Solar Securitization: Monetizing Cash Flow
Solar finance, the darling of eager ‘green’ entrepreneurs, is becoming a major opportunity for companies such as Campbell’s Soup, L’Oreal, and Toys “R” Us.
The National Renewable Energy Lab (NREL) is spearheading a team creating a new asset class that can make a huge impact on solar deployment in the United States. For business, solar securitization offers a pathway to reap additional financial rewards from existing or planned projects. For the 50% of residential systems financed by third parties, securitization could provide those projects with access to funds to install more systems. Nationally, the potential market is huge. According to NREL:
- An estimated $1.34 billion of potentially securitizable solar assets were installed in 2012.
- A $100 million securitization fund could fund the development of 100 MW of small commercial systems, or 133 MW of large commercial and industrial (C&I) systems.
For project owners, securitization is a way to monetize their cash flow from their asset. In the case of solar energy, a portion of that cash flow is owed to an installer or other entity that has helped finance the project. The remaining cash flow is available to the project owner for securitization.
For large funds, especially pension funds, cash flow has been increasingly attractive after the market failures of 2008-2010. However, solar power and other renewables have generally not been inviting for large funds, with good reason. Most do not have the expertise to evaluate the regulatory, technology and contract risks that come with renewable projects.
It is for this reason that NREL has a three year grant from the Department of Energy (DOE) to evaluate the risks and develop a securitization vehicle that would address the concerns of fund managers. NREL is supported by over 160 key solar, financial, legal, and advisory stakeholders in a working group named the Solar Access to Public Capital (SAPC, pronounced sap-see).
As Paul Schwabe, Energy and Financial Markets Analyst at NREL said, DOE has ‘sun shot’ goals to reduce non-hardware costs. As DOE sees it, innovation on the finance side will provide more potential for business as a whole.
“We don’t row the boat,” he said, “but we guide it to the benefit of the industry as a whole for more solar projects.”
Demand for Securitization
Changes in solar financing are intensifying the need for such a framework. On the positive side, in 2013 solar accounted for 29% of all new electricity generation capacity. This made solar the second largest source of new electricity generating capacity behind natural gas, according to the Solar Energy Industries Association (SEIA). Furthermore, those installations are increasingly being done by utilities which could arguably use increased cash for improvements, additional projects and maintenance. Commercial installations are also taking interest in solar energy. Wal-Mart alone has installed almost 90 Megawatts. To put this in perspective, Wal-Mart’s 90 Megawatts could power over 13,000 homes in California, or 6,000 in Tennessee, due to difference in average home efficiency in the two states.
On the negative side, while the price of solar projects has fallen, so has the subsidies and other government support that were important in the early stages. Tax equity, a reliable financing mechanism for renewable energy projects, can be underused, especially when margins are tight, as in 2008-2010. NREL’s Mike Mendelsohn sees a role for both in the future. He added that tax equity investors clearly want to be first in line for any income from the project, making a mix of securitization and tax equity unlikely.
- Pooled assets diversify credit, geographic and other risks, and spreads the costs of asset assessment, performance management, and reporting.
- Credit risk and rating are improved -- and thus cost of capital.
- Investors have access to businesses and industries to that might otherwise be out of reach,
- Asset originators can get more favorable financing terms than they may otherwise be able to obtain from traditional sources.
- Assets are removed from their originator’s balance sheet, and thus insulated from the parent’s corporate risk.
- NREL is looking to create a series of standardized contracts that can be used as a template to cover risks commonly associated with renewable energy projects. Factors likely to be considered include:
- Property ownership in the case of bankruptcy, sale or death.
- Price fluctuations, for example, the cost of energy falling so low that buyers for the solar output cannot be found.
- Maintenance and upgrades to existing equipment.
- Insurance in the case of accidents, weather or other unforeseen events.
- Other technologies that affect energy pricing, such as natural gas.
- Technology -- Most projects have been in operation for at least 12 months, which provides statistics to evaluate performance. In order to have a diversified portfolio, the final mix would ideally include different locations, technologies, owners and project size to protect against market fluctuations.
Evaluating the many variables must be based on a set of reliable, uniform metrics to help project originators and investors compare ‘apples to apples’. Some of the factors that affect solar profitability include:
- Product stat sheets: Manufacturers and installers rate product performance using statistics which vary from technology to technology, and sometimes within a product categories.
- Life-of-product: Some technologies are more reliable over the long term than others.
- Climate: Some areas of the country are sunnier than others. What is ‘efficient’ in Buffalo, NY will be very different than what is efficient in Albuquerque, NM.
- State utility regulations: Deregulation, Renewable Portfolio Standards (RPS) and other factors influence the price and stability of energy pricing.
As a path to reducing technology risk, NREL is collecting and aggregating performance through their working groups.
An Esoteric Special Purpose Vehicle (SPV) is a way to aggregate multiple projects into a single product that can be sold to investors. It is a relatively complex debt instrument with structures and pricing that are generally understood by very sophisticated originators and buyers. The upside is that the structure may lead to attractive risk/return over other debt instruments when the instruments function properly. It is the creation and design of these instruments that is the focus of NREL’s efforts.
The advantage is that the SPV provides the option to free up balance sheet capacity by off-loading assets into the SPV. As assets that were previously illiquid become monetized, businesses are free to use those funds to originate more assets, fund expanded operations, or grow market share. In an ideal scenario, the investment demand for a particular securitized asset may create demand pull, which can incentivize the upstream market to originate more assets (e.g., more solar systems).
Collateralized loan/debt obligations (CLOs)
The second vehicle is where payments from multiple middle and large business loans are pooled together and passed on to different classes of owners in various tranches. Typically the result is a series of instruments, where the most secure debt -- that is the first in line to receive cash flow -- yields lower returns than tranches down the line that have higher returns but greater risk.
NREL and SAPC are mocking up hypothetical deals and working them through the major rating agencies. These deals present a deal structure that the agencies haven’t seen before, which allows NREL to provide the working group with realistic feedback on what the rating agencies will need to evaluate future projects. As Mr. Schwabe said, “It’s priming the pump.”
In addition, the following contract templates are available through their website at http://financere.NREL.gov.
- 0% Down Residential Lease – Aggregated Business Model (for vertically integrated developers and installers)
- 0% Down Residential Lease – Disaggregated Business Model (for developers with a network of installation partners, or third-party finance providers that are discrete entities)
- Commercial PPA (Power Purchase Agreement)
Mr. Mendelsohn believes there will be at least one offering in progress that will be available this year.
Given the abuses of securitized mortgages, the effort to create robust models that will stand the test of time — and people’s willingness to try shortcuts — is important to bring solar to a scale not yet anticipated in the United States. It’s a promise to create value from real assets, and to encourage businesses of many sizes to gain more benefits from managing their own energy future.This article is a brief outline of a very complex subject. It is based on interviews and NREL documents. However, any errors are the sole responsibility of TGEink. For an in-depth description, please download The Potential of Securitization in Solar PV Finance, written by Travis Lowder and Michael Mendelsohn.