Published on January 16th, 2014 | by Rocky Mountain Institute0
Solar Asset Securitisation
Originally published by the Rocky Mountain Institute
by James Mandel
At the end of November, SolarCity issued the first publicly known solar asset-backed securitization (ABS), selling $54 million of bundled cash payments. It was a major milestone that many in the distributed solar industry have eagerly awaited. ABS provides a mainstream public capital market investment opportunity for distributed solar projects. And it provides lower cost of capital, thus improving solar monthly contract (PPA or lease) competiveness with utility rates.
In other words, securitization makes solar cheaper than the utility bill for more new customers more often. But while this offering is an important step in the right direction, several things need to happen before this type of financing is sufficiently consistent and widespread for it to trickle through to savings on customer financing rates.
Five thousand residential and commercial customers representing 44 MW of installed capacity will continue to make their normal monthly payments to SolarCity, but now those payments will go to a wide array of investors through a tradable security. Purchasers of these securities will receive a 4.8 percent annual return on their money through 2026. Standard and Poor’s rates this an investment-grade opportunity (BBB+), meaning that pension funds and other regulated investment vehicles can own them. SolarCity plans to issue a much larger security in Q2 2014, a mere three months away.
For sure, there were some unique features to SolarCity’s first issuance in November that can’t be replicated often but which helped it get off the ground. First, the average FICO score of the residential solar customer is 762, which is better than two-thirds of Americans. Second, there is overcollateralization, which means that the ABS buyers get more collateral in case of default than the $54 million purchase value.
WHY THE SECURITIZATION IS SO NOTEWORTHY
All of this is great news, but the 4.8 percent interest rate is especially worth noting. It’s a win-win.
On the one hand it represents a low cost of capital for solar developers like SolarCity seeking financing—the offering’s 4.8 percent is only about 0.5 percent higher than the 30-year fixed mortgage! It’s also roughly half the cost of capital that is currently backing distributed solar PV financing.
On the other hand it represents an impressive return for investors in today’s economic climate—this is a long-term, investment-grade security that pays nearly double the current yield on a 10-year treasury bond. As the Economist wrote in October, those types of investments are becoming increasingly scarce, and are critical to pension funds and other long-term income funds. If customers could regularly receive something close to that rate, third-party-financed solar would be much cheaper than today; if I could consistently invest money at that rate with solar’s risk profile, it would be come a big part of my (very small) investment portfolio.
Another point worth noting is the nature of this transaction. It’s what’s called take-out financing; it helps initial investors get their money back. Take-out financing is when the original financiers of a project sell their stake on to somebody else. In mortgages, many origination financiers (in most cases the bank that originally financed your load) rapidly sell their stake (the mortgage) on to somebody else (in many cases, Fannie Mae or Freddie Mac). They “take out” the money they invested in your mortgage by selling the mortgage to somebody else. In this case, SolarCity will take out money invested in completed solar projects so that they have more capital to finance more sales. However, take-out financing does not affect the initial terms of the deal. Those 5,000 customers are paying exactly what they signed up for. The important part of take-out financing that helps a customer is the expectation of take-out financing. If investors know they can exit quickly and consistently, at a favorable price, they will start to ask less of their customers. At RMI, our ultimate interest is in the affordability of solar, thus the need to create a liquid market where that expectation exists.
SolarCity’s ABS offering is the second major milestone in mainstream public access to distributed renewables investments. The first, earlier in 2013, was NRG’s IPO of a “YieldCo” (NRG Yield), which is a publically traded stock that pays monthly dividends equal to the cash flow from a bundle of renewable energy investments. Other YieldCos also garnered public capital access in 2013. The YieldCo approach of providing public equity (stock) to public investors is different, and perhaps less scalable than ABS, for which home mortgages, auto loans, and other debt products have created a massive ABS buyer and seller market.
These two developments—a solar ABS and renewables YieldCos—are fantastic news for the renewable industry. But, if solar is to grow at its current rate or faster, we’ll need these direct financings to public markets through securitization, YieldCos, and other instruments to scale quickly.
