The solar industry in the United States has seen massive growth over the last few years aided by falling panel prices and stable incentives from the federal government. Between 2010 and 2013, annual installations grew almost four-fold to around 3,300 MW. However, the availability of easily accessible and cheap funding has been a concern for project developers. The solar investment tax credit [ITC], which provides a 30% tax credit to solar project developers and has traditionally helped to attract capital from tax equity investors, is set to expire in 2016. The ’1603′ Treasury program, which allows developers to encash their tax credits, is also set to expire in 2016, and this could potentially have an impact on funding for solar projects [SEIA]. Given these potential changes, it has become important for solar project developers to look at alternatives such as asset-backed securities to raise cheaper capital.
Solar Asset Backed Securities And Their Advantages
Asset backed securities [ABS] typically pool together a set of mortgages, automobile loans or credit card loans, and pass on the payments from these assets to investors. Solar project developers are also considering ABS as a vehicle to securitize power purchase agreements [PPA] as well as residential solar leases. This could allow them to cut down on financing cost as well as attract capital from a wider base of investors who want exposure to the solar sector.
ABS pools are generally broken up into different tranches or layers with each tranche having a different amount of credit risk and a related credit rating. The tranche with the highest credit rating and lowest risk is paid off first after which the second highest rated tranche is paid off and so on. The lowest rated tranche has the highest risk and accordingly the highest return. Since each ABS security represents a fraction of ownership in a pool of solar-related assets, it improves diversification and brings down the overall risk of the investment as compared to a single, large private investment. Additionally, the creditworthiness will now depend upon the credit quality of the collateral pool and not that of the issuer. The liquidity and marketability of ABS is also likely to be better compared to private investments, while pricing could also be more accurate since securities would be publicly traded [National Renewable Energy Lab]. Given these advantages and the lower risk, ABS can help to reduce the cost of funding for solar project developers. The ABS investments are likely to be attractive to investors such as insurance companies who seek longer duration securities.
While project developers haven’t ventured into asset backed securities for rooftop solar installations as of yet, Solar City (SCTY) has been planning to securitize its solar leases into asset backed securities [Gigaom]. If the sale works out well, we believe that other solar residential lease providers such as SunPower (SPWR), which is one of the largest residential solar lease providers in the United States could follow suit.
Lack Of Data And Participation Of Rating Agencies
There are some obstacles to securitizing solar assets. For one, credit rating agencies have been hesitant to take a lead in rating these deals given that it is an new asset class which lacks data. While the ABS securities are based leases that can run as long as 20 years, only around five years of data is available for rooftop solar installations so it may not be possible to reliably estimate the performance of the systems and the consequent payments from customers over an extended period [Greentech Media]. Besides data issues, there is also the risk that homeowners could default on their lease payments as well as a risk that the lease provider goes out of business or fails to adequately maintain the systems properly leading to performance degradation of the solar power system.
Master Limited Partnerships And Real Estate Investment Trusts
Other structures such as master limited partnerships (MLPs) and Real Estate Investment Trusts (REITs) could help to bring additional financing into the solar industry. Unlike an ABS which is a debt security, MLPs are used for equity financing. While companies formed as an MLP can trade on the stock markets like regular stock of corporations, they are taxed as partnerships, meaning that they do not pay income tax at the corporate level as long as they distribute a certain percentage of their income as dividends. Taxes are paid by individuals at their marginal tax rate. While MLPs are currently available for conventional energy companies, the U.S. Congress is considering expanding the MLP structure for renewable energy companies as well.
REITs, which have traditionally been used as a tax-advantaged means of investing in real estate and real-estate related assets, have also emerged as a potential structure for solar and renewable energy projects in recent times. Quite like MLPs, REITs enjoy favorable tax treatment and trade like shares of stock on exchanges. However there has been ambiguity regarding what portions of the solar projects that the IRS may accept as REIT assets and there are several issues to be resolved before Solar REITs can become a reality [Solar Industry].
Disclosure: No positions