Our business and operations are subject to a number of risks and
uncertainties, the occurrence of which could adversely affect our business, financial condition, consolidated results of operations and ability to make distributions to stockholders and could cause the value of our capital stock to decline. We may
refer to the energy efficiency, renewable energy and the other sustainable infrastructure projects or market collectively as the sustainable infrastructure projects or industry. Please also refer to the section entitled Forward-Looking
Statements.
Risks Related to Our Business and Our Industry
Our business depends in part on U.S. federal, state and local government policies and a decline in the level of government support could harm our business.
The projects in which we invest typically depend in part on various U.S. federal, state or local governmental policies and incentives
that support or enhance project economic feasibility. Such policies may include
- 12 -
governmental initiatives, laws and regulations designed to reduce energy usage, encourage the use of renewable energy or encourage the investment in and the use of sustainable infrastructure.
Incentives provided by the U.S. federal government may include tax credits (with some of these tax credits that are related to renewable energy scheduled to be reduced in the future), tax deductions, bonus depreciation as well as federal grants and
loan guarantees. The value of tax credits, deductions and incentives may also be impacted by changes in tax laws, rates or regulations. Incentives provided by state and local governments may include renewable portfolio standards (RPS),
which specify the portion of the power utilized by local utilities that must be derived from renewable energy sources such as renewable energy as well as the state or local government sponsored programs where the financing of energy efficiency or
renewable energy projects is repaid through an assessment in the property tax bill in a program commonly referred to as property assessed clean energy (PACE). Additionally, certain states have implemented
feed-in
tariffs, pursuant to which electricity generated from renewable energy sources is purchased at a higher rate than prevailing wholesale rates. Other incentives include tariffs, tax incentives and other
cash and
non-cash
payments. In addition, U.S. federal, state and local governments provide regulatory, tax and other incentives to encourage the development and growth of sustainable infrastructure.
Governmental agencies, commercial entities and developers of sustainable infrastructure projects frequently depend on these policies and
incentives to help defray the costs associated with, and to finance, various projects. Government regulations also impact the terms of third party financing provided to support these projects. If any of these government policies, incentives or
regulations are adversely amended, delayed, eliminated, reduced or not extended beyond their current expiration dates, the demand for, and the returns available from, the financing we provide may decline, which could harm our business. Changes in
government policies, support and incentives, including retroactive changes, could also negatively impact the operating results of the projects we finance and the returns on our assets.
U.S. federal, state and local government entities are major participants in the sustainable infrastructure industry and their actions could be adverse to
our projects or our company.
The projects where we invest are, and will continue to be, subject to substantial regulation by U.S.
federal, state and local governmental agencies. For example, many projects require government permits, licenses, concessions, leases or contracts. Government entities, due to the wide-ranging scope of their authority, have significant leverage in
setting their contractual and regulatory relationships with third parties. In addition, government permits, licenses, concessions, leases and contracts are generally very complex, which may result in periods of
non-compliance,
or disputes over interpretation or enforceability. If the projects where we invest fail to obtain or comply with applicable regulations, permits or contractual obligations, they could be
prevented from being constructed or subjected to monetary penalties or loss of operational rights, which could negatively impact project operating results and the returns on our assets.
Contracts with government counterparties that support the projects where we invest may be more favorable to the government counterparties
compared to commercial contracts with private parties. For example, a lease, concession or general service contract may enable the government to modify or terminate the contract without requiring the payment of adequate compensation. Typically, our
contracts with government counterparties contain termination provisions including prepayment amounts. In most cases, the prepayment amounts provide us with amounts sufficient to repay the financing we have provided, but may be less than amounts that
would be payable under make whole provisions customarily found in commercial lending arrangements.
In addition, government
counterparties also may have the discretion to change or increase regulation of project operations, or implement laws or regulations affecting project operations, separate from any contractual rights they may have. These actions could adversely
impact the efficient and profitable operation of the projects in which we invest.
Government entities may also suspend or debar
contractors from doing business with the government or pursue various criminal or civil remedies under various government contract regulations. They may also issue
- 13 -
new government contracts or fail to extend existing government contracts. Our ability to originate new assets could be adversely affected if one or more of the ESCOs or other origination sources
with whom we have relationships with are so suspended or debarred or fail to win new, or renew existing, contracts.
Changes in the terms of energy
savings performance contracts could have a material and adverse impact on our business.
We derive a portion of our income from the
assignment to us of payment streams under energy savings performance contracts with property owners, including government customers, in which the scope and cost of improvements and services are specified. While U.S. federal, state and local
government rules governing such contracts vary, such rules may, for example, permit the funding of such contracts through long-term financing arrangements, permit long-term payback periods from the savings realized through such contracts, allow
units of government to exclude debt related to such contracts from the calculation of their statutory debt limitation, allow for award of contracts on a best value instead of lowest cost basis and allow for the use of sole
source providers. To the extent these rules become more restrictive in the future, our ability to provide financing to support these projects could be adversely impacted, which could harm our business. Changes in these rules, including retroactive
changes, could also negatively impact the operating results of the projects we finance and the returns on our assets.
A change in the fiscal health,
level of appropriations or budgets of U.S. federal, state and local governments could reduce demand for our investments.
Although our
energy efficiency assets do not normally require direct governmental appropriations and instead the resulting cash flow is generally paid for out of operations and maintenance appropriations based on the energy and operating savings derived from the
improved facility, a significant decline in the fiscal health, level of appropriations or budgets of government customers may make it difficult or undesirable for them to make existing payments or to enter into new energy efficiency improvement
projects. Alternatively, the government may choose to provide financing or other credit support for sustainable infrastructure projects, which would negatively impact on the use of private capital such as ours. This could have a material and adverse
effect on the repayment of our financings or the return on our asset for existing projects and on our ability to originate new assets. Moreover, other changes in resources available to governments may also impact their willingness to undertake
energy efficiency projects. For example, an increase in money set aside for government expenditures for energy efficiency projects may reduce demand for our financing.
In addition, to the extent we make investments that involve direct appropriations funding, we will depend on approval of the necessary
spending for the projects. The repayment of the financing, or the return on our asset, could be adversely affected if appropriations for any such projects are delayed or terminated.
Because our business depends to a significant extent upon relationships with key industry players, our inability to maintain or develop these
relationships, or the failure of these relationships to generate business opportunities, could adversely affect our business.
We rely
to a significant extent on our relationships with key industry players in the markets we target. We originate transactions through programmatic finance relationships with various parties, including global ESCOs. We also originate transactions with
renewable energy manufacturers, developers and operators such as EDF Renewable Energy, E.ON, First Solar, Invenergy, SunPower and other companies who own and operate renewable energy projects, including a number of U.S. utility companies. In
addition to the net proceeds from past and future offerings, we have traditionally financed our business by accessing the securitization, syndication or other debt markets, primarily utilizing our relationships with insurance companies and
commercial banks. We also rely on relationships with a variety of key financial participants, including institutional investors, senior lenders, and investment and commercial banks, as well as leading intermediaries, to complement our origination
and financing activities. Our inability to maintain or develop these relationships, or the failure of these
- 14 -
relationships to generate business opportunities, could adversely affect our business. In addition, individuals and entities with whom we have relationships are not obligated to provide us with
business opportunities, and, therefore, there is no assurance that such relationships will generate business opportunities for us.
If the cost of
energy generated by traditional sources of energy continues to stay at present levels or declines, demand for the projects in which we invest may decline.
Many traditional sources of energy such as coal, petroleum based fuels and natural gas can be influenced by the price of underlying or
substitute commodities. While we believe the potential for rising or increasingly volatile commodity prices and inflation will spur investment in our industry, there have been, and may continue to be, decreases in such prices, which may reduce the
demand for energy efficiency projects or other projects, including renewable energy facilities, that do not rely on traditional energy sources. For example, we believe low natural gas prices may reduce the demand for projects like renewable energy
that can substitute for natural gas. Additionally, low natural gas prices can adversely affect both the price available to renewable energy projects under future power sale agreements and the price of the electricity the projects sell on either a
forward or a spot-market basis. Technological progress in electricity generation, storage or in the production of traditional fuels or the discovery of large new deposits of traditional fuels could reduce the cost of energy generated from those
sources and consequently reduce the demand for the types of projects in which we invest, which could harm our new business origination prospects. In addition, volatility in commodity prices, including energy prices, may cause building owners and
other parties to be reluctant to commit to projects for which repayment is based upon a fixed monetary value for energy savings that would not decline if the price of energy declines. Any resulting decline in demand for our financing solutions or
the price that industry participants receive for the sale of their products could adversely impact our operating results.
If the market for various
types of sustainable infrastructure projects or the investment techniques related to such projects do not develop as we anticipate, new business generation in this target area would be adversely impacted.
The market for various types of sustainable infrastructure projects such as renewable energy projects and commercial office building energy
efficiency projects are emerging and rapidly evolving, leaving their future success uncertain. Similarly, various investing techniques, such as leasing land for renewable energy projects, purchasing interest in existing renewable energy projects,
the use of PACE financing and the use of taxable debt for state and local energy efficiency financings are emerging and the future success of these investing techniques is also uncertain. If some or all of these market segments or investing
techniques prove unsuitable for widespread commercial deployment or if demand for such projects or techniques fail to grow sufficiently, the demand for our capital may decline or develop more slowly than we anticipate. Many factors will influence
the widespread adoption and demand for such projects and investing techniques, including general and local economic conditions, commodity prices of traditional energy sources, the availability of cost-effective energy storage, the cost-effectiveness
of such projects and techniques, performance and reliability of such technologies compared to conventional power sources and technologies, the extent of government subsidies to support sustainable infrastructure and regulatory developments in the
power and natural resource industries. In addition, renewable energy projects rely on electric and other types of transmission lines, pipelines and facilities owned and operated by third parties to obtain their inputs or distribute their output. Any
substantial access barriers to these lines and facilities could make projects that depend on them more expensive, which could adversely impact the demand or financial performance for such projects and our investments.
Existing electric utility industry regulations, and changes to regulations, may present technical, regulatory and economic barriers to the purchase and use
of renewable energy and energy efficiency systems that may significantly reduce demand for systems in which we can invest.
Federal,
state and local government regulations and policies concerning the electric utility industry, and internal policies and regulations promulgated by electric utilities, heavily influence the market for electricity
- 15 -
products and services. These regulations and policies often relate to electricity pricing and the interconnection of customer-owned electricity generation. In the United States, governments and
utilities continuously modify these regulations and policies. These regulations and policies could deter customers from purchasing energy efficiency and renewable energy systems. This could result in a significant reduction in the potential demand
for such systems. For example, utilities commonly charge fees to larger, industrial customers for disconnecting from the electric grid or for having the capacity to use power from the electric grid for
back-up
purposes. In addition, there is an increasing trend towards initiating or increasing fixed fees for users to have electricity service from a utility. These fees could increase our customers cost to use energy efficiency and renewable energy
systems not supplied by the utility and make them less desirable, thereby harming our business, prospects, financial condition and results of operations. In addition, any changes to government or internal utility regulations and policies that favor
electric utilities could reduce competitiveness and cause a significant reduction in demand for systems in which we invest.
Some projects in which we
invest rely on net metering and related policies to improve project economics which if reduced could impact repayment of our financings or the return on our assets.
Many states have a regulatory policy known as net energy metering, or net metering. Net metering typically allows some project customers to
interconnect their
on-site
solar or other renewable energy systems to the utility grid and offset their utility electricity purchases by receiving a bill credit at the utilitys retail rate for the amount
of energy in excess of their electric usage that is generated by their renewable energy system and is exported to the grid. At the end of the billing period, the customer simply pays for the net energy used or receives a credit at the retail rate if
more energy is produced than consumed. Net metering policies are under review or have been limited or amended in a number of states. The ability and willingness of customers to pay for renewable energy systems which benefit from net metering rules
may be reduced if net metering rules are eliminated or their benefits reduced, which may also impact our returns on such systems.
Sustainable
infrastructure projects that involve the generation, transmission or sale of electricity such as renewable energy projects may be subject to regulation by the Federal Energy Regulatory Commission under the Federal Power Act or other regulations that
regulate the sale of electricity, which may adversely affect the profitability of such projects.
Sustainable infrastructure projects
that involve the generation, transmission or sale of electricity such as renewable energy projects may be qualifying facilities that are exempt from regulation as public utilities by the Federal Energy Regulatory Commission, (the
FERC) under the Federal Power Act, (the FPA) while certain other such projects may be subject to rate regulation by the FERC under the FPA. FERC regulations under the FPA confer upon these qualifying facilities key rights to
interconnection with local utilities, and can entitle such facilities to enter into PPAs with local utilities, from which the qualifying facilities benefit. Changes to these U.S. federal laws and regulations could increase the regulatory burdens and
costs, and could reduce the revenue of the project. In addition, modifications to the pricing policies of utilities could require sustainable infrastructure projects to achieve lower prices in order to compete with the price of electricity from the
electric grid and may reduce the economic attractiveness of certain energy efficiency measures. To the extent that the projects in which we invest are subject to rate regulation, the project owners will be required to obtain FERC acceptance of their
rate schedules for wholesale sales of energy, capacity and ancillary services. Any changes in the rates project owners are permitted to charge could impact the repayment of our financings, or the return on our assets.
In addition, the operation of, and electrical interconnection for, our sustainable infrastructure projects may be subject to U.S. federal,
state or local interconnection and federal reliability standards, some of which are set forth in utility tariffs. These standards and tariffs specify rules, business practices and economic terms to which the projects where we invest are subject and
which may impact on a projects ability to deliver the electricity it produces or transports to its end customer. The tariffs are drafted by the utilities and approved by the utilities state and U.S. federal regulatory commissions. These
standards and tariffs change frequently and it is possible that future changes will increase our administrative burden or adversely affect the terms and conditions under which the projects render services to their customers.
- 16 -
In addition, under certain circumstances, we may also be subject to the reliability standards of
the North American Electric Reliability Corporation. If project owners fail to comply with the mandatory reliability standards, they could be subject to sanctions, including substantial monetary penalties, which could also raise credit risks for, or
lower the returns available from, the projects in which we invest.
These various regulations may also limit the transferability or sale
of renewable energy projects and any such limits could negatively impact our returns from such projects.
Unfavorable publicity or public perception of
the industries in which we operate could adversely impact our operating results and our reputation.
The sustainable infrastructure
industry, including various forms of renewable energy receives significant media coverage that, whether or not directly related to our business or our projects, can adversely impact our reputation and the demand for our investments. Similarly,
negative publicity or public perception of the broader energy-related industries in which we operate could reduce demand for our investments and our projects services. Any reduction in demand for sustainable infrastructure projects or for our
investments could damage our reputation or could have a material adverse effect on our results of operations and business prospects.
Future litigation
or administrative proceedings could have a material and adverse effect on our business, financial condition and results of operations.
We may become involved in legal proceedings, administrative proceedings, claims and other litigation that arise in the ordinary course of
business. In addition, we may be subject to legal proceedings or claims arising out of the projects in which we invest. Adverse outcomes or developments relating to these proceedings, such as judgments for monetary damages, injunctions or denial or
revocation of permits, could have a material adverse effect on the projects in which we invest, which could adversely impact the repayment of or the returns available for our assets.
