Securitization: A Dirty Word, or a New Opportunity for Renewable Energy?

Michael Mendelsohn's picture

Securitization techniques–pooling assets and selling shares to investors – could potentially provide developers and consumers of renewable energy access to financial capital, a critical requirement to project deployment.  After the mortgage meltdown of 2008 and 2009 and the ensuing financial crisis, securitization became a dirty word.  But, when properly regulated, securitization mechanisms support affordable home ownership and provide many other benefits. 

Investopedia, the online financial dictionary, defines securitization as the creation of “a financial instrument by combining other financial assets and then marketing different tiers of the repackaged instruments to investors [in order to]… promote liquidity in the marketplace.” [1]
For the renewable energy (RE) industry, “liquidity in the marketplace” sounds like just what the doctor ordered.  Most RE financings are one-off, specialized arrangements. The risks and rewards of each deal are highly specific to the project, the developer, the tax equity investor, and the lender (if debt is involved).  Moreover, IRS rules and the specific nature of the investments greatly limit market liquidity.  There is no formal secondary market for RE investments, like there is for auto loans or credit card debt.  Without a formal secondary market, “prices” for capital invested (i.e., required returns) remain private, thereby making it impossible to comparison shop.  Ask any economist: information is a crucial component of an efficient market.

Figure 1. Can Wall Street pool RE assets to attract money from Main Street?
Source: Wikimedia Commons

In fact, secondary markets are critical to all forms of purchases.  Imagine a world without a used car market, where you always have to purchase your car from the dealer.  Even if you really want a brand new car, you’re glad the used car market is there because the competition keeps new car dealers in line. 

What if there was a way to allow, or even promote, securitization of RE projects?  Investor classes that are currently excluded from the market, such as pension funds and private investors, could purchase shares of a pool of assets similar to how they presently invest in a mutual fund.

Securitization techniques are currently applied to a wide range of assets, from food and mineral commodities to residential mortgage payments.  The expected mortgage payments of a single homeowner would not make for a great investment – it would require too much analysis of that homeowner’s specific risks.  But if those mortgage payments were bundled with 10,000 others and cut into tradeable ownership shares, the risk of any single default would be manageable.  Managers of pension funds and mutual funds trade those ownership shares of different securitized assets every day. 

SunRun recently made headlines because it said it was securitizing its portfolio of projects.  In fact, any publicly-traded entity can sell off shares of their projects through the sale of equity.  But shouldn’t there be an easier way for RE companies – both large, publicly traded and small, privately held entities – to raise capital in the market and offer investors a stream of revenue tied to the assets they’ve developed? 

Several low-cost support mechanisms or legislative fixes could enable the financial markets to better support RE projects.  For example, Master Limited Partnerships (MLPs) – a form of securitizing assets that allows many owners to participate as partners – is currently used to structure natural gas pipelines and other mineral extraction activities.  Perhaps these could be expanded in scope to include RE generating projects.[2]  Or perhaps accounting rules can be modified to allow ownership by “passive” entities, which could greatly expand the range of possible investors and trading of shares.[3] Or perhaps a central clearinghouse could be established to procure, pool, and securitize RE projects. 

Over the coming months, the NREL finance team will delve into the pros and cons of these issues.  Please sign in to tell us your thoughts on the potential benefits (or true evils) of securitization and if, or how, it might be used by the RE industry.

References:
[1] Investopedia 2011, http://www.investopedia.com/terms/s/securitization.asp Accessed November 2011.
[2]  Sherlock and Keightley, 2011, “Master Limited Partnerships: A Policy Option for the Renewable Energy Industry”, Congressional Research Service, June 2011. 
[3] Tracy, 2010, “Passive Loss Issues in Connection with Solar Investments”, Novogradac and Company, LLP, February 2010, http://www.novoco.com/journal/2010/02/news_qa_retc_201002.php Accessed November 2011.