Back in November 2012, the NREL finance team convened its first assembly of the Solar Access to Public Capital (SAPC) working group. The purpose was to bring together leaders from the solar, financial, legal, regulatory, and analysis professions to conceive of ways to accelerate the solar industry’s access to capital markets through securitized instruments. The group’s efforts are currently threefold: (1) the standardization of power purchase and lease contracts used by solar developers, installers, and integrators at the commercial and residential level; (2) the collection of performance and credit data to facilitate investor and ratings agency evaluation of solar assets; and (3) the submission of a solar securitization “mock filing” to several ratings agencies in order to illuminate how they will assess the risks of the solar asset class and thus drive solar-backed security issuers and originators to take appropriate mitigation measures.
There is a great deal of experience at the table during any given SAPC meeting, and this stimulates many insights about how to strategically execute solar securitization so that it becomes a widely adoptable tool for developers across the industry. SAPC members have been discussing what a solar-structured transaction could look like, how the markets will react, what it could mean for future deployment, and other heady matters. The following are just a few such insights and updates from recent meetings.
Commercial vs. Residential
One perennial topic of conversation within SAPC has been how the different cash-flow characteristics of the commercial versus the residential solar markets could be structured into tradable securities. Some experts have opined that securities backed by residential solar systems will likely trade in the asset-backed securities (ABS) market, and those backed by commercial solar systems will trade in the collateralized loan obligation (CLO) market.
Generally, the difference is in the offtaker — ABS instruments are conventionally backed by pools of unsecured consumer assets, which is more or less what the contracted cash flows from residential PV systems are. Because the system sizes are smaller, a residential solar securitization pool will include a large and diverse set of offtakers. In the commercial solar market, the cash-flow pools will require fewer underlying systems to reach the same dollar volume (i.e., because the systems are larger). Fewer systems mean fewer offtakers, which in turn mean less portfolio diversity. And, without a diversity of offtakers behind the cash flows in the pool, there is greater focus on the creditworthiness of each offtaker. Typically, CLOs are the appropriate securitization structure to manage this kind of corporate risk.
Recently, a subcommittee of structured finance and tax attorneys within SAPC hashed out two deal structures designed to avoid some of the complicated tax issues that could arise from situating securitization debt alongside tax equity in a project or portfolio’s capital stack. In one such structure, residential solar assets would be aggregated not by the developers, but by banks that could securitize a pool of loans made against several developers’ interest in the project entities (i.e. the special purpose vehicle established off of the developer’s balance sheet to facilitate non-recourse financing). If this structure were to obtain in the market (it assumes that banks would make these kinds of loans to developers for the purpose of securitizing them) then the resulting securities would not be ABSs but CLOs. CLO structures are, fundamentally, securitizations backed — or “collateralized” — by a pool of loans.
Public vs. Private Issuance
According to many of the securitization experts in SAPC, residential solar-backed securities will likely trade in a subset of the ABS market for esoteric assets. Esoteric ABS products are backed by receivables whose asset profile and risks are not well known, are less liquid because the issuance volumes are smaller than their conventional counterparts, and are generally only understood by a small group of investors. For these reasons and others, they usually carry a higher coupon (i.e., interest) rate. Securitizations of cell phone towers, franchise fees, and song royalties, among other assets, are considered esoteric.
Esoteric assets typically trade in private markets — that is, between sophisticated investors that have the financial ability and know-how to evaluate these types of investments and issuers that are granted relief from certain regulations that apply to public markets. Rule 144A and Regulation D are two “safe harbor” provisions in the Securities Act (which is the seminal U.S. law regulating the offer and sale of securities on the capital markets) that allow for the existence of private markets.
Issuance in private markets does not require registration with the Securities and Exchange Commission, and this allows issuers to avoid some significant costs. Moreover, investment products (i.e., the securities) that will be issued in private markets can more closely match the particular risk/return requirements of specific investors in this space, thus giving them strong marketability. As a tradeoff, private market investors can impose higher premiums expressed in terms of the securities’ interest rates. For example, there might be a premium for reduced liquidity (i.e., fewer investors) or because the esoteric assets trading here might be seen as higher risk. However, despite these premiums, many SAPC members agree that the private markets would be the most logical entry point for solar securitization. Even with these premiums, it may still be possible for solar issuers to find favorable costs of capital and other advantages in the private markets. Thus there may be no strong impetus for the solar asset class to transition away from esoteric classification, though this remains to be seen with higher issuance volumes.
Potential Residential Deal Structure
As part of the mock filing process, SAPC members who have experience in collateral pool analysis and security creation have been riffing on structuring variations for a hypothetical solar securitization deal. Areas of discussion include:
- Deal size: ABS-offering amounts are highly variable in terms of the total value of securities issued, though most fall in the range of $0.5 billion–$1.5 billion. Solar, which is just now getting its legs in the market, will likely need to start out issuing smaller deals (transactions) — probably somewhere around $50 million–$100 million.
- Securitization debt and tax equity: There are numerous tax complications that arise from situating the debt sourced from the sale of securities relative to tax equity in a project or portfolio’s capital stack. Because securitization will not replace tax equity as the primary mode of finance for solar projects (at least not in the near future), these complications require some troubleshooting for capital market finance solutions to gain any traction within the solar industry. As mentioned, a subcommittee of lawyers has proposed two securitization deal structures that would — theoretically — sidestep the incompatibilities of tax equity and securitization debt. The subcommittee is currently drafting term sheets to that will accompany these structures in the mock filing process.
- Tenor of securitization debt: How long should each security be issued for (i.e., before the principal and interest are due from the issuer)? If the securitization is a single tranche, then it would likely be a shorter timeframe — perhaps five years — than the underlying asset contract (which, in solar, typically spans 20–25 years). If the securitization has more than one tranche, longer-term debt is likely.
SAPC recently convened a 3-day in-person meeting during the Intersolar North America conference to hammer out some of the issues mentioned above, as well as others. Here, the group made significant progress on the standard contracts track and will have publicly available versions of a SAPC 0 percent-down residential solar lease and a SAPC commercial PPA by the end of August 2013. Check back with our securitization page to view these contracts as soon as they become available. We also anticipate that the mock filing process with the ratings agencies will be initiated sometime in the fall. Currently a subcommittee of structuring professionals is working to build hypothetical portfolios of commercial and residential solar assets in parallel with the legal subcommittee structuring effort.
SAPC will also have a presence at the major renewable energy and financial conferences in the remainder of 2013 to present to stakeholders (and, importantly, to investors) the SAPC effort and ramp up its capital markets potential. The goal in all of this is to get the securitization process as dialed-in as possible before going to market (many asset classes only accomplished this after their first securitizations), thus providing the solar industry speedy access to lower cost, abundant capital from a broader range of investors than it currently has. Solar has much to learn from other asset classes, such as mortgages and credit cards (both of which took decades of market development), but it will ultimately have to forge the territory on its own — SAPC and its membership are working to facilitate that forging.
This article was originally published on NREL Renewable Energy Finance and was republished with permission.
Lead image: Update via Shutterstock