We operate in a competitive market and future competition may impact the terms of our investments.
We compete against a number of parties who may provide alternatives to our investments including specialty finance companies, savings and loan
associations, banks, private equity, hedge or infrastructure investment funds, insurance companies, mutual funds, institutional investors, investment banking firms, financial institutions, utilities, independent power producers, project developers,
pension funds, governmental bodies, public entities established to own infrastructure assets and other entities. We also encounter competition in the form of potential customers or our origination partners electing to use their own capital rather
than engaging an outside provider such as us. In addition, we may also face competition based on technological developments that reduce demand for electricity, increase power supplies through existing infrastructure or that otherwise compete with
our sustainable infrastructure projects. Some of our competitors are significantly larger than we are, have access to greater capital and other resources than we do and may have other advantages over us. In addition, some of our competitors may have
higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships than we can. In addition, many of our competitors are not subject to the operating constraints
associated with REIT tax compliance or maintenance of an exception from the 1940 Act. These characteristics could allow our competitors to consider a wider variety of opportunities, establish more relationships and offer better pricing and more
flexible structuring than we can offer. We may lose business opportunities if we do not match our competitors pricing, terms and structure. If we are forced to match our competitors pricing, terms and structure, we may not be able to
achieve acceptable risk-adjusted returns on our assets or we may be forced to bear greater risks of loss. A portion of our competitive advantage stems from the fact that certain segments of the market opportunities in sustainable infrastructure
projects are underserved by traditional commercial banks and other sources. A significant increase in the number and/or the size of our competitors in this market could force us to accept less attractive terms on our investments. As a result,
competitive pressures we face could have a material adverse effect on our business, financial condition and results of operations.
- 17 -
Our business is affected by seasonal trends and construction cycles, and these trends and cycles could have an
adverse effect on our operating results.
The volume and timing of our originations are subject to seasonal fluctuations and
construction cycles, particularly in climates that experience colder weather during the winter months, such as the northern United States, or at educational institutions, where large projects are typically carried out during summer months when their
facilities are unoccupied. In addition, government customers, many of which have fiscal years that do not coincide with ours, typically follow annual procurement cycles. Further, government contracting cycles can be affected by the timing of, and
delays in, the legislative process related to government programs and incentives that help drive demand for sustainable infrastructure projects. As a result of such fluctuations, we may occasionally experience fluctuations in the timing of new asset
opportunities or declines in revenue or earnings as compared to the immediately preceding quarter, and comparisons of our operating results on a
period-to-period
basis
may not be meaningful.
Risks Related to Our Assets and Projects in Which We Invest
Interest rate fluctuations and increases in interest rates could adversely affect the value of our assets, which could result in reduced earnings or losses
and negatively affect our profitability.
Interest rates are highly sensitive to many factors, including governmental monetary and tax
policies, domestic and international economic and political considerations and other factors beyond our control. Many of our assets pay a fixed rate of interest or provide a fixed preferential return.
With respect to our business operations, increases in interest rates, in general, may over time cause: (1) project owners to be less
interested in borrowing or raising equity and thus reduce the demand for our assets; (2) the interest expense associated with our borrowings to increase; (3) the value of our fixed rate or fixed return assets to decline; and (4) the
value of our interest rate swap agreements to increase. Conversely, decreases in interest rates, in general, may over time cause: (1) project owners to be more interested in borrowing or raising equity and thus increase the demand for our
assets; (2) prepayments on our assets, to the extent allowed, to increase; (3) the interest expense associated with our borrowings to decrease; (4) the value of our fixed rate or fixed return assets to increase; and (5) the value
of our interest rate swap agreements to decrease. Adverse developments resulting from changes in interest rates could have a material adverse effect on our business, financial condition and results of operations.
The lack of liquidity of our assets may adversely affect our business, including our ability to value and sell our assets.
Volatile market conditions could significantly and negatively impact the liquidity of our assets. Illiquid assets typically experience greater
price volatility, as a ready market does not exist, and can be more difficult to value. In addition, validating third-party pricing for illiquid assets may be more subjective than more liquid assets. The illiquidity of our assets may make it
difficult for us to sell such assets if the need or desire arises. In addition, if we are required to liquidate all or a portion of our Portfolio quickly, we may realize significantly less than the value at which we have previously recorded our
assets. To the extent that we utilize leverage to finance our purchase of assets that are or become illiquid, the negative impact on us related to trying to sell assets in a short period of time for cash could be greatly exacerbated. As a result,
our ability to vary our portfolio in response to changes in economic and other conditions may be relatively limited, which could adversely affect our results of operations and financial condition.
We may experience a decline in the fair value of our assets.
A decline in the fair market value of available for sale securities, our financing receivables held for sale, our interest rate hedges, if any,
or any other assets which we may carry at fair value in the future, may require us to reduce the value of such assets under generally accepted accounting principles in the United States (U.S.
- 18 -
GAAP). In addition, all of our other financial assets are subject to an impairment assessment that could result in adjustments to their carrying values. Upon the subsequent disposition or
sale of such assets, we could incur future losses or gains based on the difference between the sale price received and adjusted value of such assets as reflected on our balance sheet at the time of sale. See Note 2 and Note 3 of the audited
financial statements in this Form
10-K
for additional details related to our determination of fair value.
Some
of the assets in our portfolio may be recorded at fair value (as determined in accordance with our pricing policy as approved by our board of directors) and, as a result, there could be uncertainty as to the value of these assets.
The financings we provide and the other assets we hold are not publicly traded. The fair value of assets that are not publicly traded may not
be readily determinable. As required under and in accordance with U.S. GAAP, we record certain of our assets at fair value, which may include unobservable inputs. Because such valuations are subjective, the fair value of these assets may fluctuate
over short periods of time and our determinations of fair value may differ materially from the values that would have been used if a ready market for these assets existed. The value of our common stock could be adversely affected if our
determinations regarding the fair value of these assets were materially higher than the values that we ultimately realize upon their disposal. Additionally, our results of operations for a given period could be adversely affected if our
determinations regarding the fair value of these assets were materially higher than the values that we ultimately realize upon their disposal. The valuation process can be particularly challenging during periods when market events make valuations of
certain assets more difficult, unpredictable and volatile.
We may not realize income or gains from our assets, which could cause the value of our
common stock to decline.
We seek to provide attractive risk-adjusted returns to our stockholders. However, our assets may not
appreciate in value and, in fact, may decline in value, and the assets we originate or acquire may default or not perform in accordance with our expectations. Accordingly, we may not be able to realize gains or income from our assets. Any gains that
we do realize may not be sufficient to offset any other losses we experience. Any income that we realize may not be sufficient to offset our expenses.
Many of our assets are not rated by a rating agency, which may result in an amount of risk, volatility or potential loss of principal that is greater than
that of alternative asset opportunities.
Many of our assets are not rated by any rating agency and we expect that some of the assets
we originate and acquire in the future will not be rated by any rating agency. Although we focus on sustainable infrastructure projects with high credit quality obligors, we believe that some of the projects or obligors in which we invest, if rated,
would be rated below investment grade, due to speculative characteristics of the project or the obligors capacity to pay interest and repay principal or pay dividends. Some of our assets may result in an amount of risk, volatility or potential
loss of principal that is greater than that of alternative asset opportunities.
Any credit ratings assigned to our assets or obligors are subject to
ongoing evaluations and revisions and we cannot assure you that those ratings will not be downgraded.
To the extent the assets we hold
or their underlying obligors are rated by credit rating agencies or by our internal rating process, such assets will be subject to ongoing evaluation by credit rating agencies and our internal rating process, and we cannot assure you that any
ratings will not be changed or withdrawn in the future. If rating agencies assign a lower-than-expected rating or if a rating is reduced or withdrawn by a rating agency or us, or if there are indications of a potential reduction or withdrawal of the
ratings of our assets or the underlying obligors in the future, the value of these assets could significantly decline and could result in losses upon disposition or the failure of obligors to satisfy their obligations to us.
- 19 -
Our assets are subject to delinquency, foreclosure and loss, any or all of which could result in losses to us.
Our assets are subject to risks of delinquency, foreclosure and loss. In many cases, the ability of a borrower to repay our financing
or the ability of an investment to return our capital and our expected return is dependent primarily upon the successful development, construction and operation of the underlying project. If the cash flow of the project is reduced, the
borrowers ability to repay the debt financing we provide or the ability of an investment to return our capital and our expected return may be impaired. We make certain estimates regarding project cash flows or savings during the underwriting
of our investment. These estimates may not prove accurate, as actual results may vary from estimates. The cash flows or cost savings of a project can be affected by, among other things: the terms of the power purchase or other use agreements used in
such project; the creditworthiness of the power
off-taker
or project user; power prices now and in the future; the technology deployed; unanticipated expenses in the development or operation of the project and
changes in national, regional or local economic conditions; and environmental legislation, acts of God, terrorism, social unrest and civil disturbances.
In the event of any default or shortfall of an investment, we will bear a risk of loss of principal or equity to the extent of any deficiency
between the value of the collateral, if any, and the amount of our investment, which could have a material adverse effect on our cash flow from operations. Many of the projects are structured as special purpose limited liability companies which
limits our ability to realize any recovery to the collateral or value of the project itself. In the event of the bankruptcy of a project owner or other borrower, our investment will be deemed to be subject to the avoidance powers of the bankruptcy
trustee or
debtor-in-possession
and our contractual rights may be unenforceable under state law. Foreclosure proceedings against a project can be an expensive and
lengthy process, which could have a substantial negative effect on our anticipated return on the foreclosed investment.
Our sustainable infrastructure
projects may incur liabilities that rank equally with, or senior to, our investments in such projects.
We provide a range of
investment structures, including various types of debt and equity securities, senior and subordinated loans, real property leases, mezzanine debt, preferred equity and common equity. Our projects may have, or may be permitted to incur, other
liabilities or equity preferences that rank equally with, or senior to, our positions or investments in such projects or businesses, as the case may be, including with respect to grants of collateral. By their terms, such instruments may entitle the
holders to receive payment of interest, principal payments or other distributions on or before the dates on which we are entitled to receive payments with respect to the instruments in which we invest. Also, in the event of insolvency, liquidation,
dissolution, reorganization or bankruptcy of an entity in which we have invested, holders of instruments ranking senior to our investment in that project or business would typically be entitled to receive payment in full before we receive any
distribution. After repaying such senior stakeholders, such project may not have any remaining assets to use for repaying its obligation to us. In the case of securities ranking equally with instruments we hold, we would have to share on an equal
basis any distributions with other stakeholders holding such instruments in the event of an insolvency, liquidation, dissolution, reorganization or bankruptcy of the relevant project.
Our mezzanine or subordinated loans are less protected against losses than senior debt.
We make or acquire mezzanine or subordinated loans, which are loans made to project owners for sustainable infrastructure projects that are
subordinate to other more senior interest or are secured by pledges of the borrowers ownership interests in the project and/or the project owner. These mezzanine or subordinated loans may be subordinate to senior secured loans on the project
or to the returns required by the tax equity investor in the project but senior to the project owners equity. In the event a borrower defaults on a loan and lacks sufficient assets to satisfy our mezzanine or subordinated financing, we may
suffer a loss of principal or interest. In the event a borrower declares bankruptcy, we may not have full recourse to the assets of the borrower, or the assets of the borrower may not be sufficient to satisfy our mezzanine or subordinated loan. In
addition, mezzanine or subordinated loans are by their nature structurally subordinated to more senior project level
- 20 -
financings, and in some cases, to tax equity investors. If a borrower defaults on our mezzanine or subordinated loan, on its obligations to the tax equity investor or on debt or other obligations
senior to our loan, or if a borrower declares bankruptcy, our mezzanine or subordinated loan will be satisfied only after the project level debt or other obligations or tax equity and other senior debt is paid in full. Significant losses related to
our mezzanine or subordinated loans would result in operating losses for us and may limit our ability to make distributions to our stockholders.
Our
subordinated and mezzanine debt and equity investments, many of which are illiquid with no readily available market, involve a substantial degree of risk.
We make subordinated and mezzanine debt and equity investments which may fail to be repaid or appreciate and may decline in value or become
worthless and our ability to recover our investment will depend on the success of the project in which we make such investments. Subordinated and mezzanine debt and equity investments involve a number of significant risks, including:
|
|
|
subordinated and mezzanine debt and any equity investment we make in a project could be subject to further dilution as a result of the issuance of additional debt or equity interests and to serious risks because
subordinated and mezzanine debt are subordinate to other indebtedness and in some cases, project tax equity, and equity interests are subordinate to all indebtedness (including trade creditors) and any senior securities in the event that the issuer
is unable to meet its obligations or becomes subject to a bankruptcy process;
|
|
|
|
to the extent that a project in which we invest requires additional capital and is unable to obtain it, we may not recover our investment; and
|
|
|
|
in some cases, subordinated and mezzanine debt will not pay current interest or principal or equity investments will not pay current dividends, and our ability to realize a return on our investment, as well as to
recover our investment, will be dependent on the success of the project in which we invest. The project may face unanticipated costs or delays or may not generate projected cash flows which could lead to the project generating lower rates of return
than we expected when we decided to fund the project. Further, many projects in which we make subordinated and mezzanine debt or equity investments will be subject to competitive risks and to volatility in commodity prices including the price of
energy. Even if the project is successful, our ability to realize the value of our investment may be dependent on our ability to renew commercial contracts for a project or on the occurrence of a liquidity or other event.
|
We generally do not control the projects in which we invest.
Although the covenants in our financing or investment documentation generally restrict certain actions that may be taken by project owners, we
generally do not control the projects in which we invest. As a result, we are subject to the risk that the project owner may make business decisions with which we disagree or take risks or otherwise act in ways that do not serve our interests.
We invest in joint ventures or other similar arrangements that subject us to additional risks.
Some of our projects are structured as joint ventures, partnerships and securitization, syndication and consortium arrangements. Part of our
strategy is to participate with other institutional investors in consortiums and in partnerships on various sustainable infrastructure transactions. These arrangements are driven by the magnitude of capital required to complete acquisitions and the
development of sustainable infrastructure projects and other industry-wide trends that we believe will continue. Such arrangements involve risks not present where a third party is not involved, including the possibility that partners or
co-venturers
might become bankrupt or otherwise fail to fund their share of required capital contributions. Additionally, partners or
co-venturers
might at any time have
economic or other business interests or goals different from us.
- 21 -
Joint ventures, partnerships and securitization, syndication and consortium investments generally
provide for a reduced level of control over an acquired project because governance rights are shared with others. Accordingly, decisions relating to the underlying operations, including decisions relating to the management, operation and the timing
and nature of any exit, are often made by a majority vote of the investors or by separate agreements that are reached with respect to individual decisions. In addition, such operations may be subject to the risk that the project owners may make
business, financial or management decisions with which we do not agree or the management of the project may take risks or otherwise act in a manner that does not serve our interests. Because we may not have the ability to exercise control over such
operations, we may not be able to realize some or all of the benefits that we believe will be created from our involvement. If any of the foregoing were to occur, our business, financial condition and results of operations could suffer as a result.
