The asset-backed securities (ABS) market has provided a viable means of financing to several asset classes for decades. In the solar industry, residential players like Solar City, Sunnova, Mosaic, Spruce, and Sunrun have utilized the ABS market for several years.
Residential securitizations have exceeded $500mm thus far this year, highlighted by Sunnova’s debut securitization, with several additional financings rumored to be on the horizon for the residential market.
With year-over-year solar market growth exceeding 90% in 2016, the apparent demise of YieldCos, and new institutional capital entering the solar market, it’s likely we will see solar securitization growth in 2017 and beyond. Yet, aside from a few whispers, the C&I market has been absent from a presence in ABS.
Why is C&I late to the game?
Looking at the published assigned ratings from Kroll for each of the residential solar and efficiency financings, and the criteria established by Kroll’s General Rating Methodology for ABS, it was clear that a few boxes need to be checked when looking to the ABS markets:
- Volume & Historical Performance
- Standardized transaction documentation
- Investment Grade off-taker credit rating – utilizing an industry accepted rating scale
Other criteria is certainly considered (resume of sponsor, technology, etc.), however, when comparing residential to C&I based on this criteria, one can see why C&I falls short.
Volume & Historical Performance
The maturity of the residential asset class has led to several large players and billions of tax equity dollars dedicated to a programmatic financing approach, and a high volume of cash-flowing assets, to-date. Relatively higher residential utility rates have allowed for a larger national geographic footprint compared to C&I, providing a long runway for the asset class to mature. Nearly a decade in which developers, investors and energy companies have thrown resources at the industry and fine-tuned their development, construction and operating efforts has led to a high volume of performing assets.
The C&I sector is challenged by a smaller geographic footprint, and is scattered with small to mid-sized developers. These developers, compared to their residential counterparts, are relatively new to the industry, and a large portion develop to sell,not to own. This dilution of assets among a smattering of C&I players, is partially responsible for a lack of aggregated portfolios and thus, volume. Like any other capital intensive industry with long term income potential, the market of institutional investors is impacted by the supply of mature alternative investment opportunities. As new institutional and strategic investors join the solar industry, developers will strengthen their balance sheets and be able to produce a larger volume of cash-flowing assets. That critical mass should be reached soon.
There’s no doubt residential players care deeply about customer acquisition cost. Without a programmatic, inflexible approach, residential solar wouldn’t exist. Utilizing a standardized document set, transaction process and asset management platform not only reduces transaction and operating costs, but it allows for legal and administrative risk mitigation when evaluating asset financings.
With so many small to mid-sized developers having a market presence in C&I, standardization has been absent, based on each developer’s unique circumstances. As an example, a C&I developer may rely upon a regional bank to provide construction and permanent debt on assets developed within the geographic footprint of the bank. The bank’s requirements might be quite different than those in other geographies, or might be less stringent than a larger nationwide bank, especially on topics involving credit and real estate. This variance can find its way into counter party agreements and ultimately prevent documents from being standardized. Another example lies in developers who develop to sell and not to own. A developer who’s looking to offload its projects, may not object to an off-taker having buyout provisions added to a solar services agreement, while those who take a long-term view may very well object. As the challenge for volume production is met by means of new capital invested into C&I, it’s conceivable to believe that larger developers will/can adopt a programmatic approach and standardize documents, process and risk analysis and can look to ABS for financing.
When it comes to credit ratings, the residential market utilizes the most accessible and widely used credit rating scale for consumers; the FICO Score. These scores have been synonymous with mapped default ratings and have been utilized by the ABS market for decades. Most solar securitizations boast average FICO scores of 720-750+.
For C&I a comparable rating scale for unrated entities has not yet been widely accepted by the industry. There are certainly benchmarks that exist that have mitigated risks in the eyes of current equity investors, but none have been universally accepted.
When financing projects with bank debt, most unrated off-takers are subjected to a bank’s corporate credit analysis. Some banks will sign off on the use of a third party’s rating scale (i.e. Moody’s Risk-Calc or shadow ratings), but will still utilize balance sheet & income statement ratio checks.
Is there a scale that can be adopted by the industry?
If there’s anyone that should be answering that question, it’s the rating agency that has assigned ratings to each of the major solar securitizations in recent years; Kroll Bond Rating Agency.
While evaluating credit risk for solar off-takers, Kroll will either a) utilize a public rating or b) conduct a credit analysis in determining probability of default for unrated entities. Each entity’s rating is weighted based on the discounted income attributed to the overall portfolio, and a Monte Carlo simulation is performed in order to forecast defaults.
In evaluating the near ABS miss of AES in 2015, it was clear that a lack of an industry accepted credit benchmarks led to underwriters wanting a higher bond spread than what was offered. In other words, credit risk wasn’t mitigated to a point where the offered spreads were reasonable.
Due to scattered ownership for C&I an absence of data exists to support the accuracy of any particular credit rating benchmark. However, as volume increases, data will exist to serve as a basis for projecting defaults on a go forward basis.
The C&I sector has a few years to answer these questions, before the ITC is stepped down, thus requiring a lower cost of capital. With new capital coming to the marketplace and developers growing their balance sheets & assets under management, we’re nearing the critical mass needed for C&I and ABS to converge.
The 4th annual Suncode Solar Hackathon, taking place in Oakland, CA on April 8th, 2017, saw a great turnout with fierce competition. The event, sponsored by Sunrun and DSM, and hosted by solar incubator and accelerator company Powerhouse, drew over 150 attendees, forming 23 teams for the competition. The teams were created Friday night, with each team consisting of a few developers and at least one solar industry professional, as suggested by Powerhouse.
