The U.S. solar industry was built on tax credits. At the federal level, the Investment Tax Credit (ITC) allows both residential and commercial developers to offset 30% of their cost. Various states also offer credits.

Since it was introduced in 2006, the ITC has helped boost annual installations of photovoltaic systems — panels and related components — from 104.7 megawatts of direct current to 6,201 (MWdc) in 2014. That’s approaching enough energy to power a million average American homes.

Developers typically do not have the tax liability to use these credits for themselves, so they bring in “tax equity” investors to capitalize their projects in exchange for use of the credit.

The ITC is being phased out, which is one of the reasons that there is so much interest in securitization as an alternative source of financing. In two years, by 2017, the credit is set to decline to 10% for commercial and third party installers, and zero for residential developers.

While growth in the industry isn’t expected to tank as a result, it will probably sold down.

In the meantime, any securitization of solar assets has to avoid jeopardizing this tax break for existing investors. Many of the features of the legal structure required to execute a securitization could expose tax-equity investors to a potential “recapture” of their unvested credits.

There are a few financial structures used to monetize federal tax credits. The arrangement most promising for effectively dealing with the recapture issue in a securitization is known as the “inverted lease.”

While SolarCity, the largest residential developer, used another method in its first two securitizations, for its most recent deal it bundled only assets that entered inverted-lease arrangements. And as of press time peer Sunrun had just launched a solar-backed deal that, apart from being the first from an issuer other than SolarCity, is also backed only with assets that are linked to inverted-lease arrangements.

SolarCity’s deal was mostly residential, and Sunrun’s is entirely residential.

There have been no pure commercial solar securitizations in the U.S. to date. Solar finance boutique T-REX is working on two deals backed by commercial solar assets; the first one, for $75 million, could be come in the third quarter; the second one, for $150 million, has a scheduled launch in the fourth quarter, according to Benjamin Cohen, the firm’s chief executive.

None of these assets have tax equity investors.

“The easiest way to deal with tax equity is to start with portfolios that don’t have tax equity,” said Cohen, who is aggregating assets without tax equity investors attached. “Not every deal has tax equity and part of that is because from 2009 to 2011, the U.S. Treasury’s 1603 payment allowed for a simple cash grant from Treasury in lieu of a tax credit.”

To be sure, there are other impediments to securitizing solar assets, such as the lack of standardization of contracts, which is a function of the predominance of small-to-medium-sized owners; the difficulty warehousing assets while they are accumulated; and the fact that the long terms of contracts put them at greater risk of being renegotiated if the retail price falls.

This is true of residential assets, which are typically financed by a loan or lease from the developer to the homeowner; as well as commercial assets, which can range from small establishments — say, a laundromat — that can obtain financing similar to that of a homeowner, to larger establishments — a facility powering a Walmart, for instance — that often sign power purchase agreements (PPAs).

At the utility scale, projects producing from several-to-several-hundred megawatts and providing electricity to large clients, such as cities, under PPAs, can often find financing outside the securitization market. Numerous developers have formed “yield cos,” publicly traded companies with assets that produce cash flows chiefly through long-term contracts, which in the case of solar means PPAs.

“On the utility scale projects with a publicly rated off-taker, there’s a fairly robust market right now of bank lenders and other financing providers, so the need for securitization on the utility scale PPA side isn’t as great because there’s competing, low-cost funding sources,” said Scott Zajac, CEO of Rockwood Asset Management, which invests in the solar space.

Doc Diversity

A lack of standardization in documentation and processes is a major hurdle to bundling a number of smaller developers into a single securitization — the natural course of action in order to build enough scale to interest investors.

“Ancillary fees of getting a structure — legal, accounting, placement, structuring — all are larger than what people have wanted to pay to get a bond in the market done,” said an investor in environmental assets. “The reason why fees are so high is there hasn’t been a lot of standardization.”

This inconsistency ranges from leasing, loan and PPA contracts to operation and maintenance agreements for the panels. The independent engineer [IE] reports — crucial to the due diligence in rating a deal — can be all over the map. “If you have 20 different IE reports from 20 different firms on 20 different projects and those reports are not comparable in their methodology — that makes the rating agencies’ jobs harder,” said Ronald Borod, senior counsel at DLA Piper.

There is an effort spearheaded by the Solar Access to Public Capital (SAPC) to standardize lease documents and PPAs by providing a few templates — residential lease and PPA, and commercial lease and PPA. Grouping over 200 organizations in the fields of solar deployment, finance, counsel and analysis, SAPC operates as a working group under the National Renewable Energy Laboratory (NREL) of the government’s Department of Energy.

SAPC also released last April best practices for O&M agreements.

But the take-up by developers hasn’t spread particularly far, as SAPC reported last May that about seven were using the standard contracts.

This has not mattered so far because the only deals marketed to date, bundle assets from one developer, either SolarCity or Sunrun. So rating analysts and investors need to understand how a single developer originates and manages its assets. In a multi-seller deal — required for most of the market since smaller developers lack critical mass — they need to get a handle on the processes of a number of developers.

On this front, the commercial sector faces more challenges than the residential one. “You have a pretty well developed ratings-criteria platform from the mortgage securitization and consumer credit world that can be translated to the residential PPA-ITC product market, metrics like credit scores, and zip codes that investors can look at and model,” said Zajac. “A lot of the tools and rating criteria that are out there that can be applied and adapted” to residential solar securitizations.

The commercial world is more challenging, as the counterparties that aren’t rated may not have easily accessible metrics available to asset their creditworthiness.

Source: Structured Finance News 



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