In addition, some of our joint ventures, partnerships, securitization or syndication or consortium arrangements, including some of our
equity investments, subject the sale or transfer of our interests in these projects to rights of first refusal or first offer, tag along rights or drag along rights and
buy-sell,
call-put
or other similar arrangements. Such rights may be triggered at a time when we may not want them to be exercised and such rights may inhibit our ability to sell our interest in an entity within our
desired time frame or on any other desired terms.
Energy efficiency, renewable energy and other sustainable infrastructure projects are subject to
performance risks that could impact the repayment of and the return on our assets.
Energy efficiency, renewable energy and other
sustainable infrastructure projects are subject to various construction and operating delays and risks that may cause them to incur higher than expected costs or generate less than expected amounts of output such as electricity in the case of a
renewable energy project. These risks include construction delays, a failure or degradation of our, our customers or the utilities equipment; an inability to find suitable equipment or parts; labor shortages; less than expected supply of
a projects source of renewable energy, such as solar insolation, wind, geothermal brine or biomass; or a faster than expected diminishment of such supply. Further, many projects in which we invest will be subject to competitive risks and to
volatility in commodity prices including the price of energy. Any extended interruption in the projects construction or operation, any cost overrun or failure of the project for any reason to generate the expected amount of output or cash
flow, could have a material adverse effect on the repayment of and the return on our assets.
Many of our assets depend on revenues from third-party
contractual arrangements.
Many of the projects in which we invest rely on revenue or repayment from contractual commitments of
end-customers
such as federal, state or local governments for our energy efficiency projects or utilities under power purchase agreements. There is a risk that these customers will default under their contracts.
Furthermore, the bankruptcy, insolvency or other liquidity constraints of one or more customers may reduce the likelihood of collecting defaulted obligations. Some projects rely on one customer for their revenue and thus the project could be
materially and adversely affected by any material change in the financial condition of that customer. While there may be alternative customers for such a project, there can be no assurance that a new contract on the same terms will be able to be
negotiated for the project.
Certain of our projects with contractually committed revenues or other sources of repayment under a small
number of long term contracts will be subject to
re-contracting
risk in the future. We cannot provide assurance that these contracts can be
re-negotiated
once their
terms expire on equally favorable terms or at all. If it is not possible to renegotiate these contracts on favorable terms, our business, financial condition, results of operation and prospects could be materially and adversely affected.
Revenues at some of the projects in which we invest depend on reliable and efficient metering, or other revenue collection systems, which are
often specified in the contract. There is a risk that, if one or more of such projects are not able to operate and maintain the metering or other revenue collection systems in the manner
- 22 -
expected, if the operation and maintenance costs, are greater than expected, or if the customer disputes the output of the revenue collection system, the ability of the project to repay our
financing or provide a return to us on our asset could be materially and adversely affected.
We are exposed to the credit risk of ESCOs and others.
While we do not anticipate facing significant credit risk in our assets related to government energy efficiency projects, we are
subject to varying degrees of credit risk in these projects in relation to guarantees provided by ESCOs where payments under energy savings performance contracts are contingent upon energy savings. We are also exposed to credit risk in projects in
which we invest that do not depend on funding from governments. We seek to mitigate this credit risk by employing a comprehensive review and asset selection process and careful ongoing monitoring of acquired assets. Nevertheless, unanticipated
credit losses could occur which could adversely impact our operating results. During periods of economic downturn in the global economy, our exposure to credit risks from obligors increases, and our efforts to monitor and mitigate the associated
risks may not be effective in reducing our credit risks. Certain participants in the sustainable energy industry have experienced significant declines in the value of their equity and difficulty in raising or refinancing debt, which increases the
credit risk to these companies and there can be no assurance they will be able to fulfill their obligations which could adversely impact our operating results.
Some of the projects in which we invest have sold their output under power purchase agreements which expose the projects to various risks.
Some of our projects enter into PPAs when they contract to sell all or a fixed proportion of the electricity generated by the project,
sometimes bundled with renewable energy credits and capacity or other environmental attributes, to a power purchaser, often a utility. PPAs are used to stabilize our revenues from that project. We are exposed to the risk that the power purchaser,
who we consider an obligor, will fail to perform under a PPA or the PPA will be terminated or expire, which will lead to that project needing to sell its electricity at the market price, which could be substantially lower than the price provided in
the applicable PPA. In most instances, the project also commits to sell minimum levels of generation. If the project generates less than the committed volumes, it may be required to buy the shortfall of electricity on the open market or make
payments of liquidated damages or be in default under a PPA, which could result in its termination. In the event that any of these events were to occur, our business, financial condition and results of operations could suffer as a result.
Certain of the electricity our assets generate is sold on the open market at spot-market prices. A prolonged environment of low prices for natural gas, or
other conventional fuel sources, could have a material adverse effect on our long-term business prospects, financial condition and results of operations.
Historically low prices for traditional fossil fuels, particularly natural gas, could cause demand for renewable energy to decrease or
adversely affect both the price available to our projects under PPAs that the projects may enter into in the future and the price of the electricity the projects generate for sale on a spot-market basis. Low spot market power prices, if combined
with other factors, could have a material adverse effect on the projects and our results of operations and cash available for distribution. Additionally, cheaper conventional fuel sources could also have a negative impact on the power prices the
projects are able to negotiate upon the expiration of current PPAs. As a result, the price our projects realize in the open market could be materially and adversely affected, which could, in turn, have a material adverse effect on the projects
results of operations and cash available for distribution. In the event that any of these events were to occur, our business, financial condition and results of operations could suffer as a result.
The ability of our assets to generate revenue from certain utility renewable energy projects depends on having interconnection arrangements and services.
The future success of our renewable energy assets will depend, in part, on their ability to maintain satisfactory interconnection
agreements. If the interconnection or transmission agreement of a renewable energy
- 23 -
project is terminated for any reason, they may not be able to replace it with an interconnection and transmission arrangement on terms as favorable as the existing arrangement, or at all, or they
may experience significant delays or costs in connection with securing a replacement. If a network to which one or more of the renewable energy projects is connected experiences equipment or operational problems or other forms of down
time, the affected project may lose revenue and be exposed to
non-performance
penalties and claims from its customers. These may include claims for damages incurred by customers, such as the additional
cost of acquiring alternative electricity supply at then-current spot market rates. The owners of the network will not usually compensate electricity generators for lost income due to down time. In addition, our projects may be exposed to a
locational basis risk resulting from a difference between where the power is generated and the contracted delivery point. These factors could materially affect the ability to forecast operations on these projects, which could negatively affect our
business, results of operations, financial condition and cash flow.
The generation of electric energy from renewable energy sources depends heavily on
suitable meteorological conditions. If renewable conditions are unfavorable, the electricity generation, and therefore revenue from our renewable generation assets, may be substantially below our expectations.
The electricity produced and revenues generated by a renewable electric generation facility are highly dependent on suitable weather
conditions, which are beyond our control. Furthermore, components of renewable energy systems, such as turbines, solar panels and inverters, could be damaged by natural disasters or severe weather, including hailstorms or tornadoes. The projects in
which we invest will be obligated to bear the expense of repairing the damaged renewable energy systems, and replacing spare parts for key components and insurance may not cover the costs or the lost revenue. Natural disasters or unfavorable weather
and atmospheric conditions could impair the effectiveness of the renewable energy assets, reduce their output beneath their rated capacity, require shutdown of key equipment or impede operation of the renewable energy assets, which could adversely
affect our business, financial condition and results of operations and cash flows. Sustained unfavorable weather could also unexpectedly delay the installation of renewable energy systems, which could result in a delay in our investing in new
projects or increase the cost of such projects.
We typically base our investment decisions with respect to each renewable energy facility
on the findings of studies conducted
on-site
prior to construction or based on historical conditions at existing facilities. However, actual climatic conditions at a facility site may not conform to the
findings of these studies. Even if an operating projects historical renewable energy resources are consistent with the long-term estimates, the unpredictable nature of weather conditions often results in daily, monthly and yearly material
deviations from the average renewable resources anticipated during a particular period. Therefore, renewable energy facilities in which we invest may not meet anticipated production levels or the rated capacity of the generation assets, which could
adversely affect our business, financial condition and results of operations and cash flows.
The amount of electricity renewable energy
generation assets produce is also dependent in part on the time of year. For example, because shorter daylight hours in winter months results in less solar irradiation, the generation of particular assets will vary depending on the season. Further,
time-of-day
pricing factors vary seasonally which contributes to variability of revenues. As a result, we expect the revenue and cash flow from certain of our assets to vary
based on the time of year.
Operation of electric generation facilities involves significant risks and hazards customary to the power industry that
could have a material adverse effect on our business, financial condition, results of operations and cash flows.
The ongoing operation
of the projects in which we invest involves risks that include the breakdown or failure of equipment or processes or performance below expected levels of output or efficiency due to wear and tear, latent defect, design error or operator error or
force majeure events, among other things. In addition to natural risks such as earthquake, flood, drought, lightning, hurricane and wind, other hazards, such as fire, explosion, structural collapse and machinery failure, acts of terrorism or related
acts of war, hostile cyber
- 24 -
intrusions or other catastrophic events are inherent risks in the operation of a project. These and other hazards can cause significant personal injury or loss of life, severe damage to and
destruction of property, plant and equipment and contamination of, or damage to, the environment and suspension of operations. Operation of a project also involves risks that the operator will be unable to transport its product to its customers in
an efficient manner due to a lack of transmission capacity. Unplanned outages of generating units, including extensions of scheduled outages due to mechanical failures or other problems, occur from time to time and are an inherent risk of the
business. Unplanned outages typically increase operation and maintenance expenses and may reduce revenues as a result of selling fewer megawatt hours or require the project to incur significant costs as a result of obtaining replacement power from
third parties in the open market to satisfy forward power sales obligations. The projects inability to operate its electric generation assets efficiently, manage capital expenditures and costs and generate earnings and cash flow could have a
material adverse effect on our investment and our business, financial condition, results of operations and cash flows. While the projects maintain insurance, obtain warranties from vendors and obligate contractors to meet certain performance levels,
the proceeds of such insurance, warranties or performance guarantees may not cover the lost revenues, increased expenses or liquidated damages payments should the project experience equipment breakdown or
non-performance
by contractors or vendors.
Some of the projects in which we invest may require substantial
operating or capital expenditures in the future.
Many of the projects in which we invest are capital intensive and require substantial
ongoing expenditures for, among other things, additions and improvements, and maintenance and repair of plant and equipment related to project operations. While we do not typically bear the responsibility for these expenditures, any failure by the
equity owner to make necessary operating or capital expenditures could adversely impact project performance. In addition, some of these expenditures may not be recoverable from current or future contractual arrangements.
The use of real property rights that we acquire or are used for our sustainable infrastructure projects may be adversely affected by the rights of
lienholders and leaseholders that are superior to those of the grantors of those real property rights to us.
The projects in which we
invest often require large areas of land for construction and operation or other easements or access to the underlying land. In addition, we may acquire rights to land or other real property. The rights to use the land can be obtained through
freehold title, leases and other rights of use. Although we believe that the real property rights we acquire, or our projects in which we invest, have valid rights to all material easements, licenses and rights of way, not all of such easements,
licenses and rights of way are registered against the lands to which they relate and may not bind subsequent owners. Some of our real property rights and projects generally are, and are likely to continue to be, located on land occupied pursuant to
long-term easements and leases. The ownership interests in the land subject to these easements and leases may be subject to mortgages securing loans or other liens (such as tax liens) and other easement and lease rights of third parties (such as
leases of oil or mineral rights) that were created prior to, or are superior to, our or our projects easements and leases. As a result, our rights may be subject, and subordinate, to the rights of those third parties. We typically obtain
representations or perform title searches or obtain title insurance to protect our real property interest or our investments in our projects against these risks. Such measures may, however, be inadequate to protect against all risk of loss of rights
to use the land rights we have acquired or the land on which these projects are located, which could have a material and adverse effect on our land rights, our projects and their financial condition and operating results.
- 25 -
We own land or leasehold interests that are used by renewable energy projects. Negative market conditions or
adverse events affecting tenants, or the industries in which they operate, could have an adverse impact on our underwritten returns. Moreover, such assets are concentrated in a limited number of properties, which subjects us to an increased risk of
significant loss if any property declines in value or if we are unable to lease a property.
We own a limited number of land or
leasehold interests that are used by renewable energy projects. One consequence of a limited number of real property assets is that the aggregate returns we realize may be substantially adversely affected by the unfavorable performance of a small
number of leases or a significant decline in the value of any single property. Our cash flow depends in part on the ability to lease the real estate to projects or other tenants on economically favorable terms. We could be adversely affected by
various facts and events over which we have limited or no control, such as:
|
|
|
lack of demand in areas where our properties are located;
|
|
|
|
inability to retain existing tenants and attract new tenants;
|
|
|
|
oversupply of space and changes in market rental rates;
|
|
|
|
our tenants creditworthiness and ability to pay rent, which may be affected by their operations, the current economic situation and competition within their industries from other operators;
|
|
|
|
defaults by and bankruptcies of tenants, failure of tenants to pay rent on a timely basis, or failure of tenants to comply with their contractual obligations; and
|
|
|
|
economic or physical decline of the areas where the properties are located.
|
At any time, any
tenant may experience a downturn in its business, including increased operating costs, termination of a PPA or low spot-market prices of products, that may weaken its operating results or overall financial condition, a tenant may delay lease
commencement, fail to make rental payments when due, decline to extend a lease upon its expiration, become insolvent or declare bankruptcy. Any tenant bankruptcy or insolvency, leasing delay or failure to make rental payments when due could result
in the termination of the tenants lease and material losses to us.
If a tenant elects to terminate its lease prior to or upon its
expiration or does not renew its lease as it expires, we may not be able to rent or sell the properties. Furthermore, leases that are renewed and some new leases for properties that are
re-leased,
may have
terms that are less economically favorable than expiring lease terms, or may require us to incur significant costs, such as lease transaction costs. In addition, negative market conditions or adverse events affecting tenants, or the industries in
which they operate, may force us to sell vacant properties for less than their carrying value, which could result in impairments. Any of these events could adversely affect cash flow from operations and our ability to make distributions to
stockholders and service indebtedness. A significant portion of the costs of owning property, such as real estate taxes, insurance and maintenance, are not necessarily reduced when circumstances cause a decrease in rental revenue from the
properties. In a weakened financial condition, tenants may not be able to pay these costs of ownership and we may be unable to recover these operating expenses from them.
Further, the occurrence of a tenant bankruptcy or insolvency could diminish the income we receive from the tenants lease or leases. For
instance, a bankruptcy court might authorize the tenant to terminate its leases with us. If that happens, our claim against the bankrupt tenant for unpaid future rent would be subject to statutory limitations that most likely would be substantially
less than the remaining rent we are owed under the leases. In addition, any claim we have for unpaid past rent, if any, may not be paid in full. As a result, tenant bankruptcies may have a material adverse effect on our results of operations.
In addition, since renewable energy projects are often concentrated in certain states, we would also be subject to any adverse change in the
political or regulatory climate in those states or specific counties where such properties are located that could adversely affect our properties and our ability to lease such properties.
- 26 -
Performance of projects where we invest may be harmed by future labor disruptions and economically unfavorable
collective bargaining agreements.
