapture of the unvested portion of the ITC. A
recapture event would cause a tax credit buyer
to lose its tax credit and would likely trigger an
indemnity obligation from the project owner that
sold the credits.
In a conventional tax equity partnership,
after an ITC asset is placed in service, the term
lenders do not have liens on the investor or
on the investor’s interests in the partnership.
A foreclosure will be on the borrower or
on the sponsor member’s interests in the
partnership, which will not result in a
recapture of the tax credit allocated to the tax
equity investor.
To achieve a similar result in a tax credit sale
structure, the project owner may choose to hold
the project in a joint venture between the term
borrower and an afliate and allocate the ITC
to the afliate. The afliate’s equity and assets
are not part of the lenders’ collateral, thereby
avoiding recapture if the lenders foreclose on the
term borrower.
This structure is easily adaptable for a
tax equity partnership or tax credit transfer
arrangement. It may, therefore, be attractive to
both sponsors and lenders, because it provides
the exibility to toggle between a bridge loan
repayment from a tax equity investor or a tax
credit buyer.
For transactions in which this exibility is
desired, lenders and borrowers should determine
the base case assumption of the value of the
credits for debt sizing purposes, and provide
exibility for prepayments and incremental
borrowings to toggle to the correct advance rate
once the nal take-out structure is known.
In a PTC sale transaction, in which tax credit
recapture is not a concern, the term lender may
negotiate to maintain asset-level collateral for the
tenor of the loans. One variation of this structure
is depicted in Figure 4.
This structure is more favourable for lenders
than the conventional back-leverage structure,
as it permits the lenders to maintain asset-level
liens throughout the term of the nancing, and
to remain structurally senior to obligations under
the tax credit transfer agreement. Lenders may
also require a pledge of the tax credit transfer
agreement and associated deposit account (for
example, if they are bridging to payments under
such agreement).
• Intercreditor terms – TRABL lenders will evaluate
certain due diligence terms in the tax credit
sale agreement, including remedies for under-
performance, liquidated damages for credit
shortfalls, and the scope of indemnities offered
by sellers. Lenders will attempt to ensure that
they are shielded from or have seniority over the
project owner’s obligations to a tax credit buyer.
Interparty agreements between the lenders and
tax credit buyers may provide certain terms that
apply prior to foreclosure (such as forbearance
and cure rights), and specify the lenders’ rights
to enforce the tax credit buyer’s commitment to
purchase tax credits.
Conclusion
The IRA has heralded new opportunities to
monetise tax credits and arrange project
nancing for renewable energy and energy
transition projects in the US. The nancing
landscape will remain dynamic as market players
adapt to new transaction structures that enable
optimal use of the new subsidy regimes.
n
FIGURE 4 - PTC VARIATION
Collateral Package
Borrower/Project
Company
Affiliate Partner
Sponsor Entity
Tax Equity Partnership
Lenders
Tax Credit
Purchaser
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