There’s been plenty of talk about using securitization to finance solar energy, but to date, no deals. 

The Department of Energy’s National Renewable Energy Laboratory (NREL), wants  to jumpstart the process. It recently formed a working group of manufacturers and investors to facilitate securitization of solar energy by standardizing the power purchase agreements, leases, and other instruments on which deals are based and to provide more clarity about the risks involved.

The solar energy industry has experienced rapid growth over the past five years, thanks to declining solar panel prices, federal and state tax incentives, and standards that require utilities to generate a certain percentage of power from renewable energy sources.

But the tax incentives that helped fuel this growth are expected to be reduced or eliminated over the next few years, and many banks are limiting their lending because of regulatory restrictions.

Securitization could be a good fit. Even with the drastic decline in panel prices as the result of competition from Chinese manufacturers, rooftop solar systems are still so expensive that both residential and commercial property owners tend to finance them by entering into leases or power purchase agreements. So there’s a predictable, long-term stream of revenue that could serve as collateral for deals.

And the industry is approaching the critical mass and diversification needed to securitize contracts.  According to the Interstate Renewable Energy Council, approximately 1,845 megawatts of photovoltaic capacity were installed in 2011, which is more than 10 times the capacity installed in 2007. Roughly 45% of that capacity was installed on non-residential buildings, 38% from utility scale projects, and 18% from residential properties.

DOE Leads Standardization Push

Still, there are a number of hurdles. The NREL’s Solar Access to Public Capital (SAPC) group is focused on two of these: a lack of standardization of power purchase agreements, leases, and other documents relevant to residential and commercial solar assets, and the need for robust datasets to assess performance and credit-default risk.

The working group has over 60 members representing some of the bigger names in solar as well as capital market debt players — both from the sellside and buyside — ratings agencies and a handful of lawyers.
In March the NREL, with the help of SunSpec Alliance, a group of solar photovoltaic industry participants promoting information standards, began work on the Open Solar Performance and Reliability Clearinghouse (O-SPARC). The plan is to roll out standards by year’s end. 

In a March 22 webinar, Michael Mendelsohn, a senior financial analyst at NREL and project leader of the SAPC, said that by next year the datasets could be available for a wide array of solar assets, across the U.S.
Public utilities commissions are getting on board as well; they are expected to be organized so that “interconnection requirements are standardized among the various regulators,” he said.

In an interview with ASR following the webinar, Mendelsohn said that while he hopes the industry begins using the standard contracts by fourth quarter, “there is no guarantee on the standard contract adoption; and no guarantee if developers adopt the standard contracts, the projects will be pooled and securitized.  So, we will need to market the effort to various audiences.”

The NREL projects that the amount of capital needed by 2020 for both solar photo voltaic and wind powered projects will be $65 billion; double the $35 billion needed in 2012, which was itself a record year.
Paul Detering, chief executive of Tioga Energy, which owns and operates more than 100 renewable energy systems across the U.S., also spoke at the March webinar. He said that the “key to the industry’s growth will be access to large pools of capital at lower costs and securitization could provide that access.”

Tax Credits Going Away

Andrew Giudici, a senior director at Kroll Bond Ratings, which is also part of the SAPC working group, said currently financing is made up from about 50% of tax credit and depreciation — 30% comes from the investment tax credit and 20% comes from accelerated depreciation. But with the investment tax credit set to decline to 10% in 2016, rooftop solar needs will become a cashflow strategy.

What could a residential solar photovoltaic-backed securitization look like? Mendelsohn envisions residential leases of power purchase agreements or industrial leases, with the majority performing, pooled together. He believes that the asset can be structured with “incredibly high-rated tranches if the contracts are made to high FICO borrowers and issuers can prove that people really do pay their solar bill.”

Dan Passage, a partner at Bingham McCutchen, another SAPC participant, said that the working group’s next step will be to develop “mock securitizations,” drawing up draft agreements that will be reviewed by the rating agencies, so that any concerns can be addressed.

