Travis Lowder, NREL and Ronald S. Borod, DLA Piper LLP (US)
October 11, 2013 | 0 Comments
Part one of this series examined the problem of incorporating securitization debt into a financial structure with its highly sensitive tax attributes — that is, how the legal structure of a securitization transaction contains certain elements that may trigger a recapture of the tax incentives, thus diminishing the value of a tax equity partner's investment.
This second installment will look at two solutions to this problem as proposed by a team of highly experienced structured finance and tax attorneys participating in NREL's Solar Access to Public Capital (SAPC) working group. This SAPC legal team has devised two possible structures that would allow for solar sponsors/developers to access capital market finance through securitization of their contracted cash flows: the pre-buyout option and the post-buyout option. The first structure, referenced below as the "pre-buyout" option, is executable before the tax recapture period has elapsed — that is, before the sponsor/developer has the ability to exercise its option to buy out the tax equity. The "post-buyout" option would be used to fund the sponsor/developer's buyout of the tax equity investor's interest in the project or portfolio once the tax recapture period has expired. See Table 1 below:
In the pre-buyout structure, solar developers would not be the issuers of the securities and would therefore not be required to enter into the typical process required to securitize cash flows. In other words, they would not assign their assets — the solar systems that they originate and the cash flows from those systems — in a bankruptcy "true sale" to an SPV. The pre-buyout structure instead assumes that a bank will make a series of loans to project developers that would be secured by the developers' partnership interests in their project entities. The bank would then enter into the typical securitization process of assigning those loans to an SPV, which would then issue the securities.
Here's a closer look at how this structure would work: A bank would make loans to developers backed by the developers' equity positions in their projects via the project entity. (Note: this type of lending is not yet evident in the market, but the SAPC legal team anticipates that a market could develop if banks have the option to securitize and generate capital). Each developer would pay down its loan with all or a portion of the cash flows generated by its equity position. Assuming that a bank had a portfolio of these loans, it could then pool the portfolio and the payments thereunder into an SPV. The SPV would then issue securities against the assets it held and these securities would be sold to investors. A portion of the proceeds from this sale would be used to fund the bank's origination or purchase of additional loan assets, which it would then turn around and securitize. This cycle could be repeated each time sufficient origination is aggregated by the bank to go into the securitization market.
It should be noted that the pre-buyout model is ideally suited for partnership flip agreements. It will likely not work with the sale-leaseback structure because the developer's cash flow is not usually adequate to form the basis for significant financing. This is because developers only receive a small spread between their payments due to tax equity (under the so-called "head lease") and the payments they receive on the underlying leases and PPAs.
Figure 1. The pre-buyout structure
One of the advantages of this model is that even small developers with insufficient origination or bandwidth to execute their own securitization program may have a ready market for their assets in the form of these conduit facilities (which are essentially bank SPVs that collect assets from multiple originators). Thus, although this structure does not enable the smaller solar developer to access the securitization market directly, it does allow for indirect access. Moreover, banks can securitize these loans at more favorable rates than smaller developers could securitize their own cash flows, and thus potentially pass some of this pricing through to developers in the form of a lower interest rate.
This structure would also eliminate the requirement that the smaller developers create their own infrastructure to manage their own securitization program, with the attendant costs of organizing and maintaining SPVs and third-party costs of underwriters, trustees, back-up servicers, operation and maintenance (O&M) providers, and accounting firms. The tradeoff is that developers would likely be charged an ongoing "rental fee" for their use of the bank's SPV (sometimes referred to as a conduit facility). This rent would likely be the spread captured by the bank between the rates on the developer loans and the rates on the securities issued.
Another challenge of this structure is that the securitizations will be backed by the partnership interests of the developer rather than by the leases and power purchase agreements (PPAs) from the underlying solar assets. This means that the cash flows being securitized would be subject to disruption at the project level (e.g., a developer default). Cash flows from leases and PPAs can be more insulated from these project-level risks. Also, from the ratings agency perspective, the process of analyzing the reliability of these cash flows would exponentially increase as the number of underlying partnerships increases. Although there are tangible benefits with diversity in the number of project partnerships (i.e., "portfolio effect"), this benefit can be eroded by the complexity of the analytics required to obtain a rating.