Renewable Energy Project Finance Feed https://financere.nrel.gov/finance/feed.xml Renewable Energy Project Finance RSS Feed en A Peek into YieldCo’s Relative Cost of Capital: An Analysis of a Recent Transaction https://financere.nrel.gov/finance/content/peek-yieldco-s-relative-cost-capital-analysis-recent-transaction <div class="field field-type-text field-field-blog-ss-title"> <div class="field-items"> <div class="field-item odd"> YieldCo’s True Cost of Capital </div> </div> </div> <div class="field field-type-text field-field-blog-ss-teaser"> <div class="field-items"> <div class="field-item odd"> Analysis from a recent transaction provides valuable insight. </div> </div> </div> <p><em><strong>By Lang Reynolds</strong></em></p> <p>YieldCos represent a surging trend in renewable energy finance and a valuable innovation to access relatively low-cost capital for the right players. Along with securitization and other financial innovations, YieldCos represent a critical pathway to support renewable energy project deployment and market growth past incentive expirations.</p> <p>The general purpose of a YieldCo is to lower the cost of finance through a specialized investment. By 1) transferring the project off balance sheet, and 2) refinancing the project at a lower cost of capital, sponsors can free up more capital with which to deploy more projects, and sell the energy for a competitive price. Importantly, YieldCos are generally affiliated with a parent company (i.e., a developer or asset investor), but represent a separate investment mechanism.</p> <p>However, exactly how (or even if) currently operating YieldCos are achieving this low cost of capital relative to their parent companies has not been entirely transparent. Luckily, NRG Yield's (NYLD) purchase of the Alta Wind facility last summer offers just enough transparency to suggest that, at least in this particular transaction, the YieldCo does appear to enjoy a lower cost of capital than its parent company, NRG. This article will walk through some back-of-the envelope calculations pertinent to the transaction to illustrate how this works.</p> <h2>The Transaction</h2> <p>On June 4th, 2014, NYLD announced the purchase of Alta Wind from Terra-Gen Power LLC. With a capacity of 947 MW, this wind facility in Tehachapi, California is the largest in North America [<a href="#references">2</a>]. &nbsp;NYLD has a right of first offer (ROFO) to procure &quot;drop-down transactions&quot; from NRG's development portfolio. And although other assets were procured thru the ROFO prior to the Alta Wind deal, this was the first renewable energy asset in the YieldCo marketplace with publicly-disclosed terms. The table below describes key terms of the Alta Wind transaction.</p> <table cellspacing="0" cellpadding="3" class="data"> <tbody> <tr style="background-color:#036; color:#fff;"> <td colspan="2"><strong>Alta Wind &mdash; Transaction Overview</strong></td> </tr> <tr> <th style="text-align:left; font-weight:normal;">Developer/Operator</th> <td>Terra-Gen Power LLC</td> </tr> <tr class="gray"> <th style="text-align:left; font-weight:normal;">Purchaser</th> <td>NRG Yield, Inc</td> </tr> <tr> <th style="text-align:left; font-weight:normal;">Nameplate Capacity</th> <td>947 MW</td> </tr> <tr class="gray"> <th style="text-align:left; font-weight:normal;">Power Purchase Agreement Counterparty</th> <td>Southern California Edison</td> </tr> <tr> <th style="text-align:left; font-weight:normal;">Weighted Average Contract Life</th> <td>22 Years</td> </tr> <tr class="gray"> <th style="text-align:left; font-weight:normal;">Purchase Price</th> <td>$870MM + $1,600MM Assumption of Debt</td> </tr> <tr> <td colspan="2"><span style="font-size:.8em; font-style:italic;">Source: [<a href="#references">3</a>], [<a href="#references">4</a>]</span></td> </tr> </tbody> </table> <p>Completed on August 12, 2014, the Alta acquisition was funded through a 50/50 split of equity and debt. For the equity, NYLD closed a common stock offering for net proceeds of $630 million, $442 million of which were slated for the Alta purchase. For the debt, NYLD issued $500 million in senior unsecured notes due in 2024 with a coupon rate of 5.375%. Note: This debt issuance was increased by $100 million and underwriters of the equity offering exercised their option to purchase an additional 1.58 million shares, reflecting strong demand for both capital offerings [<a href="#references">4</a>],[<a href="#references">5</a>].</p> <h2>Cost of Capital Analysis</h2> <p>Now let's look at exactly how the Alta Wind transaction illustrates the difference between NYLD's cost of capital and that of its parent company, NRG.</p> <p>We'll start with the equity. Hypothetically, if two companies are making the same acquisition at the same purchase price, the one with a higher equity valuation (i.e. the stock price) would enjoy a lower cost of equity. That is, a higher equity valuation allows a company to issue fewer shares, thereby reducing any dilution of distributions per share. In the case of the Alta Wind transaction, NYLD's equity value rose over 100% from its IPO up to the purchase announcement, resulting in a significantly higher valuation relative to its parent, NRG. At the time of the transaction, investors valued NYLD equity at almost twice the EBITDA (earnings before interest, taxes, depreciation, and amortization) of NRG over the six months prior to the equity offering. This suggests that NYLD enjoyed, at the time, cost of equity advantage over its parent.