A Low Risk, High Yield ESG Opportunity

For decades, both small and large banks have used federal tax credits to reduce the amount they pay in taxes each year.

These tax credit investments provide a financial return while making an environmental or social impact. The U.S. federal government uses tax credits to encourage private investment into projects that serve the common good. Examples include the Historic Tax Credit, Low-Income Housing Tax Credit, New Markets Tax Credit, and the Renewable Energy Investment Tax Credit and Production Tax Credit programs.

In exchange for making qualifying investments through one of these programs, investors receive tax credits that offset their federal tax liability. Among these credits, the Renewable Energy Investment Tax Credit (ITC) is poised to create the greatest impact and growth over the next decade. The ITC program awards tax credits for investing in new renewable energy generation facilities, most commonly large-scale photovoltaic solar farms. The ITC is an integral part of the fight against climate change — and offers investors a very attractive return profile.

As banks work to increase their environmental, social and governance, or ESG, impact, the ITC is a perfect tool for them to optimize environmental investing. When considering investing in an ITC opportunity, there are four key questions that can help investors get started.

1. What does the return look like?
There are three components that make up the return from an ITC investment: tax credits, tax losses and cash flow. One of the most attractive features of ITC investments is that the credits and losses can be delivered in the first year, making for a very short repayment period. Cash flow is delivered over the investment’s 5-year compliance period.

While each investment is different, an investor can expect 80% to 90% of its return to come from tax credits, and the rest from some combination of cash flow and tax benefits, including flow-through losses.

2. What are the risks?
ITC investments have two sources of risk: loss of tax credits and poor business performance.

Credits can be lost if a project becomes non-compliant or if the investment is poorly structured. In either case, the loss of credits is the most significant downside to an ITC transaction. Fortunately, it’s incredibly rare to accidentally lose credits, and banks can protect themselves against this through proper deal documentation.

Another source of risk is the variability in the cash flows generated by the underlying solar projects. The best way to protect against variance and loss here is to thoroughly underwrite the project before making an investment.

3. What are your goals?
ITC investors have a broad range of motivations. Is your bank looking to improve its ESG impact? What does the repayment period need to be? Does the bank prioritize return on investment, internal rate of return or timing certainty? Fortunately, the world of solar projects is diverse enough to accommodate a variety of different goals.

4. What is the role of a syndicator?
Syndicators are responsible for originating, structuring and managing tax credit investments on behalf of investors that either don’t have the time or knowledge to implement their own tax credit investment platforms.

A syndicator can help banks meet their investment requirements and reduce the risk of loss through proper deal structuring, project underwriting and asset management. Each syndicator provides slightly different services and receives compensation in different ways. When deciding whether to partner with a syndicator, make sure the syndicator is aligned with your institution’s interests and can help you achieve your goals.

Whether a bank is looking to generate a return on its tax dollars or find a low-risk way to have a meaningful environmental impact, ITC investments can be a great choice. Banks can simplify the complexity of the solar industry and tax credit program regulations by working with a syndicator. This makes ITC investments a rare opportunity that combines attractive risk-adjusted returns with ease of execution and impact.

The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting, investment, or tax advice or opinion provided by Twain Financial Partners, LLC to the reader.