One major kink to getting the rating agencies gold seal of approval is the lack of historical data that they require to get comfortable with the securitization of a long-term asset. “A large volume of detailed historical data can make the rating agencies feel confident about rating a deal but it doesn’t fit with a new asset class at all,” said Passage.

Another problem, according to Giudici, is that within the short history of solar, the borrower profile has already shifted. The first consumers to purchase solar panel systems did so out of concern for the environment, but today many consumers enter into leases for economic reasons. The payment histories between these two borrowers are likely to be different. “We only have five years of limited data, from mostly a different type of borrower; and what we are being asked to do is forecast the next 20 years,” Giudici said.

Shift in Borrower Profile

The long term of residential solar contracts poses another problem for potentail securitizations. The contracts typically last for 20 years. The most efficient  way to structure a deal would be to monetize the cash flows for the full term of these contracts. However, Moody’s Investors Service raised concerns in April about the potential for current solar technology to become obsolete before the end of these contracts. It said this increases the risk of default on solar securitization. “Homeowners could decide they no longer wish to make their payments or want to negotiate lower monthly payments,” Moody’s said in its report. Either option, occuring on a large scale, could have a material impact on the performance of a securitization.

Standard & Poor’s also takes issue with the long terms of solar contracts, but for a different reason. In research published in 2012, the rating agency pointed out that the average homeowner is unlikely to stay in a home for for the full length of a contract. It said any analysis of a securitization must measure the risks to the cash from under the lease if a homeowner sells the residence, loses it in a foreclosure, or even refinances.

Passage played down such concerns; he said that the banks that Bingham has worked with have presented analogous asset classes to the ratings agency that deal with similar risks that hone in on customer based assets, in other contexts; in an effort to show how those issuers do credit wise. “If the solar panel customer is someone with a $500,000 home and he has a FICO of 680, and the borrower had a large auto loan before, or a home equity loan before, there are things that we can say about that borrower,” he said.

Mendelsohn said that, while the solar datasets initially “will probably not provide the full history for the rating agencies to provide their highest ratings,” he’s hopeful that the rating agencies can become comfortable with the asset by looking at “proxy data sets on similar asset classes, credit enhancements from various sources, and enough historical data on PV system performance.”

Giudici also sees the lack of assets that are both available and appropriate for use as collateral in a securitization as another major obstacle. The last time KBRA looked at the sector ( a little more than a year ago), there were only 150,000 to 200,000 of power purchase agreement leases outstanding. “You need 10,000 for a deal so what you have here is a max of 20 deals but really only half of those are securitizable,” he said.

First Deals in the Works

Passage believes that the industry is more than ready to bring a deal to market. While he was not at liberty to talk about specific clients, he said that Bingham has worked on or looked at a number of potential securitizations – some of which would be rated and some of which would be unrated.  He is confident that the major players do have enough contracts to do a string of $100 million to $200 million deals.

Giudici said the first few deals to come to market will be done by leasing companies securitizing their own contracts, rather than by sponsors pooling assets from multiple sellers. Nevertheless, he said, “In order for the industry and the conduit to get involved right now you are going to need a substantial amount of leases or PPAs to be generated over the next six to 12 months.”

Passage disagrees. He said there are a number of companies that have written a significant amount of contracts, most of them in tax equity structures. Some of the banks or lenders to these tax equity structures are interested in refinancing out of those structures and putting the contracts into a capital markets deal, like a securitization, because it increases their return. But Passage said that there are tax issues with moving assets around when you have already claimed federal tax credits, “you can’t change ownership without forfeiting some of those credits,” he said.  

According to Passage, “There are players out there that are interested in playing the role of CLO manager” by acquiring collateral in the secondary market, “but it is very tricky when you are trying to accumulate paper that is slightly different, company to company, state to state.” 

So are NREL’s efforts toward contract standardization too premature? Mendelsohn says that, as the volume of leases grows, someone will step in and want to securitize these assets. “I envision the first few years to be a transition but ultimately things will smooth out and a regular conduit will evolve,” he said.

NREL estimates that, once securitization becomes a significant source of financing, it could reduce the cost of solar energy for both residential and utility on the scale of 8% to 16%. —NC

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