</p> <p>Next, let's take a look at the debt. The NYLD bond issue executed to fund the transaction was priced with a 5.375% coupon. As shown in the table below, this is a full 87.5 basis points lower than both of NRG's debt offerings in 2014. While the benchmark 10-Year Treasury yield fell ~24 basis points from the time of NRG's two debt issuances to NYLD's, this difference accounts for less than one third of the total spread between the offerings.</p> <p>Therefore NYLD appears to also enjoy a significant cost of debt advantage compared to NRG.</p> <table cellspacing="0" cellpadding="3" class="data"> <tbody> <tr style="background-color:#036; color:#fff;"> <th style="text-align:left;" scope="col">Issuer</th> <th style="text-align:center" scope="col">NRG</th> <th style="text-align:center" scope="col">NRG</th> <th style="text-align:center" scope="col">NYLD</th> </tr> <tr class="gray"> <th style="text-align:left; background-color:#036; color:#fff;" scope="row">Offering Size</th> <td style="text-align:center;">$1,100MM</td> <td style="text-align:center;">$1,000MM</td> <td style="text-align:center;">$500MM</td> </tr> <tr> <th style="text-align:left; background-color:#036; color:#fff;" scope="row">Offering Date</th> <td style="text-align:center;">Jan-14</td> <td style="text-align:center;">Apr-14</td> <td style="text-align:center;">July-14</td> </tr> <tr class="gray"> <th style="text-align:left; background-color:#036; color:#fff;" scope="row">Maturity</th> <td style="text-align:center;">2022</td> <td style="text-align:center;">2024</td> <td style="text-align:center;">2024</td> </tr> <tr> <th style="text-align:left; background-color:#036; color:#fff;" scope="row">Type</th> <td style="text-align:center;">Senior Unsecured</td> <td style="text-align:center;">Senior Unsecured</td> <td style="text-align:center;">Senior Unsecured</td> </tr> <tr class="gray"> <th style="text-align:left; background-color:#036; color:#fff;" scope="row">Coupon</th> <td style="text-align:center;">6.25%</td> <td style="text-align:center;">6.25%</td> <td style="text-align:center;">5.375%</td> </tr> </tbody> </table> <h2>Summary</h2> <p>Based on this transaction, NYLD appears to possess advantages in both the debt and equity components of cost of capital over its parent company, providing tangible support to the cost of capital argument for forming a YieldCo. However, it remains to be seen how much of this advantage can be maintained over time and to what degree it persists across other YieldCos. For example, it could be difficult to improve upon the cost of capital of a diversified utility such as NextEra; however for a pure-play developer with a relatively higher cost of capital, the spread could likely be more favorable. Furthermore, market conditions, especially interest rates, are expected to significantly affect the YieldCo business model. That is, distribution yields would need to keep pace with any significant increase in interest rates to maintain investor interest.</p> <p>Given the nascent state of the YieldCo marketplace, many questions are yet to be answered and outcomes are yet to be determined. Future acquisitions by other YieldCos, provided they make use of the public markets as the Alta Wind transaction did will shed more light into the relative financing costs of YieldCos and their parent companies. Over time, YieldCos, securitizations, and other financial innovations could provide significant capital-raising capabilities for developers and owners of renewable energy projects, thus reducing financial barriers to scaled deployment and competitive cost of energy.</p> <h2 id="references" style="margin-top:50px;">References</h2> <p>2. &quot;NRG Yield to buy North America's largest wind power plant.&quot; SNL Energy. Accessed August 28, 2014: <a href="http://www.snl.com/InteractiveX/article.aspx?ID=28296998&amp;KPLT=2">http://www.snl.com/InteractiveX/article.aspx?ID=28296998&amp;KPLT=2</a>.<br /> 3. Urdanick, M. (2014). &quot;A Deeper Look into YieldCo Structuring.&quot;&nbsp; <a href="https://financere.nrel.gov/finance/content/deeper-look-yieldco-structuring">https://financere.nrel.gov/finance/content/deeper-look-YieldCo-structuring</a>. <br /> 4. &quot;NRG Yield closes common stock offering SNL nyld equity offering.&quot; SNL Energy. Accessed August 28, 2014: <a href="http://www.snl.com/InteractiveX/article.aspx?ID=28758879&amp;KPLT=2">http://www.snl.com/InteractiveX/article.aspx?ID=28758879&amp;KPLT=2</a>. <br /> 5. &quot;NRG Yield Operating upsizes, prices senior note offering.&quot; SNL Energy. Accessed August 28, 2014: <a href="http://www.snl.com/InteractiveX/article.aspx?ID=28795824&amp;KPLT=2">http://www.snl.com/InteractiveX/article.aspx?ID=28795824&amp;KPLT=2</a>.