A number of the projects where we invest could have workforces that are unionized or that in the
future may become unionized and, as a result, are required to negotiate the wages, benefits and other terms with many of their employees collectively. If these projects were unable to negotiate acceptable contracts with any of their unions as
existing agreements expire, they could experience a significant disruption of their operations, higher ongoing labor costs and restrictions on their ability to maximize the efficiency of their operations, which could have a material and adverse
effect on our business, financial condition and results of operations. In addition, in some jurisdictions where our projects have operations, labor forces have a legal right to strike which may have a negative impact on our business, financial
condition and results of operations, either directly or indirectly, for example if a critical upstream or downstream counterparty was itself subject to a labor disruption which impacted the ability of our projects to operate.
We invest in projects that rely on third parties to manufacture quality products or provide reliable services in a timely manner and the failure of these
third parties could cause project performance to be adversely affected.
We invest in projects that typically rely on third parties to
select and manage various equipment and service providers. These third parties may be responsible for choosing vendors, including equipment suppliers and subcontractors. Project success often depends on third parties who are capable of installing
and managing projects and structuring contracts that provide appropriate protection against construction and operational risks. In many cases, in addition to contractual protections and remedies, project owners may seek guaranties, warranties and
construction bonding to provide additional protection.
The warranties provided by the third parties and, in some cases, their
subcontractors, typically limit any direct harm that results from relying on their products and services. However, there can be no assurance that a supplier or subcontractor will be willing or able to fulfill its contractual obligations and make
necessary repairs or replace equipment. In addition, these warranties generally expire within one to five years or may be of limited scope or provide limited remedies. If projects are unable to avail themselves of warranty protection or receive the
expected protection under the terms of the guaranties or bonding, we may need to incur additional costs, including replacement and installation costs, which could adversely impact our investment.
Liability relating to environmental matters may impact the value of properties that we may acquire or the properties underlying our assets.
Under various U.S. federal, state and local laws, an owner or operator of real estate or a project may become liable for the costs of removal
of certain hazardous substances released from the project or any underlying real property. These laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the release of such hazardous substances.
The presence of hazardous substances may adversely affect our, or another owners, ability to sell a contaminated project or borrow
using the project as collateral. To the extent that we, or another project owner, become liable for removal costs, our investment, or the ability of the owner to make payments to us, may be negatively impacted.
We acquire real property rights, make investments in projects that own real property, have collateral consisting of real property and in the
course of our business, we may take title to a project or its underlying real estate assets relating to one of our debt financings. In these cases, we could be subject to environmental liabilities with respect to these assets. To the extent that we
become liable for the removal costs, our results of operation and financial condition may be adversely affected. The presence of hazardous substances, if any, may adversely affect our ability to sell the affected real property or the project and we
may incur substantial remediation costs, thus harming our financial condition.
- 27 -
Our insurance and contractual protections may not always cover lost revenue, increased expenses or liquidated
damages payments.
Although our assets or projects generally have insurance, supplier warranties, subcontractors performance assurances
such as bonding and other risk mitigation measures, the proceeds of such insurance, warranties, bonding or other measures may not be adequate to cover lost revenue, increased expenses or liquidated damages payments that may be required in the
future.
Risks Related to Our Company
We may
change our operational policies (including our investment guidelines, strategies and policies) with the approval of our board of directors but without stockholder consent at any time, which may adversely affect the market value of our common stock
and our ability to make distributions to our stockholders.
Our board of directors determines our operational policies and may amend or
revise our policies, including our policies with respect to acquisitions, dispositions, growth, operations, compensation, indebtedness, capitalization and dividends, or approve transactions that deviate from these policies, without a vote of, or
notice to, our stockholders at any time. We may change our investment guidelines, underwriting process and our strategy at any time with the approval of our board of directors, but without the consent of our stockholders, which could result in our
originating assets that are different in type from, and possibly riskier than, the assets initially contemplated. In addition, our charter provides that our board of directors may authorize us to revoke or otherwise terminate our REIT election,
without the approval of our stockholders, if it determines that it is no longer in our best interests to qualify as a REIT. These changes could adversely affect our business, financial condition, results of operations and our ability to make
distributions to our stockholders.
Our management and employees depend on information systems and system failures could significantly disrupt our
business, which may, in turn, negatively affect the market price of our common stock and our ability to make distributions to our stockholders.
Our underwriting process and our asset and financial management and reporting are dependent on our present and future communications and
information systems. Any failure or interruption of these systems could cause delays or other problems in our originating, financing, investing, asset and financial management and reporting activities, which could have a material adverse effect on
our operating results.
Cybersecurity risk and cyber incidents may adversely affect our business by causing a disruption to our operations, a
compromise or corruption of our confidential information and/or damage to our business relationships, all of which could negatively impact our financial results.
A cyber incident is considered to be any adverse event that threatens the confidentiality, integrity or availability of our information
resources. These incidents may be an intentional attack or an unintentional event and could involve gaining unauthorized access to our information systems for purposes of misappropriating assets, stealing confidential information, corrupting data or
causing operational disruption. The result of these incidents may include disrupted operations, misstated or unreliable financial data, liability for stolen assets or information, increased cybersecurity protection and insurance cost, litigation and
damage to our relationships. As our reliance on technology has increased, so have the risks posed to both our information systems and those provided by third-party service providers. We have implemented processes, procedures and internal controls to
help mitigate cybersecurity risks and cyber intrusions, but these measures, as well as our increased awareness of the nature and extent of a risk of a cyber incident, do not guarantee that our financial results, operations or confidential
information will not be negatively impacted by such an incident.
- 28 -
We may seek to expand our business internationally, which will expose us to additional risks that we do not
face in the United States, which could have an adverse effect on our business, financial condition and operating results.
We generate
substantially all of our revenue from operations in the United States, and currently derive only a small amount of revenue from outside of the United States. We may seek to expand our revenue and projects outside of the United States in the future.
These operations will be subject to a variety of risks that we do not face in the United States, including risk from changes in foreign country regulations, infrastructure, legal systems and markets. Other risks include possible difficulty in
repatriating overseas earnings and fluctuations in foreign currencies.
Our overall success in international markets will depend, in part,
on our ability to succeed in different legal, regulatory, economic, social and political conditions. We may not be successful in developing and implementing policies and strategies that will be effective in managing these risks in each country where
we decide to do business. Our failure to manage these risks successfully could harm our international projects, reduce our international income or increase our costs, thus adversely affecting our business, financial condition and operating results.
We may seek to expand our business in part through future acquisitions
As we grow our business, we may find opportunities to use acquisitions of companies or assets to invest in new or different projects, expand
our project skill-sets and capabilities, expand our geographic markets, add experienced management and increase our product and service offerings. There are a number of risks associated with any acquisition and we may not achieve our goals in making
an acquisition. Any future acquisitions that we may make could disrupt our business, cause dilution to our stockholders and harm our business, financial condition or operating results. In addition, the time and effort involved in attempting to
identify acquisition candidates and consummate acquisitions may divert members of our management from the operations of our company.
Risks Relating to
Regulation
We cannot predict the unintended consequences and market distortions that may stem from
far-ranging
governmental intervention in the economic and financial system or from regulatory reform of the oversight of financial markets.
The U.S. federal government, the Federal Reserve Board of Governors, the U.S. Treasury, the SEC, U.S. Congress and other governmental and
regulatory bodies have taken, are taking or may in the future take, various actions to address the financial crisis or other areas of regulatory concern, such as the DoddFrank Wall Street Reform and Consumer Protection Act (the
Dodd-Frank Act). Such actions could have a dramatic impact on our business, results of operations and financial condition, and the cost of complying with any additional laws and regulations or the elimination or reduction in scope of
various existing laws and regulations could have a material adverse effect on our financial condition and results of operations. The
far-ranging
government intervention in the economic and financial system may
carry unintended consequences and cause market distortions. We are unable to predict at this time the extent and nature of such unintended consequences and market distortions, if any.
Loss of our 1940 Act exception would adversely affect us, the market price of shares of our common stock and our ability to distribute dividends.
We conduct our operations so that we are not required to register as an investment company under the 1940 Act. Section 3(a)(1)(A) of the
1940 Act defines an investment company as any issuer that is or holds itself out as being engaged primarily in the business of investing, reinvesting or trading in securities. Section 3(a)(1)(C) of the 1940 Act defines an investment company as
any issuer that is engaged or proposes to engage in the business of
- 29 -
investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40% of the value of the issuers total assets
(exclusive of U.S. Government securities and cash items) on a
non-consolidated
basis, which we refer to as the 40% test. Excluded from the term investment securities, among other things, are U.S.
Government securities and securities issued by majority-owned subsidiaries that are not themselves investment companies and are not relying on the exception from the definition of investment company set forth in Section 3(c)(1) or
Section 3(c)(7) of the 1940 Act.
We conduct our businesses primarily through our subsidiaries and our operations so that we comply
with the 40% test. The securities issued by any wholly-owned or majority-owned subsidiaries that we hold or may form in the future that are excepted from the definition of investment company based on Section 3(c)(1) or 3(c)(7) of
the 1940 Act, together with any other investment securities we may own, may not have a value in excess of 40% of the value of our total assets on a
non-consolidated
basis. Certain of our subsidiaries rely on
or will rely on an exception from registration as an investment company under the 1940 Act pursuant to Section 3(c)(5)(C) of the 1940 Act, which is available for entities which are not primarily engaged in issuing redeemable securities,
face-amount certificates of the installment type or periodic payment plan certificates and which are primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate. This exception
generally requires that at least 55% of such subsidiaries portfolios must be comprised of qualifying assets and at least 80% of each of their portfolios must be comprised of qualifying assets and real estate-related assets under the 1940 Act.
Consistent with guidance published by the SEC staff, we intend to treat as qualifying assets for this purpose loans secured by projects for which the original principal amount of the loan did not exceed 100% of the value of the underlying real
property portion of the collateral when the loan was made. We intend to treat as real estate-related assets
non-controlling
equity interests in joint ventures that own projects whose assets are primarily real
property. In general, with regard to our subsidiaries relying on Section 3(c)(5)(C), we rely on other guidance published by the SEC or its staff or on our analyses of guidance published with respect to other types of assets to determine which
assets are qualifying real estate assets and real estate-related assets.
In addition, one or more of our subsidiaries qualifies for an
exception from registration as an investment company under the 1940 Act pursuant to either Section 3(c)(5)(A) of the 1940 Act, which is available for entities which are not engaged in the business of issuing redeemable securities, face-amount
certificates of the installment type or periodic payment plan certificates, and which are primarily engaged in the business of purchasing or otherwise acquiring notes, drafts, acceptances, open accounts receivable, and other obligations representing
part or all of the sales price of merchandise, insurance, and services, or Section 3(c)(5)(B) of the 1940 Act, which is available for entities primarily engaged in the business of making loans to manufacturers, wholesalers, and retailers of,
and to prospective purchasers of, specified merchandise, insurance, and services. These exceptions generally require that at least 55% of such subsidiaries portfolios must be comprised of qualifying assets that meet the requirements of the
exception. We intend to treat energy efficiency loans where the loan proceeds are specifically provided to finance equipment, services and structural improvements to properties and other facilities and renewable energy and other sustainable
infrastructure projects or improvements as qualifying assets for purposes of these exceptions. In general, we also expect, with regard to our subsidiaries relying on Section 3(c)(5)(A) or (B), to rely on guidance published by the SEC or its
staff, including reliance on a
no-action
letter we recently obtained in connection with Sections 3(c)(5)(A) and 3(c)(5)(B) of the 1940 Act, or on our analyses of guidance published with respect to other types
of assets to determine which assets are qualifying assets under the exceptions.
Although we monitor the portfolios of our subsidiaries
relying on the Section 3(c)(5)(A), (B) or (C) exceptions periodically and prior to each acquisition, there can be no assurance that such subsidiaries will be able to maintain their exceptions. Qualification for exceptions from
registration under the 1940 Act will limit our ability to make certain investments. For example, these restrictions will limit the ability of these subsidiaries to make loans that are not secured by real property or that do not represent part or all
of the sales price of merchandise, insurance, and services.
- 30 -
There can be no assurance that the laws and regulations governing the 1940 Act, including the
Division of Investment Management of the SEC providing more specific or different guidance regarding these exceptions, will not change in a manner that adversely affects our operations. For example, on August 31, 2011, the SEC issued a concept
release (No.
IC-29778;
File No.
SW7-34-11,
Companies Engaged in the Business of Acquiring Mortgages and Mortgage-Related
Instruments) pursuant to which it is reviewing the scope of the exception from registration under Section 3(c)(5)(C) of the 1940 Act. Any additional guidance from the SEC or its staff from this process or in other circumstances could provide
additional flexibility to us, or it could further inhibit our ability to pursue the strategies we have chosen. If we or our subsidiaries fail to maintain an exception from the 1940 Act, we could, among other things, be required either to
(1) change the manner in which we conduct our operations to avoid being required to register as an investment company, (2) effect sales of our assets in a manner that, or at a time when, we would not otherwise choose to do so or
(3) register as an investment company, any of which could negatively affect our business, our ability to make distributions and the market price for our shares of common stock.
We have not requested the SEC or its staff to approve our treatment of any company as a majority-owned subsidiary and neither the SEC nor its
staff has done so. If the SEC or its staff were to disagree with our treatment of one or more companies as majority-owned subsidiaries, we would need to adjust our strategy and our assets in order to continue to pass the 40% test. Any such
adjustment in our strategy could have a material adverse effect on us.
Rapid changes in the values of our assets may make it more difficult for us to
maintain our qualification as a REIT or our exception from the 1940 Act.
If the market value or income potential of our assets changes
as a result of changes in interest rates, general market conditions, government actions or other factors, we may need to adjust the portfolio mix of our real estate assets and income or liquidate our
non-qualifying
assets to maintain our REIT qualification or our exception from the 1940 Act. If changes in asset values or income occur quickly, this may be especially difficult to accomplish. This difficulty
may be exacerbated by the illiquid nature of the assets we may own. We may have to make decisions that we otherwise would not make absent the REIT and 1940 Act considerations.
Because we expect to distribute substantially all of our REIT taxable income to our stockholders, we will need additional capital to finance our growth and
such capital may not be available on favorable terms or at all.
We may need additional capital to fund our growth. U.S. federal income
tax law generally requires that a REIT distribute annually at least 90% of its REIT taxable income, without regard to the deduction for dividends paid and excluding net capital gains, and that it pay tax at regular corporate rates to the extent that
it annually distributes greater than 90% but less than 100% of its REIT taxable income. Because we intend to grow our business, this limitation may require us to incur additional debt or raise additional equity at a time when it may be
disadvantageous to do so. We cannot make any assurance that debt and equity financing will be available to us on favorable terms, or at all, and debt financings may be restricted by the terms of any of our outstanding borrowings. If additional funds
are not available to us, we could be forced to curtail or cease new asset originations and acquisitions, which could have a material adverse effect on our business and financial condition.
The preparation of our financial statements involves use of estimates, judgments and assumptions, and our financial statements may be materially affected
if our estimates prove to be inaccurate.
