Solar’s ITC equity gap taxes the brightest minds in finance

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Securitisation has happened. After several years of speculation, SolarCity was the first to launch its solar asset backed securities. But the company that has steamed ahead since it launched on the public markets this time last year, has really only dipped its toe into this pool of capital, an asset class that shows great promise. After all, US sub-prime mortgages were valued at US$1.3 trillion in 2007, before the financial markets went pop. That would be a lot of rooftop solar.

But the scale of SolarCity's first foray into securitisation was conservative, raising US$54.4 million in bonds on November 13. The company has already said that it may launch a securitised bond issue every quarter; the next issue could raise US$200 million. The major metric for success or failure is, of course, the response from the public markets.

Given that the business models for SolarCity and competitors such as Sunrun and Sungevity are based almost entirely on the 30% Investment Tax Credit, the sunset of that federal subsidy to 10% from 2016 demands a radical rethink. SolarCity estimates that even if it installed its last solar system tomorrow it would still have a U$1 billion revenue stream for 20 years. And it is this revenue stream that securitisation taps into – the promise that homeowners will keep paying their utility bills, i.e. their lease or PPA payments to the solar company.

As we edge towards 2016, here are some numbers that make for sobering reading for chief financial operators looking for replacement sources of capital for tax equity.

This year, tax equity is estimated to fuel renewable investment to the tune of US$6.3 billion with a first-time swing from wind to solar, according to figures from Bloomberg New Energy Finance. Last year, wind investments took up US$4.2 billion and solar investments took US$1.8 billion. But in the first half of this year, the scales had tipped with US$1.2 billion invested in wind and US$2.2 billion invested in solar.

SolarCity et al have a lot of ground to cover from US$54.4 million.

Keith Martin, a transactional lawyer at Chadbourne & Parke in Washington, DC, said: “We're at a very interesting period in the life of the renewable energy industry in the US.

“Tax equity has been core financing tool for renewable energy. The federal government pays tax subsidies that are worth about 56c per US$1 of capital cost in a typical project.

“However, people are starting to look ahead to the day when tax benefits won't be the core financing tool and are looking for other ideas to drive down the cost of capital for renewable energy projects. You often hear some of the CEOs of solar companies talk about the mythical 6% weighted average cost of capital.”

Part of securitisation's problem to date has been one of image and reputation, said Chris DiAngelo, who specialises in structured finance such as securitisation at Katten Muchin Roseman in New York city.

“The securitisation industry as a whole is still trying to climb out of its reputational issues out of the sub-prime crisis,” he said. “At the moment it's difficult to integrate securitisation into a tax equity structure but that has to be surmountable because it is in other structures.

“A lot of times we don't want to look to the mortgage industry because it has quite a few scars on it although the mortgage industry might be an obvious model for solar. It's difficult to rate on an asset class that hasn't been done before.”

Ratings agencies view solar securitisation as unsecured consumer debt and it's difficult to conceive of repossession of a solar system as a meaningful remedy for default.

“It seems this industry says it never has default, but it may have payment interruptions because eventually even if the guy defaults and gets kicked out the next guy in the house is going to pay the PPA or lease. Payment interruption has transfixed rating agencies.”

Historical data on default rates and other aspects of risk should comfort investors who will mostly be institutional investors such as insurance companies or pension funds. But data will take time to collect. Standardisation is also on the cards with the formation of the Solar Access to Public Capital (SAPC) working group established by the National Renewable Energy Laboratory.

But DiAngelo said that he's no fan of standardisation for securitisation. Presumably, the complexity of structured finance is what pays dividends.

Others in renewable energy finance see different options for the continuation of solar financing.

Greg Rosen, chief investment officer at Mosaic in California, has raised US$6 million from 2,800 investors in a crowd-funding model. Mosaic makes a significant local impact, but has some way to go in terms of scale.

Master Limited Partnerships (MLPs) have great potential to scale. Currently about 128 MLPs are traded on public exchanges, 102 of which focus on energy with a market capitalisation of approximately US$450 billion.

MLPs have raised US$84 billion in the last three and a half years for the oil and gas industry mainly to fuel the expansion of shale gas. But the MLP structure is only available to the fossil fuel industry, not renewables. It makes you want to imagine a world where the reverse is true and the renewables industry is backed by US$450 billion-worth of MLPs.

MLPs are already not popular with the Treasury since they act as a tax shelter. But the fossil fuel industry has enough muscle to strongarm elected representatives in Congress. But tax reform is high on the agenda in Washington DC, so changes to MLPs may not be so wide of the mark.

“Almost nobody's opposed the idea of parity [in the renewables industry] and extending something but people are holding back becoming co-sponsors,” said George Frampton, senior council at Covington & Burling, which is advocating for the inclusion of renewables in MLPs.

“Over the years the Treasury has not liked the MLP but it's become such an effective vehicle and the people in the oil and gas industry are so strong and like it so much. This is not a tax shield this is a simplification of the tax code. If you think that the MLP is going to survive tax reform then there is an argument for making it available to everybody.”

Oil and gas MLPs have a very steady cash flow and can raise money at 5.5% or 6%, Frampton added, an enviable cost of capital for the renewable industry.

Last month, Hannon Armstrong Sustainable Infrastructure Capital, a real estate investment trust (REIT) for renewables listed on the New York Stock Exchange since April this year, announced the completion of US$200 million in transactions in the third quarter, with a pipeline target of US$2 billion to follow. It is on track to deliver its 7% yield for investors in 2013.

Although Hannon Armstrong invested US$35 million in MidAmerican's Solar Star project, Jeff Eckel, president & chief executive officer at Hannon Armstrong, said that the focus for REIT investments would be in distributed generation as it fits with its other sectors such as energy efficiency.

“We're not really that bullish for a lot of reasons on utility-scale renewables,” he said. “We like them, we just see some headwinds. Where we see tremendous tail winds is in the distributed side. We've been doing distributed energy investment for about 15 years. We've done about US$4 billion of securitisation in energy efficiency, distributed generation and distributed solar, largely in federal buildings.

“We really have seen no challenges in the REIT rules. Fortunately, we have a nice balance sheet of about US$1.8 billion of good REIT assets and every time we do one of our distributed energy transactions, whether we securitise it or purchase it for our own balance sheet, it counts as a good REIT asset. We continue to grow the good bucket to the extent that if we have US$2 billion in REIT assets we can US$ 2billion of 'bad' REIT assets such as solar – we're not asking congress to change any laws.”

Clearly, there is as yet no clear winner in this race. But what it does prove is the level of sophistication and confidence in the solar industry. And that some of the world's brightest financial minds are working hard to find ways to plug the gap left by tax equity – even if in some cases those minds also brought us the sub-prime mortgage crisis.

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