Solar Securitisation: A Rising Solar Financing Strategy

Solar securitization represents a rapidly emerging financing strategy. This article explores how securitization can open up the access to the capital markets for solar developers and installers to obtain favourable financing opportunities

The global interest in climate change is greater than ever and so is the importance of renewable energy technologies as a means to achieve climate targets both nationally and internationally. With its abundance, relative reliability and adaptability to urban settings, solar energy is widely considered as the most promising alternative to fossil fuels and coal, and is one of the most popular renewable energy sources in both the US and the UK. However, despite the critical need to decarbonize the energy system, fewer financing options remain available from traditional players such as government, banks and tax equity investors. In the UK, the government has repeatedly scaled back its green subsidy schemes and seemingly plans to retreat completely by mid-2020s. In the US, the federal investment tax credit, which allows investors to realize tax benefits from financing solar projects, is set to reduce from 30 to 10 percent at the end of 2016, thereby significantly reducing the tax equity investors' incentive to continue funding at the current level. On both sides of the Atlantic, a host of post-crisis regulations constrain banks' lending ability and, with interest rate expected to increase soon, the borrowing costs via traditional routes will rise quite significantly.

Solar securitization represents a rapidly emerging financing strategy. The solar receivables are particularly well suited to securitization technology as solar technology lends itself to long-dated contracts, which is very attractive to investors. This article explores how securitization can open up the access to the capital markets for solar developers and installers to obtain favourable financing opportunities and expand their businesses and allow solar industry to gain greater liquidity and scalability faster.

What is securitization?

Securitization is a form of asset-backed financing that transforms a pool of assets, through financial engineering, into debt securities to be offered either in public markets or to large institutional investors through private placements. The beauty of securitization is the ability to turn illiquid assets into liquid, standardized and tradable instruments. The process begins by delinking credit risk of the assets from other business risks of the originator by selling the assets to a special purpose vehicle (SPV) that is structured to be bankruptcy-remote. The SPV then sells the rights to the underlying assets by issuing the debt securities, typically in multiple tranches to match different risk appetites of the investors. The proceeds of the issuance are used to finance the business operations and pay the purchase price of the assets acquired from the originator. The SPV uses the revenues generated from the underlying assets to make interest and principal payments to the investors on the securitized bonds over a set period of time. 

Why securitize?

Securitization offers many potential benefits to solar developers including:

·  Access to Capital Markets: The ability to access broader and more diverse investors provides the developers much-needed flexibility and liquidity while also reducing the reliance on government subsidies and other equity financings. Most investors are much more comfortable dealing with debt securities than solar assets directly; and the relative ease of securitized bonds to be marketed, sold or listed abroad can broaden available financing options for many solar businesses.

·  Upfront Lump Sum Payment: The developers will receive a lump sum payment of money reflecting the value of the underlying assets upon closing securitization offerings instead of having to wait for years for the payment streams to pay back the principal over time. This lump sum payment from investors can be reinvested to expand the business and grow market share faster than it would have been without the securitization.

·  Leverage: Different securitization techniques such as subordination, over-collateralization or use of up-front cash reserves may allow the developers to lower the overall costs of capital. Using these techniques, together with offloading of the assets to a SPV that frees up the balance sheet capacity and the monetization of the assets that were previously illiquid, the solar businesses may benefit from the increased leverage, originate more assets and securitize those assets to fund expanded operations.

· Longer Tenor: Securitized bonds tend to have much longer maturities than other bonds, making them much more attractive to solar developers given the relatively longer time necessary for the developers to fully recoup the costs of typical solar projects. In solar securitizations, the maturities to date have ranged from 8 to 30 years.

·  Delinking of Credit Risks: Because the assets are transferred to a bankruptcy-remote special purpose entity, investors primarily account for the riskiness of cash flows from the investment itself and not the credit risk of the originating company. This is a significant advantage over secured or unsecured bank facilities and corporate bonds, under which credit ratings, hence the price, are directly tied to both the company's performance and the quality of the assets.

Who can securitize?

The full benefits of securitization can only be achieved if certain commercial conditions are met. First and foremost, the developer must have operational assets of certain scale and quality to take to market. Broadly, there are two types of collateral typically used in solar securitizations: government-mandated subsidies and customer payments under leases and consumer contracts. If the developer owns a robust portfolio of intellectual property rights, it may be able to securitize the future payment streams generated by such rights as well. The assets must be able to generate a relatively stable stream of cash flows over the life of the securitization. Additionally, unless the size of the asset pool to be securitized is sufficiently large, the costs associated with setting up securitization facilities may outweigh the benefits of savings from lower margins on the financing. Although future-flow securitization technique is available to raise financings against assets that have not yet come into existence, enabling the originators to raise capital multiple times larger than the current annual cash flows, only those solar developers who can demonstrate the reliability and consistency of their operations may be able to benefit from such technique. It should be noted that, because solar systems require ongoing monitoring and periodic maintenance in order to ensure optimal energy production, in most solar securitizations, the originating developer will typically act as the operations and maintenance services provider for the term of the securitization. Thus, the rating process thus far has been quite developer-centric and demanded the developers to have a fairly robust credit quality and sufficiently broad presence or network of subcontractors to effectively manage the securitized portfolio.

