The energy finance community has been eagerly anticipating the introduction of solar asset-backed securities – “solar securitization,”  – for at least three years, and may be waiting for another year or more. But sooner or later, securitization is coming to solar finance, and when it does, it will have a profound impact on the pace of solar industry development.

Sink or Securitize

The solar industry must find ways to continue to reduce costs as state and federal support for renewables shrinks, and access to less costly capital will be critical to that process. Asset-backed securitization would give the industry access to a much broader pool of investors, ultimately helping to cut the long-term cost of capital, reduce levelized energy costs, and enhance liquidity in the solar project market.

Securitization: The Basics

In the most basic form of solar securitization, the holder of a portfolio of solar assets bundles contracted revenues from a group of projects and sells that revenue stream to a special-purpose vehicle – an entity that exists solely to buy or finance specific assets.

That SPV issues that revenue stream as a tradable, interest-bearing security. Buyers of the security are senior to equity investors, thereby taking on a smaller degree of risk. For the security to be investment-grade, the project portfolio must be large, diverse and offer a credit-worthy source of revenue, which accrues from buyers of solar power.

Why It Hasn’t Happened Yet

The solar industry faces the following obstacles in bringing solar securities to the market with the kind of ratings they will need to enable solar projects to attract low-cost capital.

• Scale and Geographic Diversity. Assets must hit a critical mass and must be pooled from over a geographically-diverse area, reducing the risk that regulation or market conditions will materially affect the value of all the solar assets in the pool.
• Standardization of Asset Structures and Documentation. The structure and supporting documentation of assets must be more consistent and pools of assets standardized for underwriters and investors to have confidence in the underlying revenue streams.
• Off-take Risk. Most residential solar sponsors manage off-take risk by limiting their eligible pool of potential customers to homeowners with a minimum FICO score. But management of off-take risk for commercial and industrial customers is less standardized, making commercial and industrial solar assets more difficult to securitize.
• Technology Risk. Distributed solar asset revenue streams have tenors of 15-20 years, but most solar panels have less than 10 years of historical performance data.
• Sponsor Risk. Sponsors are still relatively new to the market. Even more established market players, such as Solar City, SunRun, Sungevity, and Viridity, have been operational for less than a decade.
• Market Risk. Solar energy might be less economical than traditional energy sources over the lifetime of the asset, and sponsors will need to persuade investors that their assets will continue to generate electricity at a price that is competitive with traditional energy, or find other means of ensuring that market risk won’t jeopardize asset values.
• Regulatory Risk. Government agencies will need to update regulations, such as disclosure and liability rules, as well as assignee rights under government energy programs to ensure that investors in solar securitizations are protected against default risk. The government could also provide credit enhancement through loss reserves or investments through entities like government-backed “green bank” programs.

The Snowball Effect

When the above challenges are resolved, the number of solar securitization issuances is likely to grow rapidly.

With less than 1% penetration among credit-worthy homeowners in the residential solar market, there is tremendous room for growth. And ultimately, commercial solar assets will also be securitized, which could lead to issuances of mixed residential and commercial asset pools. This securitization process and impact will not be restricted to the U.S. and will expand to markets abroad.

The capital the securitization will add to the market will accelerate growth, geographic diversity, and standardization across the solar industry, driving consolidation among players at all levels of the industry supply chain.

Elias Hinckley is a strategic advisor on energy finance and energy policy to investors, energy companies and governments. He is an energy and tax partner with the law firm Sullivan and Worcester where he helps his clients solve the challenges of a changing energy landscape by using his understanding of energy policy, regulation, and markets to quickly and creatively assemble successful energy deals.

David John Frenkel is an attorney in energy finance at Sullivan & Worcester in New York.