Financial statements prepared in accordance with U.S. GAAP require the use of estimates,
judgments and assumptions that affect the reported amounts. Different estimates, judgments and assumptions reasonably could be used that would have a material effect on the financial statements, and changes in these estimates, judgments and
assumptions are likely to occur from period to period in the future. Significant areas of accounting requiring the application of managements judgment include, but are not limited to determining the fair value of our assets.
- 31 -
These estimates, judgments and assumptions are inherently uncertain, and, if they prove to be wrong, then we face the risk that charges to income will be required. Any charges could significantly
harm our business, financial condition, results of operations and the price of our securities. See Managements Discussion and Analysis of Financial Condition and Results of OperationsCritical Accounting Policies for a
discussion of the accounting estimates, judgments and assumptions that we believe are the most critical to an understanding of our business, financial condition and results of operations.
Risks Related to Borrowings
We use leverage in
executing our business strategy, which may adversely affect the return on our assets and may reduce cash available for distribution to our stockholders, as well as increase losses when economic conditions are unfavorable.
We use leverage to finance our assets, including our credit facility and our nonrecourse debt as well as securitizations. In the future, our
financing sources may also include other fixed and floating rate borrowings in the form of new bank credit facilities (including term loans and revolving facilities), warehouse facilities, repurchase agreements, securitizations and public and
private debt issuances. For further information on our credit facility and nonrecourse debt, see Managements Discussion and Analysis of Financial Condition and Results of OperationsCredit Facility andNonrecourse Debt.
Changes in the financial markets and the economy generally could adversely affect one or more of our lenders or potential lenders and
could cause one or more of our lenders, potential lenders or institutional investors to be unwilling or unable to provide us with financing or participate in securitizations or could increase the costs of that financing or securitization. The return
on our assets and cash available for distribution to our stockholders may be reduced to the extent that market conditions prevent us from leveraging our assets or increase the cost of our financing relative to the income that can be derived from the
assets acquired. Increases in our financing costs will reduce cash available for distributions to stockholders. We may not be able to meet our financing obligations and, to the extent that we cannot, we risk the loss of some or all of our assets to
liquidation or sale to satisfy the obligations.
An increase in our borrowing costs relative to the interest we receive on our leveraged assets may
adversely affect our profitability and our cash available for distribution to our stockholders. Our borrowings may have a shorter duration than our assets.
Borrowing rates are currently at historically low levels that may not be sustained in the long run. As any borrowing agreements we enter into
mature, we will be required either to enter into new borrowings or to sell certain of our assets. In addition, our credit facility has rates that adjust on a frequent basis based on prevailing interest rates. An increase in interest rates, or the
flattening of the yield curve, would reduce the spread between the returns on our assets and the cost of any new borrowings or borrowings where the interest rate adjusts to market rates. This increase in interest rates would adversely affect the
returns on our assets, which might reduce our earnings and, in turn, cash available for distribution to our stockholders. In addition, as we may use short-term borrowings including repurchase agreements and warehouse facilities that are generally
short-term commitments of capital, lenders may respond to market conditions making it more difficult for us to secure continued financing. If we are not able to renew our then existing facilities or arrange for new financing on terms acceptable to
us, or if we default on our covenants or are otherwise unable to access funds under any of these facilities, we may have to curtail entering into new transactions and/or dispose of assets. We will face particular risk in this regard given that we
expect many of our borrowings will have a shorter duration than the assets they finance.
We do not have a formal policy limiting the amount of debt we
may incur. Our board of directors may change our leverage policy without stockholder approval.
Although we are not restricted by any
regulatory requirements to maintain our leverage ratio at or below any particular level, the amount of leverage we may deploy for particular assets will depend upon the availability of
- 32 -
particular types of financing and our assessment of the credit, liquidity, price volatility and other risks of those assets and the credit quality of our financing counterparties. In March 2015,
we increased our overall leverage target, or debt to equity ratio, to 2.5 to 1 from less than 2.0 to 1. Our debt to equity ratio was approximately 1.7 to 1 as of December 31, 2016, in part as a result of our November common equity offering. We
also have increased the percentage of fixed rate debt to approximately 67% as of December 31, 2016, or towards the high end our targeted fixed rate debt percentage range of approximately 50% to 70%. In February 2017, our board of directors
approved an increase in our targeted fixed rate debt percentage to approximately 60% to 85%. See Item Item 7, Managements Discussion and Analysis of Financial Conditions and Results of OperationsLiquidity and Capital
Resources, for the further information on the calculation of these ratios. However, our charter and bylaws do not limit the amount or type of indebtedness we can incur, and our board of directors has changed, and has the discretion to deviate
from or change at any time in the future, our leverage policy, which could result in an investment portfolio with a different risk profile. We utilize nonrecourse facilities on certain types of assets that have significantly higher leverage. On
these facilities, the lenders primary recourse is to the pledged assets and if the value of the pledged assets is below the value of the debt or if we default on the facility, the lender would be able to foreclose on all the pledged assets,
which would result in losses and reduce our assets and the cash available for distributions to stockholders. Moreover, we have more limited experience dealing with certain types of debt financings for our assets and we may apply too much
leverage to our assets or use the wrong kinds of financings to leverage our assets.
We will require additional borrowings and equity raises in the
future to achieve our targets
To achieve our leverage target and to grow our business, we will require new sources of debt and equity
which may be difficult to arrange or which may have significantly higher costs. Certain participants in the sustainable energy industry have experienced significant declines in the value of their equity and may face difficulty in raising new equity
or in raising or refinancing debt. If we were to experience such declines or difficulties, we may be forced to limit our growth, liquidate assets or incur higher costs which may significantly harm our business, financial condition, results of
operations, and our ability to make or grow our distributions, which could cause the value of our common stock to decline.
The use of securitizations
and special purpose entities would expose us to additional risks.
We presently hold, and to the extent that we securitize loans in the
future, we anticipate that we will often hold the most junior certificates or the residual value associated with a securitization. We may also establish other funds or special purpose entities, where we would hold only a partial or subordinate
interest or a residual value after taking into account our nonrecourse debt facilities or a right to participate in the profits of such entity once it achieves a predefined threshold. As a holder of the residual value or other such interests, we are
more exposed to losses on the underlying collateral because the interest we retain in the securitization vehicle or other entity would be subordinate to the more senior notes or interests issued to investors and we would, therefore, absorb all of
the losses, up to the value of our interests, sustained with respect to the underlying assets before the owners of the notes or other interests experience any losses. In addition, the inability to securitize our portfolio or assets within our
portfolio could hurt our performance and our ability to grow our business.
We also use various special purpose entities to own and
finance our assets. These subsidiaries incur various types of debt, which can be used to finance one or more of our assets. This debt is typically structured as nonrecourse debt, which means it is repayable solely from the revenue from the
investment financed by the debt and is secured by the related physical assets, major contracts, cash accounts and in some cases, a pledge of our ownership interests in the subsidiaries involved in the projects. Although this subsidiary debt is
typically nonrecourse to us, we make certain representations and warranties or enter into certain guaranties of our subsidiarys obligations or covenants to the nonrecourse debt holder, the breach of which may require us to make payments to the
lender. We may also from time to time determine to provide financial support to the subsidiary in order to maintain rights to the project or otherwise avoid the adverse consequences of a default. In the event a subsidiary defaults on its
indebtedness, its creditors may foreclose on the collateral securing the indebtedness,
- 33 -
which may result in us losing our ownership interest in some or all of the subsidiarys assets. The loss of our ownership interest in a subsidiary or some or all of a subsidiarys
assets could have a material adverse effect on our business, financial condition and operating results.
Our existing credit facility and nonrecourse
debt contain, and any future financing facilities may contain, covenants that restrict our operations and may inhibit our ability to grow our business and increase revenues.
Our existing senior secured revolving credit facility contains, and any future financing facilities may contain, various affirmative and
negative covenants, including maintenance of an interest coverage ratio and limitations on the incurrence of liens and indebtedness, investments, fundamental organizational changes, dispositions, changes in the nature of business, transactions with
affiliates, use of proceeds and stock repurchases. In addition, the terms of our nonrecourse debt include restrictions and covenants, including limitations on our ability to transfer or incur liens on the assets that secure the debt. For further
information see Managements Discussion and Analysis of Financial Condition and Results of OperationsCredit Facility andNonrecourse Debt.
The covenants and restrictions included in our existing financings do, and the covenants and restrictions to be included in any future
financings may, restrict our ability to, among other things:
|
|
|
incur or guarantee additional debt;
|
|
|
|
make certain investments, originations or acquisitions;
|
|
|
|
make distributions on or repurchase or redeem capital stock;
|
|
|
|
engage in mergers or consolidations;
|
|
|
|
reduce liquidity below certain levels;
|
|
|
|
incur operating losses for more than a specified period; and
|
|
|
|
enter into transactions with affiliates.
|
Our nonrecourse debt limits our ability to take
action with regard to the assets pledged as security for the debt. These restrictions, as well as any other covenants contained in any future financings, may interfere with our ability to obtain financing, or to engage in other business activities,
which may significantly limit or harm our business, financial condition, liquidity and results of operations. Our financing agreements may contain cross-default provisions, so that if a default occurs under any one agreement, the lenders under our
other agreements could also declare a default. Although as of December 31, 2016, there were no defaults in our existing credit facility and nonrecourse debt, a default and resulting repayment acceleration could significantly reduce our
liquidity, which could require us to sell our assets to repay amounts due and outstanding. This could also significantly harm our business, financial condition, results of operations, and our ability to make distributions, which could cause the
value of our common stock to decline and adversely affect our ability to qualify, or remain qualified, as a REIT. A default will also significantly limit our financing alternatives such that we will be unable to pursue our leverage strategy, which
could curtail the returns on our assets.
We will have to pay off the remaining balance or refinance our borrowings when they become due. The failure
to be able to pay off the remaining balance or refinance such borrowings or an increase in interest rates of such refinancing could have a material impact on our business.
Some of our borrowings will have a remaining balance when they become due. See Note 7 and 8 of our audited financial statements in this Form
10-K
for more information on our borrowings. If our subsidiary is unable to repay or refinance the remaining balance of this debt, or if the terms of any available refinancing are
- 34 -
not favorable, we may be forced to liquidate assets or incur higher costs which may significantly harm our business, financial condition, results of operations, and our ability to make
distributions, which could cause the value of our common stock to decline.
If a counterparty to repurchase transactions defaults on its obligation to
resell the underlying security back to us at the end of the transaction term, or if the value of the underlying security has declined as of the end of that term, or if we default on obligations under the repurchase agreement, we will lose money on
repurchase transactions.
If we engage in repurchase transactions, we will generally sell loans or other financings to lenders
(
i.e.
, repurchase agreement counterparties) and receive cash from the lenders. The lenders will be obligated to resell the same financings back to us at the end of the term of the transaction. Because the cash we will receive from the lender
when we initially sell the financing to the lender is less than its value (this difference is the haircut), if the lender defaults on its obligation to resell the same loans back to us we would incur a loss on the transaction equal to the amount of
the haircut (assuming there was no other change in value). We would also lose money on a repurchase transaction if the value of the underlying loans has declined as of the end of the transaction term, as we would have to repurchase the loans for
their initial value but would receive loans worth less than that amount. We may also be forced to sell assets at significantly depressed prices to meet margin calls, post additional collateral and maintain adequate liquidity, which could cause us to
incur losses. Moreover, to the extent we are forced to sell assets at such time, given market conditions, we may be selling at the same time as others facing similar pressures, which could exacerbate a difficult market environment and which could
result in our incurring significantly greater losses on our sale of such assets. In an extreme case of market duress, a market may not even be present for certain of our assets at any price. Such a situation would likely result in a rapid
deterioration of our financial condition and possibly necessitate a filing for protection under the United States Bankruptcy Code (the Bankruptcy Code). Further, if we default on one of our obligations under a repurchase transaction, the
lender will be able to terminate the transaction and cease entering into any other repurchase transactions with us. We expect that our repurchase agreements will contain cross-default provisions, so that if a default occurs under any one agreement,
the lenders under our other agreements could also declare a default. If a default occurs under any of our repurchase agreements and the lenders terminate one or more of our repurchase agreements, we may need to enter into replacement repurchase
agreements with different lenders. There can be no assurance that we will be successful in entering into such replacement repurchase agreements on the same terms as the repurchase agreements that were terminated or at all. Any losses we incur on our
repurchase transactions could adversely affect our earnings and thus our cash available for distribution to our stockholders. In the event of our insolvency or bankruptcy, certain repurchase agreements may qualify for special treatment under the
Bankruptcy Code, the effect of which, among other things, would be to allow the lender under the applicable repurchase agreement to avoid the automatic stay provisions of the Bankruptcy Code and to foreclose on the collateral agreement without
delay, which could ultimately reduce the amounts we could otherwise recover.
Risks Related to Hedging
We, or the projects in which we invest, enter into hedging transactions that could expose us to contingent liabilities in the future and adversely impact
our financial condition.
Subject to maintaining our qualification as a REIT, part of our strategy, or the strategy of the projects in
which we invest, involves entering into hedging transactions that could require us to fund cash payments in certain circumstances (
e.g.
, the early termination of the hedging instrument caused by an event of default or other early termination
event, or the decision by a counterparty to request margin securities it is contractually owed under the terms of the hedging instrument). The amount due would be equal to the unrealized loss of the open swap positions with the respective
counterparty and could also include other fees and charges. These economic losses will be reflected in our, or the projects, financial statements, and our, or the projects, ability to fund these obligations will depend on the liquidity
of our, or the projects, assets and access to capital at the time, and the need to fund these obligations could adversely impact our financial condition.
- 35 -
We have limited experience hedging the interest rate or commodity risk of our assets and liabilities and such
hedging, if any, may adversely affect our results of operations.
We have limited experience hedging the interest rate or commodity
risk of our assets and liabilities. However, we have entered into interest rate hedges for certain of our liabilities and as part of our strategy, we may pursue various hedging strategies to seek to reduce our exposure to adverse changes in interest
rates or commodity prices. Our hedging activity will vary in scope based on the level and volatility of interest rates or the underlying commodity, our types of assets and liabilities and other changing market conditions. Interest rate or commodity
hedging may fail to protect or could adversely affect us because, among other things:
|
|
|
our hedging strategies may be poorly designed or improperly executed as a result of from our limited experience hedging the interest rate or commodity risk;
|
|
|
|
interest rate or commodity hedging can be expensive, particularly during periods of rising and volatile interest rates or commodity prices;
|
|
|
|
available interest rate or commodity hedges may not correspond directly with the interest rate or commodity risk for which protection is sought;
|
|
|
|
the duration of the hedge may not match the duration of the related liability or exposure;
|
|
|
|
the amount of income that a REIT may earn from certain hedging transactions (other than through taxable REIT subsidiaries, or TRSs), to offset interest rate losses is limited by U.S. federal tax provisions
governing REITs;
|
|
|
|
the credit quality of the hedging counterparty owing money on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction;
|
|
|
|
the hedging counterparty owing money in the hedging transaction may default on its obligation to pay; and
|
|
|
|
our hedging transactions, which are intended to limit losses, may actually adversely affect our earnings, which could reduce our cash available for distribution to our stockholders.
|
In addition,
over-the-counter
hedges entered into to hedge
interest rates or commodity prices involve risk since they often are not traded on regulated exchanges or cleared through a central counterparty. We would remain exposed to our counterpartys ability to perform on its obligations under each
hedge and cannot look to the creditworthiness of a central counterparty for performance. As a result, if a hedging counterparty cannot perform under the terms of the hedge, we would not receive payments due under that hedge, we may lose any
unrealized gain associated with the hedge and the hedged liability would cease to be hedged. While we would seek to terminate the relevant hedge transaction and may have a claim against the defaulting counterparty for any losses, including
unrealized gains, there is no assurance that we would be able to recover such amounts or to replace the relevant hedge on economically viable terms or at all. In such case, we could be forced to cover our unhedged liabilities at the then current
market price. We may also be at risk for any collateral we have pledged to secure our obligations under the hedge if the counterparty becomes insolvent or files for bankruptcy.
