Banks face collateral damage from clean energy firm's bankruptcy

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A California bankruptcy is highlighting the need to carefully vet tax credit deals.

DC Solar, a clean energy firm, filed for bankruptcy protection on Feb. 4. An FBI agent has alleged that the company was operating an investor scheme by booking revenue on equipment that may not exist.

The situation is causing concern for five banks that received more than $100 million in total tax credits, going back to at least 2013, tied to the firm. Each bank has warned that some of those credits could be invalidated.

Only one of the banks, East West Bancorp in Pasadena, is based in California.

The issue drives home the importance of banks knowing who they are working with, industry observers said. Much like lending, risk tied to tax credits is typically higher when banks stray out of market.

“This is a good example of what happens when … you’re out of touch with the source of the credit,” said Damon DelMonte, an analyst at Keefe, Bruyette & Woods.

Most tax credit programs, including historical tax credits and programs tied to low-income housing, have a history of strong performance, DelMonte said, adding that banks are comfortable with them because the projects usually take place in their own markets.

Renewable energy programs, however, are relatively new and untested, said DelMonte, who does not cover any of the banks with exposure to DC Solar.

A spokesman for United Financial Bancorp in Hartford, Conn., and a spokeswoman for Meta Financial Group in Sioux Falls, S.D., declined to comment. A spokeswoman at Hancock Whitney in New Orleans declined to discuss the matter beyond what was disclosed in a recent regulatory filing.

Calls to East West and Valley National Bancorp in Wayne, N.J. were not immediately returned.

To be sure, banks typically pore over these types of deals and fraud can be hard, if not impossible, to predict.

State Bank of Cross Plains in Wisconsin spends an “immense” amount of time conducting due diligence on tax credit opportunities, said Mark DeBiasio, the bank’s chief financial officer. The bank uses external legal counsel and accounting professionals that specialize in tax credits to review projects.

The bank, which avoids out-of-market deals, recently participated in two projects that involved tax credits: a new hotel being built on a historic site and the construction of affordable housing.

“The knowledge base when dealing with tax credits is very specialized,” DeBiasio said. “A lot of people say the words ‘tax credits,’ but you need to surround yourself with a team of experts.”

An external audit provides more confidence that a project is structured in a way that secures the tax credits.

“There are tons of legitimate programs but you have to know what you’re doing,” DeBiasio said.

DC Solar serves as a reminder of the importance of doing your homework, said Richard Baier, president and CEO of the Nebraska Bankers Association.

“Sometimes there’s a tendency to say, ‘Look, we’ve got these credits that are going to be our backstop,’ and that isn’t always the case,” Baier said.

While banks must be willing to innovate, Baier said they need to focus primarily on products and services where they have expertise.

“We like to be on the leading edge but we don’t want to be on the bleeding edge,” he said.

At the same time, it’s never wise to rely solely on tax credits to make a project work, said Baier, who once served as director of the Nebraska Department of Economic Development.

Credits “can make a good project great but they cannot make a bad project good,” he said.

The overall financial impact tied to DC Solar’s bankruptcy and alleged fraud is unclear.

Mark Fitzgibbon, an analyst at Sandler O’Neill, said United, which made a $19 million investment in DC Solar last year and recognized $18 million in tax benefits from 2014 to 2018, might have to write off the entire investment in a worst-case scenario.

United, under that scenario, would also need to reverse the recognized tax benefits. That would mean a total charge of $33 million, which could lower the company’s tangible book value by nearly 6%, to $10.89 a share, Fitzgibbon said.

Banks rarely disclose specifics about their tax credit dealings beyond touting the benefits to their tax rates, DelMonte said.

“So when something like this comes up it takes people by surprise,” he said.

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