UNDERSTANDING THE FUTURE OF SOLAR SECURITIZATION BY LOOKING AT THE PAST
At this point, we should be asking what these two milestones have done for consumers looking to purchase solar. Where is the tidal wave of low-cost capital cutting prices in half or more? After all, mortgage securitization—the sub-prime mortgage securitization fiasco of 2008 not withstanding—is a big reason that mortgages have led to some of the most affordable homeownership conditions in history.
To understand how solar ABS can scale, it’s useful to look at how mortgages pulled off the transition from unique, handcrafted (and predatory) products to the mass-produced reason that rates of homeownership have nearly tripled since their conception.
Mortgages have had one giant advantage, without which the market might never have evolved: the Federal Housing Authority (FHA). While banks originally crafted individualized mortgages, often only for people they knew and with 5–6 year interest-only terms and massive balloon payments, the FHA saw potential in long-term lending as a path to homeownership for the middle class.
The FHA did several things to scale the market and lower the cost of capital:
- standardized terms
- created a minimum threshold of construction quality
- created demand for mortgages that met the first two criteria through a mortgage purchase program
These steps created a basic market for mortgages. A critical fourth step was led by the Fair Isaac Corporation (FICO):
- FICO saw an opportunity in evaluating credit risk for individuals. Even with its early ingenuity, it still took FICO 37 years (1958–1995) between creating a credit scoring system and getting officially recommended by our nation’s largest underwriters, Fannie Mae and Freddie Mac.
Today, solar is taking these mortgage lessons – standardized terms, minimum quality standards, assessing credit risk and ensuring construction quality—to take the next steps towards reliable, low-cost capital at scale.
The solar industry is organizing to accomplish this goal with the help of NREL’s Solar Access to Public Capital (SAPC) initiative. SolarCity and others are doing the most boring of work: standardizing the terms and language in leases and power purchase agreements. They are also creating a common approach to bundling and underwriting these contracts. This mundane work, however, should lead to the most exciting of outcomes: scaling solar ABS! For the market to be reliable and liquid, solar securities need to be interchangeable; it shouldn’t matter that you’re buying a SolarCity-issued security, just that you are buying a bundle of 20-year leases.
ASSESSING CREDIT RISK AND ENSURING CONSTRUCTION QUALITY
If FHA was going to enable 30-year home financing, it needed to make sure homes would last that long. And the market truly ignited when the Fair Isaac Corporation started providing standard scoring of credit risk. While FICO’s model has been stretched to apply to the residential market, the industry is still grappling for solutions to the commercial market. Like the standard terms, this is also tedious work with immensely high stakes: currently, it looks like the commercial solar market will be significantly lower in 2013 than it was in 2012, while residential solar continues healthy growth. Yet commercial solar should be the market leader, with low installation costs that can approach utility-scale costs while participating in electricity markets at retail (vs. wholesale) pricing.
Again, the industry is trying to self-organize to deliver a solution much quicker than the 30 years that it took FICO to become a common standard. truSolar, a consortium of leading solar market participants is striving to establish uniform credit screening standards for commercial and industrial PV projects and, in turn, enhance availability of lower cost capital to drive the industry forward. When complete, this will help banks evaluate the default risk for commercial solar projects inclusive of all potential risk elements, including the credit of the payer (the main focus of FICO), construction quality (in housing, FHA took this step), and other elements.
This is hard work, and will take time. Credit scoring tools require lots of data, improve over time, and depend on honest reporting of outcomes. To make sure that the credit risk tool has credibility, the working group will create a public standards body to curate the tool and the data behind it, and to license it as appropriate. As with SAPC, expect to see some of the first outputs from this during 2014.
A SECURITIZED SOLAR FUTURE
SolarCity’s exciting issuance of a solar asset-backed securitization opens another door to low-cost public capital. But bringing access to that capital to scale requires solar finance to come of age just as mortgages did. Standardizing terms, ensuring minimum construction quality, and assessing credit risk can all serve to push the solar industry in that direction.
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