</p> https://financere.nrel.gov/finance/content/peek-yieldco-s-relative-cost-capital-analysis-recent-transaction#comments Thu, 07 May 2015 21:02:50 +0000 Editor 4126 at https://financere.nrel.gov/finance Credit Enhancements https://financere.nrel.gov/finance/content/credit-enhancements <div class="field field-type-text field-field-slideshowhead"> <div class="field-items"> <div class="field-item odd"> Credit Enhancements </div> </div> </div> <div class="field field-type-text field-field-slideshowtext"> <div class="field-items"> <div class="field-item odd"> <p style="margin:10px;">A new <a href="http://www.nrel.gov/docs/fy15osti/62618.pdf">NREL analysis</a> examines the various types of credit enhancements that could be used to drive capital market investment in the solar asset class.</p> </div> </div> </div> <p>A new <a href="http://www.nrel.gov/docs/fy15osti/62618.pdf">NREL analysis</a> examines the various types of credit enhancements that could be used to drive capital market investment in the solar asset class</p> https://financere.nrel.gov/finance/content/credit-enhancements#comments Thu, 16 Apr 2015 00:31:33 +0000 financewebadmin 4125 at https://financere.nrel.gov/finance Residential Solar and the Uniform Commercial Code: A Primer on Solar-Financiers’ Rights in a Home Foreclosure https://financere.nrel.gov/finance/content/residential-solar-and-uniform-commercial-code-primer-solar-financiers-rights-home-foreclosur <div class="field field-type-text field-field-blog-ss-title"> <div class="field-items"> <div class="field-item odd"> Solar, Security Interests, and the UCC </div> </div> </div> <div class="field field-type-text field-field-blog-ss-teaser"> <div class="field-items"> <div class="field-item odd"> Could the characterization of solar assets under the Uniform Commercial Code complicate residential solar financing? </div> </div> </div> <p>U.S. residential solar PV has been growing at a breakneck pace. Annual installations have increased nearly five-fold in the past five years and, in 2014, surpassed annual commercial capacity additions for the first time in the history of PV market tracking. Additionally, nearly a third of the entire solar industry's workforce&mdash;comprising over 174,000 employees&mdash;works in residential solar [<a href="#references">1</a>, <a href="#references">2</a>, <a href="#references">3</a>].</p> <p>Consistently high growth notwithstanding, residential solar remains something of a new phenomenon, and several industries are still trying to understand what it means for their businesses. One question being asked by housing regulators, mortgage bankers, ratings agencies, and others is: how do security interests in solar assets affect the claims in the case of default? And what rights do solar financiers have with regard to mortgage holders?</p> <p>This article will address these questions, but will first provide some background on the Uniform Commercial Code (UCC), a critical piece of the puzzle. If you are already familiar with the workings of the UCC, then it may be best to skip to the section on &quot;Why It Matters.&quot;</p> <h2>Security Interests and the UCC</h2> <p>Many solar financiers today offer at least the following three products: leases, power purchase agreements (PPAs), and loans. The first two are third-party ownership (TPO) products&mdash;i.e., ownership of the system remains with the financier and the customer pays a monthly sum (fixed or dependent on energy production) to access that system. In a loan arrangement, the customer owns the system and remits to the financier a monthly payment of principal and interest to pay down the debt.</p> <p>To protect themselves against customer defaults and other credit events, financiers will commonly take a security interest in the solar system that they have financed. In addition, they officially give notice of their rights to the system (the collateral) so that they may legally take possession of it if the customer breaches its contract (and so that another financier cannot). In the case of TPO, the financier already owns the system, but will usually take a security interest and file a financing statement to give notice of its position, just the same as it would for a loan.</p> <p>Financiers can take security interests as per the UCC, which is a set of legal rules for creating and enforcing rights in property subject to sales, leases, loans, and other types of transactions. Because all states have adopted the code, it serves as the overarching legal framework for commercial/financial transactions in the United States.</p> <p>A financier can receive a security interest if the debtor has rights In general, financiers can &quot;perfect&quot; their security interest in collateral&mdash;that is, to make it effective against competing claims from other creditors&mdash;by filing a UCC-1 Financing Statement [<a href="#references">4</a>]. They will typically do this with the secretary of state where the borrower is located, at which point the filing serves as the notice of lien to all interested parties. A financier may also choose to file a UCC-1 in the real property records (usually through the county clerk) because this gives an added layer of protection, and because solar collateral could be considered a &quot;fixture&quot; under state real estate law&mdash;more on this in the next section.