The hacking began Friday night with the goal of launching an energy startup aimed at creating a solution to help advance solar industry growth. The teams were given suggested challenge questions to solve, but could solve alternative solar issues identified by their teams. The Sunrun sponsored challenge question that most groups aimed to solve was the following:
“Reimagine the Solar Homeowner Experience. What are customers interested in knowing about? How do they want to interact with the system? How do we maximize value for both the customer and the solar company? At what point in the process do they want a portal? Create a demonstration portal.”
The pitches began at 6:30 and continued into the late evening. Overall, the turnout of the event was great, with only standing room left by the end of the night.
My personal favorite pitch, which ended up being voted the people’s choice award, was REC Chain. The concept was to use Blockchain to validate and facilitate fair trading of Renewable Energy Certificates. The pitch seemed so complex that after the two-minute presentation, one judge asked if they had worked on this project before the Hackathon! The answer was of course no, as all participants were required to only work on their concept the day of the event. Instead, their work highlighted the advances that can be achieved over the course of a day when the bright minds of the California solar industry are gathered together.
While there were a variety of submissions, common themes that came up during the event were optimizing battery storage, qualifying marketing leads, and developing software optimization applications. There were a few that went off the beaten path, such as Independence American Media, which aims to alleviate the partisan nature of our clean tech news. The Energy Escort team also had an interesting app that simplified the process for customers to determine if they are using too much energy in real time. The app screen turns red for electrical overuse at high rate times, yellow if you should slow down on energy use, and green if it made sense to continue consuming energy.
Overall, the event embodied the entrepreneurial startup spirit that I had hoped for, and presented innovative ideas and concepts that addressed top solar industry issues. It will be interesting to follow how the teams that formed during the event develop, as this event has been the breeding grounds of numerous notable solar companies including Utility API, Powerhive, and Sunswarm.
On October 11th, Sustainable Capital Finance’s Maggie Parkhurst participated in a GRID Alternatives Women’s Build or “WE Build” event, in Richmond, California. This series of community focused solar panel installations is organized by the friendly and knowledgeable crews from Grid Alternatives and Solar Corps. “This experience showed me how a solar installation can positively affect the community. It took our group only one day to install the panels but the system will have a lasting positive impact on the homeowner’s quality of life and the environment.” – Maggie Parkhurst
GRID Alternatives is a solar nonprofit headquartered in Oakland, CA. Their mission is to give on-site job training while providing underserved homeowners with free or reduced price solar systems. The Women in Solar initiative aims to bring more women into the solar industry through on-site training, solar education and leadership opportunities.
GRID Alternatives provides important services for community members and useful skills for people trying to enter the solar workforce. SCF is excited to participate on future GRID projects and continue to support Grid Alternatives’ mission!
For more information on GRID Alternatives check out their site!
Shiraz Madan, CEO of Sustainable Capital Finance, will be attending the Solar Power Finance and Investment Summit on March 23rd in San Diego, CA. Key topics to be discussed include the recent extension of the Investment Tax Credit (ITC) and financing innovations in the solar sector.
The event is hosted by InfoCast and will be attended by numerous industry insiders. This event gives participants an opportunity to network and will explore industry trends through panels and interviews with industry experts. SCF is eager to add to the solar conversation and provide useful insights on the implications of the ITC extension for the Commercial and Industrial (C&I) solar financing division.
“I am looking forward to hearing the perspectives of key industry leaders,” said Shiraz Madan. “This is an exciting time for the industry and I’m eager to participate in the conversation.”
To schedule a meeting, or to learn more about upcoming events that SCF will be attending, please contact firstname.lastname@example.org.
Last month, the long winded debate regarding the Investment Tax Credit (ITC) step-down was put to rest. Under the revised legislation, the credit will stay at 30%, and will be extended 5 years with the credit set to scale down to 26% in 2020, 22% in 2021, and then finally settling at 10% for commercial projects and 0% for residential by the end of 2022. With the extension in place, it is predicted that there will be an additional 225,000 solar jobs by 2020: this is nearly double the number of currently-existing solar jobs. (Source SEIA)
What does this mean for the solar industry as a whole? According to research conducted by SEIA and Greentech Media, the credit is projected to spur a 54% increase in total installations through 2020, which translates to roughly 20 GW of solar deployed annually. The commercial sector similarly predicted to increase by 51%. (Source GTM)
How will the credit specifically affect the Commercial and Industrial (C&I) sector? With lowered costs and less of a scramble towards the end of 2016, we will see a gradual increase in installs instead of a huge burst in Q4 of 2016. This is great news for the industry, but more importantly for the C&I sector, as this untapped market should begin to flourish in the wake of this extension.
Oftentimes, C&I projects require more time, coordination, and expertise to take projects to NTP. This extension will provide time for more project planning without a restrictive time frame, and will also allow for industry investors and developers to fully realize the sector’s growth potential.
SCF has standardized the underwriting process for commercial off-takers with the implementation of software tools and standardized ratings. This has mitigated many of the former risks associated with C&I, making the sector more attractive for investors.
While residential solar has always been on the forefront of solar installs, the C&I space will now be able to streamline efficiencies within businesses models, and work on lowering production costs and fees associated with commercial solar. This makes this sector more financially feasible for large-scale customers, a market that up to this point has been largely untapped.