Securitization has long been eyed as a financing alternative for the solar energy industry, which has to-date relied heavily on tax incentives. But the short operating history of most solar projects, lack of standardization and the long terms of residential leases were seen as an impediment to getting a credit rating.

SolarCity has proven it’s possible – but at a cost.

On Nov. 14th, the company priced $54.4 million of “sunshine bonds” backed by cash flows generated from a pool of 5,033 photovoltaic (PV) systems and leased to U.S. homeowners.

These leases produce a stream of revenue that is predictable, but at up to 20 years, is longer than the term of a typical securitization. It’s also longer than the average homeowner stays in a home. That creates a risk to cash flows to a transaction because it exposes contracts to default or re-negotiating their solar utilization contract.

The private placement, called Solar Asset Backed Notes, Series 2013-1, was assigned a preliminary ‘BBB+’ rating from Standard & Poor’s. The notes have a weighted average life of 7.05-years and priced at 265 basis points over the interpolated swaps curve. They have an interest rate coupon of 4.80%.  

While the deal is small, it points the way for other developers to tap the securitization market for funding. And the timing couldn’t better. Federal and state tax incentives that helped fuel the growth in solar are expected to be reduced by 15% at the end of 2015. 

“The SolarCity transaction demonstrates that both investors and rating agencies can think creatively and follow a less statistical approach and embrace a more fundamental analysis as a way of the driving their stress cash flows,” said Ron D’Vari, chief executive and co-founder of New Oak Capital.

D’Vari believes that the transaction provides a good benchmark, at least for distributed residential, or “roof top,” solar securitization.  

While S&P may be willing think creatively, it still used some fairly conservative assumptions that could limit appeal of obtaining a credit rating for other solar deals. The agency said in its presale report that the limited operating history of the asset class would likely constrain ratings to low investment grade for the near future.

“In a way the deal proves that the rating agencies, even when they are going to rate a deal, maybe are not giving the rating that the deal really deserves,” said Dan Passage, a partner in law firm Bingham’s structured transactions group.

“It is always likely to help with marketing of bonds to have a rating than not” he said, because “some investors can only invest in rated products.”

Nevertheless, he said, obtaining a rating “is still an expensive process, both in terms of time and treasure … If [the rating] is not appropriately high, it is almost punitive in the end.”

Bob Kelly, SolarCity’s chief financial officer said that he is “disappointed yet understanding” of  the ‘BBB+’ rating.

One of the big challenges, said Kelley, was to correct what he calls S&P’s “misconception” of the asset class: the rating agency previously viewed the business as an installation, default/recovery, foreclosure business, instead of an “energy producing business” where the focus should be more on vacancy and reassignments.
“What we are really selling is energy from the solar rooftop,” Kelley said.  “SolarCity lowers what is typically the highest operating cost for households and gives them long-term control over that cost. Customers highly value those attributes, and that’s why these assets perform so well.”

In other words, the solar panels themselves are worthless; instead the value lies in the energy the panels produce.  The top three states represented in the pool backing the SolarCity deal are California, Arizona and Colorado and the weighted average price per kWh is $.15. California currently charges $.25 per kWh. Based on the characteristics of the assets and their financial statistics – SolarCity provided operational data for seven years – it became quite obvious that “you had was an ‘A’ rated credit and above."

Residential solar customers with a weighted average FICO of 762 make up 71% of the pool and 28.9% of the pool is made up of commercial and government customers, according to S&P’s presale report.

It was the unpredictable nature of utility prices in the future and changes in solar technology that could impact the price of energy that moved the rating away from the financial single-A level characteristics and into the triple-B world, according to Kelley.

Credit Suisse, the deal’s underwriter, declined to comment for this article.

Unknowns cited by S&P in its presale report include: legislative risks, continued drop in prices of panels and invertors, technological obsolescence of current PV technology over the entire lease term of up to 223 months, drop in kWh rates offered by public utility over long life of the transaction due to alternative energy price drop, PPA customer reassignment and renegotiation rates, customer base credit quality drift due to ownership turnover, and operator replacement disruption. 

The national average PV system installed price has dropped to about $5.0/W on 2013 depending on the size of the distributed system, compared with approximately $8.5/W according to S&P.

 “The more uncertain we feel the risk created by the limited operating history creates a greater amount of stress,” said Weili Chen, one of the lead S&P analysts on the SolarCity deal. “In our view the level of stress that we put on the residential portion of the portfolio is a ‘BBB’ category.”

S&P’s base assumptions and stress assumptions did not give any credit to contract renewals after the credit expires. Instead the rating agency looked at the contractual cash flows and no additional cash flows, after the contractual term, was assumed.

However SolarCity did provide data that speaks to the risk of renegotiation of customer assets before a contract ends, according to S&P. Since 2008, SolarCity has been given permission to operate approximately 39,000 financed systems; of these systems, roughly 900, or 2.4% of the total, have completed contract reassignments, of which the overwhelming majority have experienced full recoveries. Of these 900, approximately 82% were reassigned as the result of the normal sale of a customer’s home (and not because of foreclosure, short sale, death or divorce). The remaining cases were because of various other reasons. In 91% of the contract reassignments, there was a full recovery and the remainder resulted in a weighted average recover of 78%.

“There is some history associated not only with Solar City but with the industry as a whole that suggests that reassignment performance has been pretty good,” said Chen. “Overall the reassignments rated so far are [really] low and the recovery rates are very high.” Nevertheless, she said, “in our analysis, if a customer defaults and another homeowner does not take over the contract, we assume zero recovery.”

So while a credit rating opens the door to bigger investor base, it is at the cost of issuing a lower rated security. SolarCity felt it was worth the trouble to obtain a rating because this is the  company’s long-term strategy for funding the business. “To be a sustainable business you need to create the right capital structure, access multiple sources of capital and drive down the cost of capital,” said Kelley. “Going non-rated doesn’t open up the market to the sources of capital we will need over the next five to 10 years.”

However Passage said the costs for some issuers just may not make sense considering that there are other classes of investors – such has hedge funds, private equity funds, family offices and pockets of capital inside insurance companies – that can invest in unrated securities. These investors are sizeable enough to absorb the foreseeable supply at this early stage of solar securitizations.

Passage said that Bingham is working on two potential solar deals; one sponsor is seeking a rating and the other is not. The one that is seeking a rating may nevertheless opt to go without one if it decides it’s not worth the cost.

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