Furthermore, our interest rate swaps and other hedge transactions are subject to increasing statutory and other regulatory requirements and,
depending on the identity of the counterparty, applicable international requirements. Recently, new regulations have been promulgated by U.S. and foreign regulators to strengthen the oversight of swaps, and any further actions taken by such
regulators could constrain our strategy or increase our costs, either of which could materially and adversely impact our results of operations.
In addition, the Dodd-Frank Act requires certain derivatives, including certain interest rate swaps, to be executed on a regulated market and
cleared through a central counterparty. Unlike
over-the-counter
swaps, the counterparty for the cleared swaps is the clearing house, which reduces counterparty risk.
However, cleared swaps require us to appoint clearing brokers and to post margin in accordance with the clearing houses rules,
- 36 -
which has resulted in increased costs for cleared swaps compared to
over-the-counter
swaps. Our
over-the-counter
hedges with swap dealers will become subject to margin regulations promulgated by U.S. regulators on March 1, 2017, which regulations are expected to
increase the required margin, and the cost to us of
over-the-counter
swaps. The margin requirements for both cleared and uncleared swaps also limit eligible margin to
cash and specified types of securities, which may further increase the costs of hedging and induce us to change or reduce the use of hedging transactions. The margin regulations are not expected to apply to any
over-the-counter
swaps that were entered into prior to the effective date of such regulations.
In addition, the projects in which we invest, may enter into various forms of hedging including interest rate and power price hedging. To the
extent they enter into such hedges, the financial results of the project will be exposed to similar risks as described above which could adversely impact our results of operations.
If we choose not to pursue, or fail to qualify for, hedge accounting treatment, our operating results may suffer because losses on the derivatives that we
enter into may not be offset by a change in the fair value of the related hedged transaction.
We may choose not to pursue, or fail to
qualify for, hedge accounting treatment relating to derivative and hedging transactions. We may fail to qualify for hedge accounting treatment for a number of reasons, including if we use instruments that do not meet the Accounting Standards
Codification (ASC) Topic 815 definition of a derivative (such as short sales), we fail to satisfy ASC Topic 815 hedge documentation and hedge effectiveness assessment requirements or our instruments are not highly effective. If we fail
to qualify for, or choose not to pursue, hedge accounting treatment, our operating results may suffer because losses on the derivatives that we enter into may not be offset by a change in the fair value of the related hedged transaction.
Risks Related to Our Common Stock
There can be no
assurance that an active trading market for our common stock will continue, which could cause our common stock to trade at a discount and make it difficult for holders of our common stock to sell their shares.
Our common stock is listed on the NYSE. However, there can be no assurance that an active trading market for our common stock will continue,
which could cause our common stock to trade at a discount. Accordingly, no assurance can be given as to the ability of our stockholders to sell their common stock or the price that our stockholders may obtain for their common stock. Some of the
factors that could negatively affect the market price of our common stock include:
|
|
|
our actual or projected operating results, financial condition, cash flows and liquidity or changes in business strategy or prospects;
|
|
|
|
changes in the mix of our financing products and services, including the level of securitizations or fee income in any quarter;
|
|
|
|
actual or perceived conflicts of interest with individuals, including our executives;
|
|
|
|
our ability to arrange financing for projects;
|
|
|
|
equity issuances by us, or share resales by our stockholders, or the perception that such issuances or resales may occur;
|
|
|
|
seasonality in construction and demand for our investments;
|
|
|
|
actual or anticipated accounting problems;
|
|
|
|
publication of research reports about us or the sustainable infrastructure industry;
|
|
|
|
changes in market valuations of similar companies;
|
|
|
|
adverse market reaction to any increased indebtedness we may incur in the future;
|
- 37 -
|
|
|
commodity price changes;
|
|
|
|
additions to or departures of our key personnel;
|
|
|
|
speculation in the press or investment community;
|
|
|
|
our failure to meet, or the lowering of, our earnings estimates or those of any securities analysts;
|
|
|
|
increases in market interest rates, which may lead investors to demand a higher distribution yield for our common stock, and would result in increased interest expenses on our debt;
|
|
|
|
changes in governmental policies, regulations or laws;
|
|
|
|
failure to qualify, or maintain our qualification, as a REIT or failure to maintain our exception from registration as an investment company under the 1940 Act;
|
|
|
|
price and volume fluctuations in the stock market generally; and
|
|
|
|
general market and economic conditions, including the current state of the credit and capital markets.
|
Market factors unrelated to our performance could also negatively impact the market price of our common stock. One of the factors that
investors may consider in deciding whether to buy or sell our common stock is our distribution rate as a percentage of our stock price relative to market interest rates. If market interest rates increase, prospective investors may demand a higher
distribution rate or seek alternative investments paying higher dividends or interest. As a result, interest rate fluctuations and conditions in capital markets can affect the market value of our common stock.
Common stock and preferred stock eligible for future sale may have adverse effects on our share price.
Subject to applicable law, our board of directors, without stockholder approval, may authorize us to issue additional authorized and unissued
shares of common stock and preferred stock on the terms and for the consideration it deems appropriate.
In addition, we entered into a
registration rights agreement pursuant to which we granted registration rights to those persons who received common stock (including common stock issuable upon exchange of units of limited partnership interests in our Operating Partnership (OP
units)) in our formation transactions. On August 27, 2014, the SEC declared effective the registration statement, which covers the resale of 3,178,410 shares of our common stock (including 331,282 shares of common stock issuable upon
exchange of an equivalent number of OP units). In certain circumstances, the registration rights agreement also requires us to provide piggyback and underwritten offering demand rights to those holders who received common stock (including common
stock issuable upon exchange of OP units) in our formation transactions.
We cannot predict the effect, if any, of future sales of our
common stock or the availability of shares for future sales, on the market price of our common stock. Sales of substantial amounts of common stock or the perception that such sales could occur may adversely affect the prevailing market price for our
common stock.
We cannot assure you of our ability to make distributions in the future. If our portfolio of assets fails to generate sufficient income
and cash flow, we could be required to sell assets, borrow funds or make a portion of our distributions in the form of a taxable stock distribution or distribution of debt securities.
We are generally required to distribute to our stockholders at least 90% of our REIT taxable income (without regard to the deduction for
dividends paid and excluding net capital gains) each year for us to qualify, and maintain our qualification, as a REIT under the Internal Revenue Code of 1986, as amended (the Internal Revenue Code). Our current policy is to pay
quarterly distributions, which on an annual basis will equal all or
- 38 -
substantially all of our taxable income. In the event that our board of directors authorizes distributions in excess of the income or cash flow generated from our assets, we may make such
distributions from the proceeds of future offerings of equity or debt securities or other forms of debt financing or the sale of assets.
Our ability to make distributions may be adversely affected by a number of factors. Therefore, although we anticipate making quarterly
distributions to our stockholders, our board of directors has the sole discretion to determine the timing, form and amount of any distributions to our stockholders. If our portfolio of assets fails to generate sufficient income and cash flow, we
could be required to sell assets, borrow funds or make a portion of our distributions in the form of a taxable stock distribution or distribution of debt securities. To the extent that we are required to sell assets in adverse market conditions or
borrow funds at unfavorable rates, our results of operations could be materially and adversely affected. Our board of directors will make determinations regarding distributions based upon various factors, including our earnings, our financial
condition, our liquidity, our debt and preferred stock covenants, maintenance of our REIT qualification, applicable provisions of the MGCL and other factors as our board of directors may deem relevant from time to time. We believe that a change in
any one of the following factors could adversely affect our results of operations and impair our ability to make distributions to our stockholders:
|
|
|
our ability to make profitable investments and loans;
|
|
|
|
margin calls or other expenses that reduce our cash flow;
|
|
|
|
defaults in our asset portfolio or decreases in the value of our portfolio; and
|
|
|
|
the fact that anticipated operating expense levels may not prove accurate, as actual results may vary from estimates.
|
As a result, no assurance can be given that we will be able to make distributions to our stockholders at any time in the future or that the
level of any distributions we do make to our stockholders will achieve a market yield or increase or even be maintained over time, any of which could materially and adversely affect us.
In addition, distributions that we make to our stockholders will generally be taxable to our stockholders as ordinary income. However, a
portion of our distributions may be designated by us as long-term capital gains to the extent that they are attributable to capital gain income recognized by us or may constitute a return of capital to the extent that they exceed our earnings and
profits as determined for tax purposes. A return of capital is not taxable, but has the effect of reducing the basis of a stockholders investment in shares of our common stock.
Future offerings of debt or equity securities, which may rank senior to our common stock, may adversely affect the market price of our common stock.
Our present debt ranks, and any future debt would rank, senior to our common stock. Such debt is, and likely will be, governed by a
loan agreement, an indenture or other instrument containing covenants restricting our operating flexibility. Additionally, any equity securities or convertible or exchangeable securities that we issue in the future may have rights, preferences and
privileges more favorable than those of our common stock and may result in dilution to owners of our common stock. We and, indirectly, our stockholders will bear the cost of issuing and servicing such debt or securities. Because our decision to
issue debt or equity securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, holders of our common stock will
bear the risk of our future offerings reducing the market price of our common stock and diluting the value of their stock holdings in us.
Risks
Related to Our Organization and Structure
Our business could be harmed if key personnel terminate their employment with us.
Our success depends, to a significant extent, on the continued services of Jeffrey Eckel, Brendan Herron, Steven Chuslo, Rhem Wooten, Nate
Rose, Daniel McMahon and the other members of our senior management
- 39 -
team. Upon completion of our IPO and our formation transactions, several of our officers, including Jeffrey Eckel, our chief executive officer, Brendan Herron, our executive vice president and
chief financial officer, Steven Chuslo, our executive vice president and general counsel, Rhem Wooten and Daniel McMahon, our executive vice presidents, and Nate Rose, our executive vice president and chief operating officer, entered into new
employment agreements with us. These employment agreements provide for an initial four-year term of employment. Notwithstanding these agreements, there can be no assurance that any or all of these members of our senior management team will remain
employed by us. We do not maintain key person life insurance on any of our officers other than two policies we maintain for Mr. Eckel under which we are a named beneficiary in the amount of approximately $3 million. The loss of services of
one or more members of our senior management team could harm our business and our prospects.
Conflicts of interest could arise as a result of our
structure.
Conflicts of interest could arise in the future as a result of the relationships between us and our affiliates, on the one
hand, and our Operating Partnership or any partner thereof, on the other. Our directors and officers have duties to our company under applicable Maryland law in connection with our management. Our duties, as the general partner, to our Operating
Partnership and our partners may come into conflict with the duties of our directors and officers to us.
Under Delaware law, a general
partner of a Delaware limited partnership owes its limited partners the duties of good faith and fair dealing. Other duties, including fiduciary duties, may be modified or eliminated in the partnerships partnership agreement, except that
conflict of interest transactions may still run afoul of implied contractual standards under Delaware law. The partnership agreement of our Operating Partnership provides that, for so long as we own a controlling interest in our Operating
Partnership, any conflict that cannot be resolved in a manner not adverse to either our stockholders or the limited partners will be resolved in favor of our stockholders. We have not obtained an opinion of counsel covering the provisions set forth
in the partnership agreement of our Operating Partnership that purport to waive or restrict our fiduciary duties that would be in effect under common law were it not for the partnership agreement of our Operating Partnership.
Additionally, the partnership agreement of our Operating Partnership expressly limits our liability by providing that neither we, as the
general partner of the Operating Partnership, nor any of our directors or officers, will be liable or accountable in damages to our Operating Partnership, its limited partners or their assignees for errors in judgment, mistakes of fact or law or for
any act or omission if the general partner, director or officer, acted in good faith. In addition, our Operating Partnership is required to indemnify us, our affiliates and each of our and their respective officers, directors, employees and agents
to the fullest extent permitted by applicable law against any and all losses, claims, damages, liabilities (whether joint or several), expenses (including, without limitation, attorneys fees and other legal fees and expenses), judgments,
fines, settlements and other amounts arising from any and all claims, demands, actions, suits or proceedings, civil, criminal, administrative or investigative, that relate to the operations of the Operating Partnership, provided that our Operating
Partnership will not indemnify any such person for (1) willful misconduct or a knowing violation of the law, (2) any transaction for which such person received an improper personal benefit in violation or breach of any provision of the
partnership agreement of our Operating Partnership, or (3) in the case of a criminal proceeding, the person had reasonable cause to believe the act or omission was unlawful.
Certain provisions of Maryland law could inhibit changes in control.
Certain provisions of the MGCL may have the effect of deterring a third party from making a proposal to acquire us or of impeding a change in
control under circumstances that otherwise could provide the holders of our common stock with the opportunity to realize a premium over the then-prevailing market price of our common stock. We are subject to the business combination
provisions of the MGCL that, subject to limitations, prohibit certain business combinations (including a merger, consolidation, statutory share exchange, or, in circumstances specified in the statute, an asset transfer or issuance or
reclassification of equity securities)
- 40 -
between us and an interested stockholder (defined generally as any person who beneficially owns 10% or more of our then outstanding voting stock or an affiliate or associate of ours
who, at any time within the
two-year
period prior to the date in question, was the beneficial owner of 10% or more of our then outstanding voting stock) or an affiliate thereof for five years after the most
recent date on which the stockholder becomes an interested stockholder. After the five-year prohibition, any business combination between us and an interested stockholder generally must be recommended by our board of directors and approved by the
affirmative vote of at least (1) 80% of the votes entitled to be cast by holders of outstanding shares of our voting stock and (2) two thirds of the votes entitled to be cast by holders of our voting stock other than shares held by the
interested stockholder with whom or with whose affiliate the business combination is to be effected or held by an affiliate or associate of the interested stockholder. These super-majority vote requirements do not apply if, among other conditions,
our common stockholders receive a minimum price, as defined under the MGCL, for their shares in the form of cash or other consideration in the same form as previously paid by the interested stockholder for its shares. These provisions of the MGCL do
not apply, however, to business combinations that are approved or exempted by a board of directors prior to the time that the interested stockholder becomes an interested stockholder. Our board of directors has by resolution exempted business
combinations between us and (1) any other person, provided, that such business combination is first approved by our board of directors (including a majority of our directors who are not affiliates or associates of such person), (2) the
Predecessor and its affiliates and associates as part of our formation transactions and (3) persons acting in concert with any of the foregoing. As a result, any person described in the preceding sentence may be able to enter into business
combinations with us that may not be in the best interests of our stockholders, without compliance by our company with the supermajority vote requirements and other provisions of the statute. There can be no assurance that our board of directors
will not amend or revoke the exemption at any time.
