1. By John Joshi
F
As much as $10.3 trillion inancing renew-
able energy has
will be needed to fund never been more
important. Around the
alternative energy projects globe, from the United
States to China to Bra-
over the next two decades. zil, energy needs are
growing at an ever fast-
As the bank market starts to er rate while the tradi-
tional carbon-based en-
shrink, capital markets and ergy complex is under
a great deal of strain.
securitization ought to be Global warming is a
key issue that needs to
ideally placed to step up and be addressed. And the
need and desire to en-
help reach that target. But sure energy security is
of paramount concern
they need some help. for many nations.
Renewable energy
can provide many of
the solutions: it’s kind-
er on the environment, To prevent more of this... Shutterstock
is sustainable and because it’s local it removes the need to import energy sources from
politically unstable or unfriendly nations. But there’s a problem: funding infrastructure
Energy
projects is no easy task. The capital markets in general and securitization in particular
could play a major role. But in the United States, at least, part of the issue stems from
the fact that financing renewable projects is too dependent on cash grants and tax credits
which have to be renewed every few years by Congress. The Investment Tax Credit, for Renewable
example, is applied to a project immediately while the Production Tax Credit is based on
the amount of energy produced.
Being dependent on Congressional whim makes it hard to secure long-term funding.
So I propose two solutions to channel capital towards long-term financing of renewable
energy projects.
A GSE for Renewables
Financing
First, I would argue that one crucial change needed is for the United States to establish an
entity modeled after government sponsored entities like Fannie Mae and Freddie Mac to
provide guarantees on loans, bonds and super-senior tranches of asset-backed securities.
Let’s call it a renewable energy government sponsored entity, or REGSE.
I know that calling for yet more government support after the financial crisis may
4
2. immediately strike many as unpalatable. So let me explain the exploit. The idea of a climate bond has been around for some
reasoning. time. But securitization could play a large role, too. Both se-
Financing alternative energy is already heavily dependent cured and unsecured bonds can be more appealing than bank
on government support. One of the ways this happens is by loans thanks to the ability to offer longer maturity tenors, third-
using so-called tax equity: selling, at a discount, tax credits that party credit enhancement and more flexible covenants. They
stem from operating losses. Of course, to take advantage of in- also, of course, can tap into a much larger investing universe.
vesting in tax credits, an entity has to have income to offset the And securitization offers both debt and equity financing
tax credits and reduce its tax- of portfolio assets with lower
able income. Unsurprisingly, correlation and increased di-
the economic downturn hit versity and stronger credit
that market hard: the Solar enhancement. The structures
Energy Industries Associa- can be more efficient and of-
tion reckons the number of fer better leverage for equity
tax-equity buyers has shrunk investors. Credit risk can be
from around 30 to just seven delinked from the asset origi-
or eight. nators and the structure can
The 2009 American Re- isolate the assets in a bank-
covery and Investment Act ruptcy remote vehicle to pro-
helped out by providing cash tect against the originators
grants instead. Most projects defaulting.
since have used the cash grant Of course, securitization
Shutterstock
to source investor capital. And ...securitization could help finance more of these has its own challenges. Regu-
they allowed more investors to participate in renewable energy lators around the world, including the Securities and Exchange
projects: hedge funds, for example, have been active lenders, re- Commission, are weighing how to impose mandatory risk re-
ceiving the cash grant within 60 days of a project starting. At tention rules on originators securitizing their assets. If the final
the end of last year, Congress renewed the grants for another rules require lenders to keep a 5% vertical slice, it might be rela-
two years. tively manageable. But if regulators decide that keeping 5% of
But replacing such stop-gap and ad hoc measures with a the first-loss position is preferable, banks would have to set aside
more robust debt guarantee program, with proper oversight of up to 10 times as much capital, which is bound to be prohibitive.
course, would be a marked improvement.
Consider just how much investment globally is needed. The A Role, at Last, for Covered Bonds?
International Energy Agency estimates that $10.3 trillion will The second solution I propose is to combine REGSE support
be required to fund alternative energy projects over the next with a covered bond market mechanism to provide additional
two decades just to maintain the climate stabilization target of liquidity for banks to recycle their capital and access the struc-
not allowing temperatures to rise by more than 2 degrees Celsius. tured finance markets for renewable energy projects.
