Quick, what’s the biggest cause of brain damage for solar developers when structuring a PPA? Financing. Along with a shortage of tax equity in the post-1603 environment, arranging debt financing can be even more onerous — most lenders still view the solar asset class as exotic with a high risk profile due to a lack of industry standardization.
The solution might just be the truSolar initiative, an industry credit screen intended to reduce project risk to lenders and increase debt financing on PPAs with third-party ownership. Think of it as the Kelly Blue Book of solar.
PPAs utilize third party ownership of projects allowing offtakers to avoid the upfront capital investment required. The capital structure is typically comprised of tax equity, sponsor equity and debt, but less than 5 percent of U.S. banks are actively involved in financing solar projects, according to the truSolar press release. The idea is to develop an appetite for lending for the remaining banks.
“truSolar will make financing projects more efficient by standardizing the way lenders look at project risk,” according to Greg Rosen, Chief Investment Officer of Mosaic and one of the founding members of the truSolar working group.
truSolar was established as a working group of sixteen market leaders in the solar energy industry in January of this year. Lead members Distributed Sun and DuPont Photovoltaic Solutions are joined by Standard & Poor’s, Booz Allen Hamilton, Mosaic, ABB, Assurant and others.
Metrics Justify the Need
According to surveys conducted among project originators during one of its industry days, truSolar market research projects that $1 trillion will be needed between now and 2030 to fund the non-residential (commercial/industrial/government/military) solar market. NREL has estimated that the commercial and industrial rooftop PV segment alone will exceed 100 GW by that date. With the investment tax credit (ITC) reverting from 30 percent to 10 percent of project cost basis in 2016, there will be funding holes to fill.
Could improved screening processes get lenders comfortable with the solar asset class?
Industry thought leaders like Chase Weir, CEO of Distributed Sun and co-founder of truSolar, believe so. Citing further market research conducted by his firm, Weir said that 96 percent of project developers have a failure rate over 50 percent. truSolar aims to address the high cost of capital on projects that lenders have accepted as bankable, said Weir, adding that 43 percent of developers say capital is too expensive and uncompetitive. He added that 80 percent of project originators representing over $3 billion in capital are unhappy with their current financing partners.
Professionalizing through universal project screening and risk assessment at each stage of the project cycle – from origination to O&M – would get more lenders into the game to fund lower-risk projects and offer better pricing to developers, according to Weir.
What Are Lenders Looking For?
The most active lenders have an appetite for developers with a track record of successful projects, prior existing relationship, a strong balance sheet, and sponsor equity, according to Rosen. On a project basis, lenders often look for a floor of $10 million for system and development costs, and on a pipeline basis, they look for bankable projects that consist of $100 million or more. That leaves a big financing gap for developers and projects that can’t join that exclusive club. Rosen sees the truSolar screen as facilitating debt financing on projects that may not fall into that bucket (mid-market PPA projects loosely defined as 1-2 MW or smaller).
Lenders are looking primarily at contracted cash flows, said Rosen, referring to the 25-year PPA electricity revenue stream based on the kilowatt-hour rate. Through a collaborative process with solar industry professionals,truSolar is in the early stages of building and refining a process that will evaluate component selection, design optimization, warranties and other methods of mitigating project risk, then scoring them to ensure that annual production guarantees are honored leading to predictable electricity revenue streams. Bankers then apply those contracted cash flows to determine annual net profit on the project to meet the minimum Debt Service Coverage Ratio (DSCR) of 1.25, he adds.
Most utility-scale projects have a debt component, said Rosen, and a typical capital stack is 50 percent debt/40 percent tax equity/10 percent sponsor equity. But mid-market PPAs, those under the utility scale threshold of 1 – 2 MW, may still have difficulty attracting debt financing lacking standardized PPAs and other documentation with the same transaction costs as bigger projects. Instead of originating what lenders may determine to be “unbankable” projects, developers would reverse-engineer the origination process, equipped with a checklist of what lenders are looking for.
Benefits to Military and Government Sector
The truSolar initiative will make the development process more streamlined not only for the commercial segment, but also the government/military by lowering transaction costs, according to Gary Leatherman, principal at Booz Allen Hamilton.
With a 25 percent renewable energy target by 2025, the U.S. Military represents a huge solar market segment and industry opportunity. But although the DOD is a creditworthy off-taker, challenges still exist.
According to Leatherman, meeting Army mission objectives, like energy security through renewables, while still ensuring investors a fair return is a huge challenge. The truSolar initiative addresses that challenge and was part of the impetus for Booz Allen joining the working group. By reducing risk to lenders and lowering the cost of capital, project economics would improve with an increasing investor return.
Creating a bankability standard would further engage the private sector to raise capital for military projects. With a rating score, individual projects could more easily be aggregated and securitized, said Leatherman, which is another source of financing to grow the still nascent solar industry.
Is truSolar a Game Changer?
The venture capital community, with about one-third of their portfolio in cleantech, has compared the renewable energy industry life cycle to the 1980 – 1985 period of the internet and IT boom.
In other words, it’s still early.
Unlike Europe, where debt financing has historically played a prominent role for solar PPAs due to a unified national energy policy that includes long-term feed-in tariffs, the solar asset class is still exotic to lenders in the U.S. market. More importantly, U.S. lenders do not have a standard to follow that helps them evaluate solar deals.
Can truSolar transform the renewable energy finance landscape? Industry pioneers are betting on it.
Lead image: Finance concept via Shutterstock