The control share provisions of the MGCL provide that, subject to certain
exceptions, a holder of control shares of a Maryland corporation (defined as shares which, when aggregated with all other shares controlled by the stockholder (except solely by virtue of a revocable proxy), entitle the stockholder to
exercise one of three increasing ranges of voting power in electing directors) acquired in a control share acquisition (defined as the direct or indirect acquisition of ownership or control of issued and outstanding control
shares) has no voting rights with respect to such shares except to the extent approved by our stockholders by the affirmative vote of at least two thirds of all the votes entitled to be cast on the matter, excluding votes entitled to be cast
by the acquirer of control shares, our officers and our directors who are also our employees. Our bylaws contain a provision exempting from the control share acquisition statute any and all acquisitions by any person of shares of our stock. There
can be no assurance that this provision will not be amended or eliminated at any time in the future.
The unsolicited takeover
provisions of Title 3, Subtitle 8 of the MGCL permit our board of directors, without stockholder approval and regardless of what is currently provided in our charter or bylaws, to implement certain takeover defenses, some of which (for example, a
classified board) we do not yet have. Our charter contains a provision whereby we have elected to be subject to the provisions of Title 3, Subtitle 8 of the MGCL, pursuant to which our board of directors has the exclusive power to fill vacancies on
our board of directors. These provisions may have the effect of inhibiting a third party from making an acquisition proposal for us or of delaying, deferring or preventing a change in control of us under the circumstances that otherwise could
provide the holders of shares of common stock with the opportunity to realize a premium over the then current market price.
Our authorized but
unissued shares of common and preferred stock may prevent a change in our control.
Our charter permits our board of directors to
authorize us to issue additional shares of our authorized but unissued common or preferred stock. In addition, our board of directors may, without common stockholder approval, amend our charter to increase the aggregate number of our shares of stock
or the number of shares of stock of any class or series that we have the authority to issue and classify or reclassify any unissued shares of common or preferred stock and set the terms of the classified or reclassified shares. As a result, our
board of directors may establish a series of common or preferred stock that could delay or prevent a transaction or a
- 41 -
change in control that might involve a premium price for shares of our common stock or otherwise be in the best interest of our stockholders.
Our rights and the rights of our stockholders to take action against our directors and officers are limited, which could limit stockholder recourse in the
event of actions not in our stockholders best interests.
Our charter eliminates the liability of our present and former
directors and officers to us and our stockholders for money damages to the maximum extent permitted under Maryland law. Under Maryland law, our present and former directors and officers will not have any liability to us or our stockholders for money
damages other than liability resulting from:
|
|
|
actual receipt of an improper benefit or profit in money, property or services; or
|
|
|
|
active and deliberate dishonesty by the director or officer that was established by a final judgment and was material to the cause of action adjudicated.
|
Our charter authorizes us to indemnify our directors and officers for actions taken by them in those and other capacities to the maximum
extent permitted by Maryland law. Our bylaws require us to indemnify each present and former director or officer, and each person who served any predecessor of our company in a similar capacity, to the maximum extent permitted by Maryland law, in
connection with the defense of any proceeding to which he or she is made, or threatened to be made, a party or a witness by reason of his or her service to us or any predecessor. In addition, we may be obligated to pay or reimburse the expenses
incurred by such persons in connection with any such proceedings without requiring a preliminary determination of their ultimate entitlement to indemnification.
Our charter contains provisions that make removal of our directors difficult, which could make it difficult for our stockholders to effect changes to our
management.
Our charter provides that, subject to the rights of holders of any series of preferred stock, a director may be removed
with or without cause upon the affirmative vote of holders of at least two thirds of the votes entitled to be cast generally in the election of directors. Vacancies may be filled only by a majority of the remaining directors in office, even if less
than a quorum. These requirements make it more difficult to change our management by removing and replacing directors and may prevent a change in control of our company that is in the best interests of our stockholders.
Ownership limitations may restrict change of control or business combination opportunities in which our stockholders might receive a premium for their
shares.
In order for us to qualify as a REIT for each taxable year after 2013, no more than 50% in value of our outstanding capital
stock may be owned, directly or constructively, by five or fewer individuals during the last half of any calendar year, and at least 100 persons must beneficially own our stock during at least 335 days of a taxable year of 12 months, or during a
proportionate portion of a shorter taxable year. Individuals for this purpose include natural persons, private foundations, some employee benefit plans and trusts, and some charitable trusts. To assist us in preserving our REIT
qualification, among other purposes, our charter generally prohibits any person from directly or indirectly owning more than 9.8% in value or in number of shares, whichever is more restrictive, of the aggregate outstanding shares of our capital
stock, the outstanding shares of any class or series of our preferred stock or the outstanding shares of our common stock. These ownership limits could have the effect of discouraging a takeover or other transaction in which holders of our common
stock might receive a premium for their shares over the then prevailing market price or which holders might believe to be otherwise in their best interests. Our board of directors has established exceptions from these ownership limits that permit
certain institutional investors and their clients to hold shares of our common stock in excess of these ownership limits.
- 42 -
We are subject to financial reporting and other requirements for our accounting, internal audit and other
management systems and resources and the failure to comply with such requirements may adversely effect our business, operating results and stock price.
We are subject to reporting and other obligations under the Exchange Act, including the requirements of Section 404 of the Sarbanes-Oxley
Act of 2002 (the Sarbanes-Oxley Act). Section 404 requires annual management assessments of the effectiveness of our internal controls over financial reporting and, starting with the calendar year ending December 31, 2016, our
independent registered public accounting firm to express an opinion on the effectiveness of our internal controls over financial reporting. These reporting and other obligations place significant demands on our management, administrative,
operational, internal audit and accounting resources and may cause us to incur significant expenses. We may need to continue to upgrade our systems or create new systems; implement additional financial and management controls, reporting systems and
procedures; expand or outsource our internal audit function; and hire additional accounting, internal audit and finance staff. If we are unable to accomplish these objectives in a timely and effective fashion, our ability to comply with the
financial reporting requirements and other rules that apply to reporting companies could be impaired. We believe that we currently have in place accounting, internal audit and other management systems and resources that will allow us to maintain
compliance with the requirements of the Sarbanes-Oxley Act. Any failure to maintain effective internal controls could have a material adverse effect on our business, operating results and stock price.
Risks Related to Our Taxation as a REIT
Qualifying as
a REIT involves highly technical and complex provisions of the Internal Revenue Code, and our failure to qualify or remain qualified as a REIT would subject us to U.S. federal income tax and applicable state and local tax, which would negatively
impact the results of our operations and reduce the amount of cash available for distribution to our stockholders.
We elected and
qualified as a REIT for U.S. federal income tax purposes commencing with our taxable year ended December 31, 2013. The U.S. federal income tax laws governing REITs are complex, and judicial and administrative interpretations of the U.S. federal
income tax laws governing REIT qualification are limited. To qualify as a REIT and remain so qualified, we must meet, on an ongoing basis through actual operating results, various tests regarding the nature and diversification of our assets and our
income, the ownership of our outstanding shares, and the amount of our distributions. Even a technical or inadvertent violation could jeopardize our REIT qualification. Our ability to satisfy the asset tests depends upon our analysis of the
characterization and fair market values of our assets, some of which are not susceptible to a precise determination, and for which we will not obtain independent appraisals.
We received a private letter ruling from the Internal Revenue Service (IRS), which we refer to as the Ruling, relating to our
ability to treat certain of our assets as qualifying REIT assets. We are entitled to rely on this Ruling for those assets which fit within the scope of the Ruling only to the extent that we have the legal and contractual rights described therein, we
continue to operate in accordance with the relevant facts described in the ruling request we submitted, that such facts were accurately presented and to the extent such ruling is not inconsistent with the Real Property Regulations (as discussed in
more detail below). As a result, no assurance can be given that we will always be able to rely on this Ruling.
In August of 2016, the
Treasury Department and the IRS published regulations which we refer to as the Real Property Regulations relating to the definition of real property for purposes of the REIT income and asset tests which apply to us with respect to our
taxable years beginning after December 31, 2016. Among other things, the Real Property Regulations provide that an obligation secured by a structural component of a building or other inherently permanent structure qualifies as a real estate asset
for REIT qualification purposes only if such obligation is also secured by a real property interest in the inherently permanent structure served by such structural component. This aspect of the Real Property Regulations has important implications
for our qualification as a REIT since a significant portion of our REIT qualifying assets consists of financing receivables
- 43 -
that are secured by liens on installed structural improvements designed to improve the energy efficiency of buildings and a significant portion of our REIT qualifying gross income is interest
income earned with respect to such financing receivables.
The structural improvements securing our financing receivables generally
qualify as fixtures under local real property law, as well as under the Uniform Commercial Code, or the UCC, which governs rights and obligations of parties in secured transactions. Although not controlling for REIT purposes, the general
rule in the United States is that once improvements are permanently installed in real properties, such improvements become fixtures and thus take on the character of and are considered to be real property for certain state and local law purposes. In
general, in the United States, laws governing fixtures, including the UCC and real property law, afford lenders who have secured their financings with security interests in fixtures with rights that extend not just to the fixtures that secure their
financings, but also to the real properties in which such fixtures have been installed. By way of example only, Section 9-604(b) of the UCC, which has been adopted in all but two states in the United States, permits a lender secured by fixtures,
upon a default, to enforce its rights under the UCC or under applicable real property laws. Although there is limited authority directly on point, given the nature of, and the extent to which, the structural improvements securing our financing
receivables are integrated into and serve the related buildings, we believe that the better view is that the nature and scope of our rights in such buildings that inure to us as a result of our financing receivables are sufficient to satisfy the
requirements of the Real Property Regulations described above. In addition to the limited authority directly on point, two other important caveats apply in this regard. First, the Real Property Regulations do not define what is required for an
obligation secured by a lien on a structural component to also be secured by a real property interest in the building served by such structural component. However, the initial proposed version of the Real Property Regulations, which never became
effective, included a requirement that the interest in the real property held by a REIT be equivalent to the interest in a structural component held by the REIT in order for the structural component to be treated as a real estate asset.
This requirement was ultimately not included in the final Real Property Regulations, in part in response to comments that such requirement may negatively affect investment in energy efficient and renewable energy assets. We believe the deletion of
this requirement implies that under the final Real Property Regulations, our rights in the building need not be equivalent to our rights in the structural components serving the building. Second, real property law is typically relegated to the
states and the specific rights available to any lien or mortgage holder, including our rights as a fixture lien holder described above, may vary between jurisdictions as a result of a range of factors, including the specific local real property law
requirements and judicial and regulatory interpretations of such laws, and the competing rights of mortgage and other lenders. While a number of cases have addressed the rights of fixture lien holders generally, there are limited judicial
interpretations in only a few jurisdictions that directly address the rights and remedies available to a fixture lien holder in the real property in which the fixtures have been installed. Such rights have been addressed in some cases which support
our position and, in factual circumstances distinguishable from our own, in some cases where the courts have found these rights to be more limited. The resolution of these issues in many jurisdictions therefore remains uncertain. As a result of the
foregoing, no assurance can be given that the IRS will not challenge our position that our financing receivables meet the requirements of the Real Property Regulations or that, if challenged, such position would be sustained.
The preamble to the Real Property Regulations provides that, to the extent a private letter ruling issued prior to the issuance of the Real
Property Regulations is inconsistent with the Real Property Regulations, the private letter ruling is revoked prospectively from the applicability date of the Real Property Regulations. We do not believe that the Ruling is inconsistent with the Real
Property Regulations because we believe the analysis in the Ruling was based on similar principles as the relevant portions of the Real Property Regulations, and accordingly we do not believe that the Real Property Regulations impact our ability to
rely on the Ruling. However, no assurance can be given that the IRS would not successfully assert that we are not permitted to rely on the Ruling because the Ruling has been revoked by the Real Property Regulations.
If the IRS were to assert that a significant portion of our financing receivables do not qualify as real estate assets and do not generate
income treated as interest income from mortgages on real property, we would fail to
- 44 -
satisfy both the gross income requirements and asset requirements applicable to REITs. If this were to occur, we would be required to restructure the manner in which we receive such income and we
may realize significant income that does not qualify for the REIT 75% gross income test, which could cause us to fail to qualify as a REIT.
In addition, our compliance with the REIT income and quarterly asset requirements also depends upon our ability to successfully manage the
composition of our income and assets on an ongoing basis in accordance with existing REIT regulations and rules and interpretations thereof. Moreover, the IRS, new legislation, court decisions or other administrative guidance, in each case possibly
with retroactive effect, may make it more difficult or impossible for us to qualify as a REIT. Our ability to satisfy the requirements to qualify as a REIT also depends in part on the actions of third parties over which we have no control or only
limited influence, including in cases where we own an equity interest in an entity that is classified as a partnership for U.S. federal income tax purposes. Thus, given the highly complex nature of the rules governing REITs, the ongoing importance
of factual determinations, and the possibility of future changes in our circumstances, no assurance can be given that we will so qualify for any particular year.
If we fail to qualify as a REIT in any taxable year, and we do not qualify for certain statutory relief provisions, we would be required to
pay U.S. federal income tax on our net taxable income, and distributions to our stockholders would not be deductible by us in determining our taxable income. In such a case, we might need to borrow money or sell assets in order to pay our taxes. Our
payment of income tax would negatively impact the results of our operations and decrease the amount of our income available for distribution to our stockholders. Furthermore, if we fail to maintain our qualification as a REIT, we no longer would be
required to distribute substantially all of our taxable income to our stockholders, which would leave our board of directors with more discretion over our future distribution levels. In addition, unless we were eligible for certain statutory relief
provisions, we could not re-elect to qualify as a REIT for the subsequent four taxable years following the year in which we failed to qualify.
Complying with REIT requirements may force us to liquidate or forego otherwise attractive investments.
To qualify as a REIT, we must ensure that we meet the REIT gross income tests annually and that, at the end of each calendar quarter, at least
75% of the value of our total assets consists of cash, cash items, government securities, shares in REITs and other qualifying real estate assets. The remainder of our investment in securities (other than government securities and REIT qualified
real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the
value of our total assets (other than government securities, securities of a TRS and securities that are qualifying real estate assets) can consist of the securities of any one issuer, and no more than 25% (20% beginning with the taxable year ending
December 31, 2018) of the value of our total assets can be represented by securities of one or more TRSs, and no more than 25% of the value of our assets can consist of debt instruments issued by publicly offered REITs that are not otherwise
secured by real property. If we fail to comply with these requirements at the end of any calendar quarter, we must correct the failure within 30 days after the end of the calendar quarter or qualify for certain statutory relief provisions to avoid
losing our REIT qualification and suffering adverse tax consequences. As a result, we may be required to liquidate from our portfolio, or contribute to a TRS, otherwise attractive investments, and may be unable to pursue investments that would be
otherwise advantageous to us in order to satisfy the source of income or asset diversification requirements for qualifying as a REIT. These actions could have the effect of reducing our income and amounts available for distribution to our
stockholders.