If originators have to retain risk, a covered bond market
Investment Shortfall; Capital Markets Opportunity would allow the balance sheet capital provider to recycle the
Yet in 2009 just $162 billion was invested, according to Bloom- capital after a project is out of the build-out phase and has
berg. That’s less than a third of the IEA’s average annual base achieved a certain amount of seasoning in power generation and
Energy
case estimate and 7% low- revenues before securing
er than the year before. The International Energy Agency estimates permanent financing from
Virtually all the capital the securitization market.
came either from com- that $10.3 trillion will be required to Access to the covered
Renewable
panies tapping their own bond market would allow
balance sheets or from the
fund alternative energy projects over the banks to recycle their cap-
bank loan market. And next two decades ital efficiently and allow
both sources are limited. investors to participate
Moreover, the bank market is likely to shrink further thanks in high quality renewable energy projects. The flow of capital
to regulatory changes such as the Basel III rules that require would increase substantially to the sector. The ratings on the
financial institutions to hold more short- and long-term liquid- projects could be enhanced via GSE support on the senior part
Financing
ity and more Tier 1 capital in general and even more capital in of the structure. The capital ratios for banks could benefit by
particular against lower-rated loans and securities they hold. So reducing the overall risk with REGSE support.
even as the economy recovers, banks will be taking risk off their A GSE-style guarantee, though, would render some of
books. the challenges moot, assuming renewable energy loans were
That ought to be an opportunity for the capital markets to granted the same risk-retention exemption as qualifying
4
3. mortgages look set to get. would not be subject to congressional appropriations. The
It’s not a new idea. The Coalition for Green Capital (CGC), House passed the bill in June 2009 but it is still stuck on the
a non-profit organization in Washington, DC, has been push- Senate Legislative Calendar.
ing for the government to establish a Green Bank that can cul- These aren’t ideal proposals, but they do demonstrate that
tivate “a stable, long-term investment environment, lasting for a Congress recognizes the viability of and need for securitization
decade, to encourage profitable business deployment of sustain- as a key financing tool for the renewable energy sector.
able energy.” CGC’s proposal includes creating an Energy Inde- But more is needed. A GSE-style guarantee would allow
pendence Trust — a non-profit company run by the private sec- the financing of longer dated maturities of debt as well pro-
tor as a federal corporation along the lines of a GSE entity that vide cheaper debt financing and equity leverage for projects. A
would provide low-cost, long-term financing for energy projects. combination of regulatory policy initiatives similar to CEDA,
Congress has been mulling similar plans, too. The Ameri- development of a Green Bank and the covered bond market,
can Clean Energy and Security Act (H.R.2454) seeks to estab- and government guarantees may allow us to create the appropri-
lish a new Clean Energy Deployment Administration (CEDA) ate securitization structures which, in turn, and with the right
“to promote access to affordable financing for accelerated and combination of leverage, would enable a significantly lower
widespread deployment” of clean energy, energy infrastructure, cost of capital for energy infrastructure projects. Investors and
energy efficiency and manufacturing technologies. The House our society will benefit from access to a new asset class.
version of the bill has provisions that allow CEDA to guarantee The views expressed are those of the author and do not necessarily represent the
tax-equity deals and power purchase agreements. The bill also views of ASF.
allows CEDA to provide credit support to a portfolio of taxable
John Joshi is a managing director at CapitalFusion Part-
debt obligations for energy efficiency and to install renewable ners LLC, FinCap Solutions LLC and a senior advisor at
energy capacity, though it’s limited to two megawatts. The Sen- SeaCrest Investment Management. At CapitalFusion Part-
ate version of the bill allows CEDA to use financial mechanisms ners and FinCap Solutions he has responsibilities in business
including securitization, indirect credit support, other means of development and oversight of all strategic business initiatives.
credit enhancement and secondary market support through lend- At SeaCrest he is responsible for Sustainable Investment
Research and the portfolio management team for the Clean
ing on the security of debt for clean energy technology. Funding Earth Fund Strategy.
for CEDA would come directly from the U.S. Treasury and
