By Elias Hinckley and John Frenkil
Special To Solar Power World
The energy finance community has eagerly anticipated the introduction of solar asset-backed securities — “solar securitization” — for at least three years, and may be waiting for another year or more. But sooner or later, securitization is coming to solar finance. When it does, it will have a profound impact on the pace of solar industry development.
Sink or Securitize
The solar industry must find ways to continue to reduce costs as state and federal support for renewables shrinks, and access to less-costly capital will be critical. Asset-backed securitization would give the industry access to a much broader pool of investors, ultimately helping to cut the long-term cost of capital, reduce levelized energy costs and enhance liquidity in the solar project market.
Securitization: The Basics
In the most basic form of solar securitization, the holder of a portfolio of solar assets bundles contracted revenues from a group of projects and sells that revenue stream to a special-purpose vehicle (SPV) — an entity that exists solely to buy or finance specific assets.
That SPV issues that revenue stream as a tradable, interest-bearing security. Buyers of the security are senior to equity investors, thereby taking on a smaller degree of risk. For the security to be investment-grade, the project portfolio must be large, diverse and offer a credit-worthy source of revenue, which accrues from buyers of solar power.
Why It Hasn’t Happened Yet
The solar industry faces the following obstacles in bringing solar securities to the market with the kind of ratings they will need to enable solar projects to attract low-cost capital.
- Scale and Geographic Diversity. Assets must hit a critical mass and must be pooled from over a geographically-diverse area, reducing the risk that regulation or market conditions will materially affect the value of all the solar assets in the pool.
- Standardization of Asset Structures and Documentation. The structure and supporting documentation of assets must be more consistent and pools of assets standardized for underwriters and investors to have confidence in the underlying revenue streams.
- Off-Take Risk. Most residential solar sponsors manage off-take risk by limiting their eligible pool of potential customers to homeowners with a minimum FICO score. But management of off-take risk for commercial and industrial customers is less standardized, making commercial and industrial solar assets more difficult to securitize.
- Technology Risk. Distributed solar asset revenue streams have tenors of 15 to 20 years, but most solar panels have fewer than 10 years of historical performance data.
- Sponsor Risk. Sponsors are still relatively new to the market. Even more established market players, such as Solar City, SunRun, Sungevity, and Viridity, have been operational for less than a decade.
- Market Risk. Solar energy might be less economical than traditional energy sources over the lifetime of the asset, and sponsors will need to persuade investors that their assets will continue to generate electricity at a price that is competitive with traditional energy, or find other means of ensuring that market risk won’t jeopardize asset values.
- Regulatory Risk. Government agencies will need to update regulations, such as disclosure and liability rules, as well as assignee rights under government energy programs to ensure that investors in solar securitizations are protected against default risk. The government could also provide credit enhancement through loss reserves or investments through entities like government-backed green-bank programs.
The Snowball Effect
When the above challenges are resolved, the number of solar securitization issuances is likely to grow rapidly.
With less than 1% penetration among credit-worthy homeowners in the residential solar market, there is tremendous room for growth. Ultimately, commercial solar assets will also be securitized, which could lead to issuances of mixed residential and commercial asset pools. This securitization process and impact will not be restricted to the United States and will expand to markets abroad.
The capital the securitization will add to the market will accelerate growth, geographic diversity and standardization across the solar industry, driving consolidation among players at all levels of the industry supply chain.
Elias B. Hinckley is a partner in the Environment, Energy & Natural Resources Group of our Washington, D.C. office. Hinckley focuses on helping his clients navigate a changing energy, tax, and finance landscape by efficiently and creatively structuring deals.
John Frenkil is an associate in the Environment, Energy & Natural Resources Group in the Sullivan & Worcester’s Washington D.C. office. His practice focuses on the representation of lenders, equity investors and developers in domestic and international energy projects.
Christopher Doyle says
I believe there must also be a component of ensuring basic quality in distributed, residential systems. Its near impossible for aggregated systems to be properly rated without having some sort of metric for basic installation standards. The level of quality of actual installation in residential systems is still relatively low due to the rapid growth of the industry and emerging workforce. At this moment each leasing provider has a different method for ensuring basic installation practices, some not doing anything.