REIT distribution requirements could adversely affect our ability to execute our business plan and may require us to incur debt or sell
assets to make such distributions.
In order to qualify as a REIT, we must distribute to our stockholders, each calendar year, at least
90% of our REIT taxable income (including certain items of
non-cash
income), determined without regard to the deduction
- 45 -
for dividends paid and excluding net capital gain. To the extent that we satisfy the 90% distribution requirement, but distribute less than 100% of our taxable income, we will be subject to U.S.
federal corporate income tax on our undistributed income. In addition, we will incur a 4%
non-deductible
excise tax on the amount, if any, by which our distributions in any calendar year are less than a
minimum amount specified under U.S. federal income tax laws. We intend to distribute our taxable income to our stockholders in a manner intended to satisfy the REIT 90% distribution requirement and to avoid the 4%
non-deductible
excise tax.
In addition, differences in timing between the recognition of taxable
income, our U.S. GAAP income and the actual receipt of cash may occur. For example, we may be required to accrue interest and discount income on debt securities or interests in debt securities before we receive any payments of interest or principal
on such assets, and there may be timing differences in the accrual of such interest and discount income for tax purposes and for U.S. GAAP purposes.
As a result of the foregoing, we may generate less cash flow than taxable income in a particular year and find it difficult or impossible to
meet the REIT distribution requirements in certain circumstances. In such circumstances, we may be required to: (i) sell assets in adverse market conditions, (ii) borrow on unfavorable terms, (iii) distribute amounts that would
otherwise be invested in future acquisitions, capital expenditures or repayment of debt, (iv) make a taxable distribution of our shares as part of a distribution in which stockholders may elect to receive shares or (subject to a limit measured
as a percentage of the total distribution) cash or (v) use cash reserves, in order to comply with the REIT distribution requirements and to avoid U.S. federal corporate income tax and the 4%
non-deductible
excise tax. Thus, compliance with the REIT distribution requirements may hinder our ability to grow, which could adversely affect the value of our common stock.
Even if we qualify as a REIT, we may face tax liabilities that reduce our cash flow.
Even if we qualify for taxation as a REIT, we may be subject to certain U.S. federal, state and local taxes on our income and assets, including
taxes on any undistributed income, tax on income from some activities conducted as a result of a foreclosure, and state or local income, franchise, property and transfer taxes, including mortgage recording taxes. In addition, any TRSs we own will be
subject to U.S. federal, state and local corporate income or franchise taxes. In order to meet the REIT qualification requirements, or to avoid the imposition of a 100% tax that applies to certain gains derived by a REIT from sales of inventory or
property held primarily for sale to customers in the ordinary course of business, we may hold some of our assets through TRSs. Any taxes paid by such TRSs would decrease the cash available for distribution to our stockholders.
The failure of assets subject to a repurchase agreement to be considered owned by us or a mezzanine loan to qualify as a real estate asset may adversely
affect our ability to qualify as a REIT.
We may enter into repurchase agreements under which we will nominally sell certain of our
assets to a counterparty and simultaneously enter into an agreement to repurchase the sold assets. We believe that we will be treated for U.S. federal income tax purposes as the owner of the assets that are the subject of any such agreements and
that the repurchase agreements will be treated as secured lending transactions notwithstanding that such agreements may transfer record ownership of the assets to the counterparty during the term of the agreement. It is possible, however, that the
IRS could assert that we did not own the assets during the term of the repurchase agreement, in which case we could fail to qualify as a REIT.
In addition, we may acquire mezzanine loans, which are loans secured by equity interests in a partnership or limited liability company that
directly or indirectly owns real property. In IRS Revenue Procedure
2003-65,
the IRS provided a safe harbor pursuant to which a mezzanine loan, if it meets each of the requirements contained in the Revenue
Procedure, will be treated by the IRS as a real estate asset for purposes of the REIT asset tests, and interest derived from the mezzanine loan will be treated as qualifying mortgage interest for purposes of the REIT 75% gross income test. Although
IRS Revenue Procedure
2003-65
provides a safe harbor on which taxpayers may rely, it does not prescribe rules of substantive tax law. We may acquire mezzanine loans that may not meet
- 46 -
all of the requirements for reliance on this safe harbor. In the event we own a mezzanine loan that does not meet the safe harbor, the IRS could challenge such loans treatment as a real
estate asset for purposes of the REIT asset and income tests, and if such a challenge were sustained, we could fail to qualify as a REIT.
We may be
required to report taxable income for certain investments in excess of the economic income we ultimately realize from them.
To the
extent we acquire debt investments in the secondary market for less than their face amount, the amount of such discount will generally be treated as market discount for U.S. federal income tax purposes. We expect to accrue market
discount on the basis of a constant yield to maturity of a debt investment. Accrued market discount is reported as income when, and to the extent that, any payment of principal of the debt instrument is made, unless we elect to include accrued
market discount in income as it accrues. Principal payments on certain loans are made monthly, and consequently accrued market discount may have to be included in income each month as if the debt investment was assured of ultimately being collected
in full. If we collect less on the debt investment than our purchase price plus the market discount we had previously reported as income, we may not be able to benefit from any offsetting loss deductions.
Similarly, some of the debt investments that we acquire may have been issued with an original issue discount. We will be required to report
such original issue discount based on a constant yield method and will be taxed based on the assumption that all future projected payments due on such debt investments will be made. If such debt investments turn out not to be fully collectible, an
offsetting loss deduction will become available only in the later year that uncollectability is provable. In addition, in the event that any debt investments acquired by us are delinquent as to mandatory principal and interest payments, or in the
event payments with respect to a particular debt investment are not made when due, we may nonetheless be required to continue to recognize the unpaid interest as taxable income as it accrues, despite doubt as to its ultimate collectability. While we
would in general ultimately have an offsetting loss deduction available to us when such interest was determined to be uncollectible, the utility of that deduction could depend on our having taxable income in that later year or thereafter. Although
we do not presently intend to, we may, in the future, acquire debt investments that are subsequently modified by agreement with the borrower. If such amendments are significant modifications under the applicable Treasury Regulations, we
may be required to recognize taxable income as a result of such amendments. Finally, we may be required under the terms of indebtedness that we incur with private lenders to use cash received from interest payments to make principal payments on that
indebtedness, with the effect of recognizing income but not having a corresponding amount of cash available for distribution to our stockholders.
The interest apportionment rules under Treasury Regulation
Section 1.856-5(c)
provide that, if a
loan is secured by both real property and other property, a REIT is required to apportion its annual interest income to the real property securing the loan based on a fraction, the numerator of which is the value of such real property, determined
when the REIT commits to acquire the loan, and the denominator of which is the highest principal amount of the loan during the year. Beginning in 2016, if a mortgage loan is secured by both real property and personal property and the
value of the personal property does not exceed 15% of the aggregate value of the property securing the mortgage loan, the mortgage loan is treated as secured solely by real property for this purpose. IRS Revenue Procedure
2014-51
interprets the principal amount of the loan to be the face amount of the loan, despite the Internal Revenue Code requiring taxpayers to treat any market discount, that is the difference between
the purchase price of the loan and its face amount, for all purposes (other than certain withholding and information reporting purposes) as interest rather than principal. The interest apportionment regulations apply only if the loan in question is
secured by both real property and other property and, beginning in 2016, the value of personal property securing the mortgage exceeds 15% of the aggregate value of the property securing the mortgage.
If the IRS were to assert successfully that our loans were secured by property other than real estate, the interest apportionment rules
applied for purposes of our REIT testing, and that the position taken in IRS Revenue Procedure
2014-51
should be applied to certain loans in our portfolio, then depending upon the value of the real
- 47 -
property securing our loans and their face amount, and the sources of our gross income generally, we may fail to meet the 75% REIT gross income test. If we do not meet this test, we could
potentially lose our REIT qualification or be required to pay a penalty to the IRS.
The taxable mortgage pool rules may increase the taxes
that we or our stockholders may incur, and may limit the manner in which we effect future securitizations.
Securitizations by us or
our subsidiaries could result in the creation of taxable mortgage pools for U.S. federal income tax purposes. As a result, we could have excess inclusion income. Certain categories of stockholders, such as
non-U.S.
stockholders eligible for treaty or other benefits, U.S. stockholders with net operating losses, and certain U.S.
tax-exempt
stockholders that are subject to
unrelated business income tax, could be subject to increased taxes on a portion of their dividend income from us that is attributable to any such excess inclusion income. In the case of a stockholder that is a REIT, a regulated investment company (a
RIC) common trust fund or other pass-through entity, our allocable share of our excess inclusion income could be considered excess inclusion income of such entity. In addition, to the extent that our common stock is owned by U.S.
tax-exempt
disqualified organizations, such as certain government-related entities and charitable remainder trusts that are not subject to tax on unrelated business income, we may incur a corporate level
tax on a portion of any excess inclusion income. Because this tax generally would be imposed on us, all of our stockholders, including stockholders that are not disqualified organizations, generally will bear a portion of the tax cost associated
with the classification of us or a portion of our assets as a taxable mortgage pool. A RIC, or other pass-through entity owning our common stock in record name will be subject to tax at the highest U.S. federal corporate tax rate on any excess
inclusion income allocated to their owners that are disqualified organizations. Moreover, we could face limitations in selling equity interests in these securitizations to outside investors, or selling any debt securities issued in connection with
these securitizations that might be considered to be equity interests for tax purposes. Finally, if we were to fail to qualify as a REIT, any taxable mortgage pool securitizations would be treated as separate taxable corporations for U.S. federal
income tax purposes that could not be included in any consolidated U.S. federal corporate income tax return. These limitations may prevent us from using certain techniques to maximize our returns from securitization transactions.
Although our use of TRSs may be able to partially mitigate the impact of meeting the requirements necessary to maintain our qualification as a REIT, our
ownership of and relationship with our TRSs is limited and a failure to comply with the limits would jeopardize our REIT qualification and may result in the application of a 100% excise tax.
A REIT may own up to 100% of the stock of one or more TRSs. Subject to certain exceptions, a TRS may hold assets and earn income that would not
be qualifying assets or income if held or earned directly by a REIT. Both the subsidiary and the REIT must jointly elect to treat the subsidiary as a TRS. A corporation of which a TRS directly or indirectly owns more than 35% of the voting power or
value of the stock will automatically be treated as a TRS. Overall, no more than 25% (20% beginning with the taxable year ending December 31, 2018) of the value of a REITs total assets may consist of stock or securities of one or more
TRSs. In addition, the TRS rules limit the deductibility of interest paid or accrued by a TRS to its parent REIT to assure that the TRS is subject to an appropriate level of corporate taxation. The rules also impose a 100% excise tax on certain
transactions between a TRS and its parent REIT that are not conducted on an
arms-length
basis. Our TRSs will pay U.S. federal, state and local income or franchise tax on their taxable income, and their
after-tax
net income will be available for distribution to us but will not be required to be distributed to us, unless necessary to maintain our REIT qualification. While we will be monitoring the aggregate value of
the securities of our TRSs and intend to conduct our affairs so that such securities will represent less than 25% (or 20% beginning January 1, 2018) of the value of our total assets, there can be no assurance that we will be able to comply with
the TRS limitation in all market conditions.
- 48 -
Dividends payable by REITs generally do not qualify for the reduced tax rates on dividend income from regular
corporations, which could adversely affect the value of our shares.
The maximum U.S. federal income tax rate for certain qualified
dividends payable to U.S. stockholders that are individuals, trusts and estates is 20%. Dividends payable by REITs are generally not eligible for the reduced rates and therefore may be subject to a 39.6% maximum U.S. federal income tax rate on
ordinary income. Although the reduced U.S. federal income tax rate applicable to dividend income from regular corporate dividends does not adversely affect the taxation of REITs or dividends paid by REITs, the more favorable rates applicable to
regular corporate dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks of
non-REIT
corporations that pay dividends, which could adversely affect the value of the shares of REITs, including shares of our common stock.
The tax on
prohibited transactions limits our ability to engage in transactions, including certain methods of securitizing loans, which would be treated as sales for U.S. federal income tax purposes.
A REITs net income from prohibited transactions is subject to a 100% tax. In general, prohibited transactions are sales or other
dispositions of property, other than foreclosure property, but including loans, held as inventory or primarily for sale to customers in the ordinary course of business. We might be subject to this tax if we were to sell or securitize loans in a
manner that was treated as a sale of the loans as inventory for U.S. federal income tax purposes. Therefore, in order to avoid the prohibited transactions tax, we may choose not to engage in certain sales of loans, other than through a TRS, and we
may be required to limit the structures we use for our securitization transactions, even though such sales or structures might otherwise be beneficial for us.
Complying with REIT requirements may limit our ability to hedge effectively.
The REIT provisions of the Internal Revenue Code may limit our ability to hedge our assets and operations. Under these provisions, any income
that we generate from transactions intended to hedge our interest rate exposure will be excluded from gross income for purposes of the REIT 75% and 95% gross income tests if (i) the instrument (A) hedges interest rate risk on liabilities
used to carry or acquire real estate assets or certain other specified types of risk, or (B) hedges an instrument described in clause (A) for a period following the extinguishment of the liability or the disposition of the asset that was
previously hedged by the hedged instrument, and (ii) such instrument is properly identified under applicable Treasury Regulations. Income from hedging transactions that do not meet these requirements will generally constitute
non-qualifying
income for purposes of both the REIT 75% and 95% gross income tests. As a result of these rules, we may have to limit our use of hedging techniques that might otherwise be advantageous or implement
those hedges through a TRS. This could increase the cost of our hedging activities because our TRS would be subject to tax on gains or the limits on our use of hedging techniques could expose us to greater risks associated with changes in interest
rates than we would otherwise want to bear. In addition, losses in our TRS will generally not provide any tax benefit to us, although such losses may be carried forward to offset future taxable income of the TRS.
We may be subject to adverse legislative or regulatory tax changes that could reduce the market price of shares of our common stock.
At any time, the U.S. federal income tax laws or regulations governing general corporate taxation or REITs or the administrative
interpretations of those laws or regulations may be changed, possibly with retroactive effect. See Item 7. Management Discussion and Analysis of Financial Condition and Operating ResultsFactors Impacting our Operating
ResultsU.S. Federal Income Tax Legislation for recently adopted REIT legislation. We cannot predict if or when any new U.S. federal income tax law, regulation or administrative interpretation, or any amendment to any existing U.S.
federal income tax law, regulation or administrative interpretation, will be adopted, promulgated or become effective or whether any such law, regulation or interpretation may take effect retroactively. We and our stockholders could be adversely
affected by any such change in, or any new, U.S. federal income tax law, regulation or administrative interpretation.
- 49 -
Liquidation of our assets may jeopardize our REIT qualification.
To qualify as a REIT, we must comply with requirements regarding our assets and our sources of income. If we are compelled to liquidate our
assets to repay obligations to our lenders, we may be unable to comply with these requirements, thereby jeopardizing our qualification as a REIT, or we may be subject to a 100% tax on any resultant gain if we sell assets that are treated as
inventory or property held primarily for sale to customers in the ordinary course of business.
Your investment has various U.S. federal income tax
risks.
We urge you to consult your tax advisor concerning the effects of U.S. federal, state, local and foreign tax laws to you with
regard to an investment in shares of our common stock.