Solar securitization has been a popular theme at IronOak Energy, and for good reason.
Access to gobs of low cost capital is every solar developer’s dream, along with, of course, limitless net metering (but what about Value of Solar?), a permanent ITC (debatable), and friendly utilities (now you know I am reaching - just kidding...kind of).
As opposed to the other items on the solar developer wishlist, solar securitization is actually happening in real time. Pioneering companies like SolarCity and SunRun are paving the way with new securities offerings as we speak.
The market is not huge, but has crested the $300M mark in 2015. This past January, SolarCity completed its first securitization of distributed solar loans, and achieved the industry’s first investment credit rating. Others will undoubtedly follow, if the way is clear.
Back in June of 2015, we wrote about the idea of solar securitization finding more traction in the market. But, be careful what you wish for. While securitization may be the shiny new-ish finance toy for the solar industry, it is not a one-size-fits-all solution to finance (or refinance) projects.
But be wary of the double-edged sword of solar securitization
The solar industry rides on the shoulders of tax equity investors, at least until the ITC is phased out. As such, one must consider — how would securitization change the project finance equation?
For one, securitization would expose tax equity investors to potential recapture of any unvested credits. Translation - backing a security with projects that do not utilize any tax equity will make the deal much simpler and more palatable.
But who wants to leave money on the table? Luckily, the inverted lease was designed to tackle sticky tax equity issues like this and can be used to mitigate this recapture risk. As of 2014, SolarCity and SunRun started to create solar securities primarily of inverted lease arrangements. Problem solved. But that is not really the only issue that should concern project developers.
The dark cloud hanging over solar securitization is that developers or third-party asset owners would have some of their upside undercut due to the fact that their equity in the underlying assets relies on retained value.
Equity holders are always at the end of the cashflow line, but adding security holders to the mix places yet another claim on the project cashflows before equity holders get a piece of the pie. And that pie needs to be comprised of sweet, high-grade offtakers.
As we all witnessed in the mortgage-backed security debacle, bundling lots of disparate (even toxic!) assets into a nicely packaged security may doop the market for a while, but it will come back to bite you. The same holds for solar-backed securities.
Which means that not every residential or C+I solar project is going to pass muster as a security-grade product. This is one of the reasons that the initial transaction costs for creating a security are substantially higher than essentially any other project finance mechanism.
High transaction costs along with the additional cost burden of compliance reporting can start to eat into that delectable low cost of capital, unless you have your ducks in the row.
Some seriously good reasons to dip your toes into the securitization pool
The first thing that you probably said when trying to sound smart about investing was “diversification.” I’ll wager the second thing you said (and you really had no idea what this meant) was “liquidity.”
Diversification and liquidity are two of the primary ingredients in the low cost of capital cake mix. Diversification because high concentrations in terms of geography, offtakers, operations, and policy attract those pesky risk premiums that increase the cost of capital.
Liquidity because it is the lubricant that allows markets to function and buyers and sellers to repeatedly engage in transactions. Add in a little sponsor bankruptcy risk mitigation and some public credit ratings to the mix and you have the makings of a very enticing offering to gargantuan fixed income institutional investor class.
And what do institutional investors like more than anything? You guessed, boring standardization. All those legal and accounting fees that allow you to create boring, standardized securities also unlocks a velocity and scale of financing that could leave traditional project financing in the dust.
Institutional investors have been invited to table, but will they dine?
As we know, institutional investors have a big appetite, which, in the case of solar, has meant that they can only find the requisite scale in bigger utility-scale deals. Securitization could hold the key to allowing smaller residential and C+I projects to access lower cost capital from institutional investors.
This issue of scale is a big one though. Securities of the size that would attract institutional investors have been few and far between.
The question of the day is who can follow SolarCity and SunRun’s lead to bring the solar securitization market out of the hundreds of millions and into the billions.
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