As with our series on Hedging Strategies for Power Contracts, we will offer a series of posts explaining how to prepare a solar portfolio for securitization. We originally published a variation of this post as an Industry Current in Power Finance & Risk.
In the residential solar space, with less than 1% market penetration among credit-worthy homeowners, there is significant room for growth in the industry. The capital added to the market by securitization has, and will, accelerate growth, geographic diversity, and standardization across the solar industry and this will in turn drive significant consolidation among players old and new at all levels of the solar industry’s supply chain. This securitization process and its impact will not be restricted to the U.S. and will expand to markets abroad.
This post provides an understanding for how these securitizations will come together and what some unique challenges are to solar securitizations.
As state and federal support for renewables shrinks, the industry must find ways to continue to reduce costs, and access to less expensive capital will be a vital piece of this process. The use of solar securitizations (also called “asset-backed securitizations” or “ABS”) will enable the solar industry to access a much larger and more diverse investor base, which will eventually help to reduce the long-term cost of capital to a likely range of 3% to 7%, compared with the 8% to 20% rate required by some project finance equity and tax equity investors in the current market.
The U.S. Department of Energy estimates that securitization will lower the levelized cost of energy by between 8% to 16%. For investors who seek to exit portfolios of solar assets or remove the assets and accompanying risk from their balance sheets, securitization will increase liquidity for solar projects and free-up cash to make additional investments.
How Securitization Works
Securitization gained popularity in the 1970s with home mortgages in the United States and has since expanded to other income-producing assets, including credit cards, shipping containers, and aircraft.
In the most basic form of a solar securitization, the holder, or “originator,” of a portfolio of solar assets identifies and isolates contracted revenues from a series of solar projects. The originator then bundles the contracted revenues into a “reference portfolio,” and sells the revenue stream (but not the physical solar asset itself) to an issuer, typically a special purpose vehicle (SPV). The SPV then issues a tradable, interest-bearing security to investors in the capital markets. The revenues generated by the reference portfolio fund a trustee account that passes through payments, either fixed or floating, to the investors in the new security. These investors are senior to equity investments and for stable income producing assets like solar projects represent a relatively low risk investment.
In order to obtain an investment-grade rating for the securitization, as required by the investors best positioned to buy long tenor fixed-rate securities, such as pensions and insurance funds, the sponsor will need to develop a large enough portfolio with geographical diversity and a credit worthy source of underlying revenue (the buyers of the solar electricity).