By Jeff Elliott, President of Huntington Equipment Finance, Huntington Commercial Bank
Key takeaways
- The Inflation Reduction Act’s enhanced Investment Tax Credit and Domestic Content Bonus significantly reduce capital costs of renewable energy projects, spurring further growth in the sector.
- While tax equity investment volume remained steady in 2023, the demand from renewable project sponsors is exceeding supply.
- Sponsors struggling to fund their projects due to limited tax capacity are beginning to seek alternate financing options, which could offer greater proceeds and control.
- Sale-leaseback agreements offer a compelling option for sponsors to secure upfront capital without relying on inventor tax capacity, as well as mitigate risk.
Burgeoning demand in the renewable energy sector is increasingly straining traditional financing methods. Tax equity investing has long been sponsors’ preferred financing option for its tax benefits and long-term commitment to fund projects, but tax capacity can be limited. The American Council on Renewable Energy (ACORE) estimates that tax equity will need to increase from today’s $20 billion annual market to more than $50 billion to meet the goals of the Inflation Reduction Act (IRA)†. While the supply of tax equity is rising, it is not yet able to meet the needs of the sector.
However, additional provisions within the IRA have made another form of financing – sale-leaseback – attractive for project sponsors grappling with limited tax capacity. This alternate financing approach could alleviate the capacity strain while helping project sponsors realize more immediate proceeds.
The Inflation Reduction Act and renewable energy financing
The Inflation Reduction Act (IRA) of 2022 fueled investment in renewable energy projects. Investment in renewable projects, including building electrification and manufacturing clean energy, reached $239 billion in 2023, up 38% from the year before‡. Solar accounted for 53% of all new electric capacity added in this year, the first time in 80 years that a renewable energy source captured the majority of capacity added to the U.S. grid§.
Additional provisions under the IRA have further spurred this trend. Under the IRA, renewable energy projects can qualify for a higher Investment Tax Credit (ITC) rate of 30% if they meet specific labor requirements. An additional bonus of 10% is offered if the project uses a specified percentage of American-made components≠. Projects qualifying for both the base ITC and Domestic Content Bonus can achieve a total ITC of 40%, significantly reducing capital costs and project viability.
Early 2024 saw the first projects qualifying for the IRA’s ITC and Domestic Content Bonus. Greenbacker Renewable Energy Company LLC secured financing for three projects to repower utility-scale wind energy assets and complete a wind farm equipment replacement, representing a significant energy transition milestoneⱢ. Financing for these projects was done through a sale leaseback structure provided by Huntington. This financing structure was used as it offered higher immediate proceeds and combined the advantages of tax equity financing and back-leverage lending.
Tax equity financing landscape
2023 was also a landmark year for tax equity investments, as highlighted by industry experts in a recent Cost of Capital: 2024 Outlook discussion moderated by Keith Martin with Norton Rose Fulbright. Despite predictions of a downturn, tax equity volumes held steady between $20 and $22 billion with direct tax credit transfer deals adding approximately $4 billionΩ.
Tax equity volume is expected to remain at the same level in 2024. Tax equity is the preferred option for many sponsors, as noted during Cost of Capital: 2024 Outlook discussion, and demand will continue to outstrip supplyⱠ. As of February 2024, experts estimated 50% - 60% of their total tax equity had already been committed for the year††. Financing through tax equity is becoming more and more difficult for project sponsors.
While tax credit transfers and trades offer some relief, they often fall short of addressing the broader needs of project sponsors. These mechanisms, though beneficial, depend heavily on market conditions and investor tax appetites, which can fluctuate significantly.
Financing renewable energy projects through a sale-leaseback
While sale-leaseback structures have historically taken a backseat to tax equity investments as a renewable financing option, the IRA’s enhanced provisions have changed the dynamic. Sale-leaseback financing arrangements ensure the full value of tax credits is realized quickly, making it an appealing option for renewable energy sponsors seeking quick access to capital, ease of transaction, and control retention.
While other financing options like tax credit trades or green bonds are valuable, they still rely on tax capacity or market appetite. Sale-leaseback can provide funding independent of those constraints, as financial institutions can fully utilize the tax credits and could in turn offer more favorable terms.
This equipment leasing structure provides several benefits:
- Immediate capital injection: Sponsors receive upfront capital from the sale, which can be reinvested in ongoing or new energy projects.
- Off-balance sheet financing: By moving assets off the balance sheet, renewable project sponsors can improve financial ratios and borrowing capacity.
- Control retention: Sponsors maintain operational control over their project without needing to share decision-making power with investors.
- Risk transfer: Depreciation and obsolescence risks are transferred to the financier, allowing sponsors to focus on managing their project and mitigate additional upgrade or maintenance costs.
Engaging in a sale-leaseback can affect a company’s tax position by transferring asset depreciation to the financier, potentially resulting in different tax treatment for the lease payments. While sale-leaseback agreements provide a compelling alternative to tax equity in the current constrained market, sponsors should carefully consider this option to ensure it aligns with project goals and financial strategies.
The future of financing renewable energy projects
While tax equity capacity has become a bottleneck for renewable project financing, the IRA’s ITC and Domestic Content Bonus have changed the energy financing landscape. Project sponsors could consider sale-leaseback financing as an alternative to keep their projects moving forward.
To learn more about how Huntington can support sale-leaseback financing for your renewable energy projects, reach out to the Huntington Equipment Finance team.