Market status: it is still nascent but growing fast

In the UK, the solar securitizations have centred around its feed-in tariff (FIT) and renewable obligation certificates (ROC) schemes. Under the FIT scheme, there is certainty of subsidy generation and of minimum sale price for selling solar power back to the grid. The ROC scheme is slightly different and its prices fluctuate, unless an agreed power purchase agreement is in place. In any event, under both schemes, there is a long-dated cash flow that is government mandated, providing certainty that investors look for. Among the first securitization deals were the two FIT securitizations closed in 2012, each with the size of £66 million and £40 million issuances, securitizing the FIT revenues for two 20 megawatt (MW) and two 5 MW solar projects respectively. Both deals were unrated and indexed to the retail price index (RPI), with 24-year and 25-year maturity respectively. In 2013, the UK saw its first solar conduit bond issuance that pooled small projects. This £60 million senior secured RPI-linked deal priced at a 2.59% coupon, was listed on the London Stock Exchange, and the proceeds were used to refinance four solar parks developed in the UK with an aggregate output of 15MW. The underlying revenue stream for this deal consists of renewable obligation certificates.

On the other hand, the US solar securitizations in the private sector developed around customer agreements in connection with commercial and residential rooftop solar photovoltaic (PV) systems. These customer agreements are structured as either leases or power purchase agreements (PPAs). The lease customers pay a fixed monthly fee with an electricity production guarantee whereas the PPA customers pay a rate based on how much electricity the solar energy system actually produces. These long-term lease and PPAs create recurring customer payments, investment tax credits, accelerated tax depreciation, and other incentives. To date, there have been five solar PV securitizations completed in the US. All of them have been privately placed and their collateral pools consisted predominantly or exclusively of residential solar PV systems. The size of the pool ranges from 5,033 to 16,400 PV systems with the weighted average of remaining terms of the related contracts ranging from 217 to 233 months. The customers weighted average FICO scores ranged from 742 to 767. All of these securitizations required originators to put aside at least 6 months of interest payments as well as expected inverter replacement expenses in cash reserve accounts at the outset. The table below shows the specifics of each US solar PV securitizations to date:

Solar PV securitizations to date have been limited to a single developer deal that is sponsored by a large-scale, experienced developer. Also, there has not yet been a pooled solar securitization or a purely commercial solar PV securitization in the US. But some developers are now targeting standalone commercial and industrial portfolios and many other developers are adding securitization to their financing repertoires. As market becomes more comfortable with the asset class, multi-borrower deals are likely to emerge allowing smaller developers to take part.

Because the solar securitization industry is still embryonic, there are still many hurdles to be overcome for the asset class to burgeon. So far, the lack of historical data for solar systems and the lack of standardization of underlying contractual arrangements have made it difficult for rating agencies and investors to accurately evaluate the risks involved with solar-backed securities. If rating agencies can build models and methodologies based on historical data, it would help to make solar a scalable market, allowing traditional investors to join the buy-side. As more deals are issued and historical data accumulates, ratings are expected to improve, thereby further lowering the costs of capital for the originators. Another issue to keep an eye on is, as technology evolves and costs continue to come down, securitized contracts may be terminated or renegotiated. Although originators may agree to make up for any potential shortfalls, investors may feel nervous about those uncertainties and be discouraged from actively investing in solar-backed securities. Additionally, as is applicable to all fledgling industries, new regulations can impose unexpected constraints on how solar businesses operate, which in turn may adversely affect the value of the assets.

CONCLUSION

For the renewable energy sector to play a key role in tackling the risks posed by climate change, enormous upfront investments are necessary. However, with constraints on traditional funding sources and reduced governmental subsidies, solar developers are facing increasing challenges securing near-term financings and finding an alternative financing venue. Securitization can help developers to monetize future cash flows, gain access to larger and diverse pools of investment and expand their businesses, which in turn may potentially lower the costs of capital and make solar more affordable for consumers to further ramp up demand. That said, securitization of solar assets could be instrumental in meeting the increasing demand for solar financing, particularly in an environment where traditional sources of financing are diminishing.