Solar securitizations: Practical advice
Solar securitizations may see a hiatus for part of 2016 in anticipation that equilibrium will be restored in the debt capital markets. Seven deals have been completed, with the blended yield rates on the SolarCity deals completed in late January and February rising to 5.81% and 6.25%, with 74% or 75% advance rates, compared to debt rates in the low 4% range for earlier SolarCity securitizations. The higher rates reflect the volatile market conditions of late 2015 and early 2016. Asset-backed securities or ABS spreads reached a 3-year high in January. Issuers may wait to resume offerings until the markets calm down.
The trend has been to focus on residential, rather than commercial and industrial, portfolios because of the stronger interest in residential portfolios in the market.
The rooftop market is shifting toward direct sales with financing often provided by the developers. This should make securitizations easier by eliminating the complexities of layering securitization on top of tax equity.
Back-levered debt is being used in combination with tax equity structures at LIBOR plus 250 to 350 bps to bridge to securitizations.
SunPower announced that it anticipates its first securitization to close in the first quarter of 2017, a little later than the market expected. The company has been putting assets into its yield co, 8Point3, as an alternative to going to the ABS market.
Speakers at a Standard & Poor’s roundtable in January on the solar ABS market said interest in the solar asset class is booming. The solar sessions at the annual ABS industry conference in Las Vegas in March attracted standing-room-only audiences.
At least two or three new issuers are expected to enter the market by the end of 2016 in addition to those that have already done securitizations. Annual deal volume could also increase in 2016 despite the hiatus. There were two transactions a year in 2014 and 2015. There have already been two deals in 2016.
Here is some practical advice to solar companies that are thinking about doing a securitization for the first time.
Think about the assets that would be in the securitization pool. The market has indicated in its responses to securitizations to date that a pool that is as standardized as possible is preferred. The initial SolarCity securitizations were mostly residential systems with a minority of commercial and governmental customers (up to 29% by value). Later transactions by both SolarCity and Sunrun were exclusively residential. Residential as a class has been well received in the market. While there have been attempts at securitizing pools that are exclusively or predominately commercial and governmental customers, there have not been any successful transactions to date, so there is less of a clear path both with the rating agencies and the market on securitizing commercial and governmental customer contracts.
Do you have a large enough pool of customer agreements? The smallest solar securitization involved around 6,000 customer agreements. The others have been larger with as many as 16,000 customer agreements.
The customer agreements within the pool should be substantially consistent in format as well as on key legal and business terms. Standardization is key. The securitizations to date have been done by developers who originate their own customer agreements so there is a high degree of consistency across the customer agreements. Trying to securitize a pool with diverse customer agreements is more challenging.
The company must have the infrastructure to be able to produce detailed historic and current asset information, both in terms of IT and accounting systems and personnel.
Rating agencies will do a detailed analysis of PV system production historic performance and manufacturers of panels and inverters, historic customer performance and loss and delinquency data, underwriting and credit policies (both for origination and modifications during a contract term), the company’s serving process (both collections and O&M), geographic and utility district concentration, and similar details. They will ask for data for both the proposed asset pool as well as the company’s overall installed fleet.
Companies that have a portfolio of tax equity investors and back-leveraged financing have a head start on being able to meet these requirements.
Structural issues will need to be addressed both with the rating agencies and in the offering document.
The market has shown that ABS deals can be done around the sponsor share of cash flows in tax equity deals. Securitizations have been done on cash flows in both partnership flip and inverted lease transactions. However, such deals are hard to do if the tax equity investor has the right to sweep cash to cover any tax indemnities that the sponsor owes the tax equity investor. Sponsors have negotiated to cap the percentage of cash that can be swept for this purpose. In at least one deal, the sponsor posted an insurance policy to reduce the likelihood of a cash sweep. The premiums on such insurance range from 2.5% to 4% of the potential payout.
Other securitization structures with tax equity involve a specific agreement with the tax equity investor to subordinate its claims to the securitized debt. In inverted lease tax equity structures, the tax equity lessee has subordinated its potential claims against the lessor to payment of the securitized debt.
At least one potential issuer with a large portfolio of residential solar systems foundered over the inability of the rating agencies to get comfortable with a cash sweep.
A solar company doing its first securitization should plan on the transaction taking at least four to six months. The ratings process includes due diligence on the company itself, including its credit profile if the company is not already rated, and on its origination, servicing and O&M operations, as well as asset-specific due diligence. All of this takes time. Structural complications, like securitizing cash flow that has been strained through a tax equity transaction, can add additional time, since the rating agencies will need to understand everything that could block access to the cash flow needed to repay the ABS debt.
For a securitization of an asset type that has not been successfully securitized or where there is less standardization across customer agreements, such as commercial and governmental contracts, the timeline would be longer to accommodate additional due diligence, both by the rating agencies and for the offering document.
One reason that ABS deals take as long as they do is they require preparation of offering documents for so-called 144A offerings. In addition, special disclosures are required such as Rule 15Ga-2 filings of summaries of due diligence reports with the SEC, posting all material documents and making other disclosures (including transcripts or summaries of rating agency discussions) on a Rule 17g-5 website to be available to other nationally-recognized statistical rating organizations who may choose to issue an unsolicited rating.
The rights to the cash flow being securitized are moved into a special-purpose entity that issues notes that are repaid from cash flows. The notes are generally non-recourse. However, the issuer will be required to make representations that the solar systems and customer agreements in the asset pool meet required eligibility criteria, and it will have to pay indemnities if the representations are breached. The sponsor will be expected to post a guarantee or other credit support to ensure payment.
At least one rating is required. The ratings on the securitized notes should exceed any rating on the solar company. In recent deals, the market has moved to two tranches of debt, an A and a B tranche, in order to increase the total advance rate. Ratings in the securitizations to date have been low investment grade (BBB to A) for the senior tranche of notes and high non-investment grade (BB+ or BB) for the junior tranche. Advance rates against the projected cash flow have been as high as 76% in recent deals. The advance rate is the percentage of the net present value of the share of contracted cash flows the sponsor expects to receive after any tax equity transaction, discounted at an agreed discount rate (typically 6.0%). The advance rates can expect to drift higher over time as this type of paper establishes a longer track record.
FICO scores are used as a basic credit rating tool for residential customers. The weighted average FICO scores in the securitizations to date have been very high: 730 to 760 with no subprime customer agreements.
The customer agreements usually have remaining terms of almost 20 years. However, the tenor of recent securitizations has been much shorter (six to eight years) to achieve a lower interest rate. Rating agencies have so far not given any credit to renewal value of customer agreements beyond the initial 20-year contracted term.
Required debt service coverage ratios have typically been set at 1.25x, below which there is a retention of remaining cash flow on any payment date that would otherwise be distributed to the issuer, and 1.15x, below which all excess cash flow would be applied to pay down the debt.
The A tranche receives a higher rating and lower interest rate than the B tranche, as well as priority in unscheduled principal payments. In certain circumstances, it also has priority over B tranche interest.
The investors for this paper tend to be funds managed by institutional asset managers and institutions like insurance companies.
The best practical advice is to retain accountants, bankers and lawyers with securitization experience and work with those advisors to craft a structure and timeline. Spend the front-end time on asset due diligence and a detailed term sheet of key terms. Be sure the company is ripe for an ABS deal before launching a full process to securitize.