</p> <p>Additionally, Section 9-103 of the UCC allows lenders a special type of security interest known as a &quot;purchase money security interest&quot; (PMSI). A PMSI arises where money from a loan is used to purchase the collateral for that loan. In other words, if a borrower will be using a loan to purchase a solar system, the lender would want to take a PMSI in that solar system as per the UCC. PMSIs have the distinct advantage of prioritizing the filer over all other lienholders on the asset. That means that the PMSI-perfected lender has first rights to the collateral and any recoveries in the case of a default.</p> <h2>Why It Matters: Fixtures vs. Personal Property</h2> <p>PMSIs will hold up if the collateral is regarded as personal property under the UCC. This may not be the case if they are regarded as &quot;fixtures.&quot;</p> <p>Fixtures represent something of an intermediate category between real property and personal property. Section 9-102 of the UCC defines fixtures as &quot;goods that have become so related to particular real property that an interest in them arises under real property law&quot; [<a href="#references">5</a>]. The category of fixtures can include installations such as a central air unit or a solar system.</p> <p>The last part of the definition&mdash;about an interest arising in the fixture under real property law&mdash;has implications for solar financiers. Say a particular state makes the determination that solar systems are indeed fixtures [<a href="#references">6</a>]. Now say that a homeowner in that state installs a solar system on his/her roof and then a few years later defaults on his/her home mortgage loan. <strong>If the mortgage holder forecloses on that home as a result, then it may be able to claim rights to the system as per the provisions of state real estate law. This could, in effect, prevent the solar financier from repossessing its collateral or obtaining first claim on any recoveries from that collateral.</strong></p> <p>Obviously, this represents a business risk for the residential solar industry, and many finance/installation companies have consequently taken the position that solar assets are personal property, not fixtures [<a href="#references">7</a>]. Their contracts (leases, PPAs, and loan documents) contain language specifying them as such, although this language does not bind the real estate mortgagee unless he/she also signs that same contract, or signs a disclaimer of any interest in the solar system.</p> <p>But even if homeowners and the solar industry intend that rooftop PV installations are personal property, the ultimate deciders on this issue are the state courts and arbiters who would be called upon to resolve any competing claims of the solar financier and the mortgage lender. Currently, there are no legal precedents in any state related to solar PV assets [<a href="#references">8</a>], so the legal outcomes are uncertain.</p> <h2>What Can Be Done?</h2> <p>There is an opportunity here. Instead of waiting for a legal dispute between a mortgage holder and a solar financier to go to court, the solar and mortgage banking industries could proactively seek an open dialogue to help each other mutually benefit from recognition of the solar asset class. For example, the two industries could mutually adopt some standard form of recognition that would allow the solar financiers to reach an agreement with new homeowners in previously foreclosed properties within, say, 90 days of the new owners buying the property (whether subject to the existing mortgage or a new one). This would sidestep any legal confrontations in the case of a foreclosure, and it would give solar financiers the opportunity to try and recover some cash flow on their collateral. If the solar industry could start such a dialogue with Fannie Mae and Freddie Mac, it stands to resolve potential conflicts with a large portion of the U.S. mortgage market, not to mention open the door for other mortgage banks to follow suit.</p> <p>The mortgage industry could be in a position to benefit as well. Solar systems owned by the homeowner (i.e., loan-financed or purchased outright) have been shown to increase the value of the homes on which they're installed [<a href="#references">9</a>, <a href="#references">10</a>, <a href="#references">11</a>]. Moreover, recent guidelines from HUD indicate that solar systems can be financed with mortgages (allowing for a mortgage increase of up to 20% in excess of the maximum insurable limit) [<a href="#references">12</a>]. This which would increase principal amounts and therefore revenue potential for lenders. Lastly, homeowners that go solar in markets with a relatively high cost of electricity and access to net metering may enjoy positive cash flow even after taking out debt to finance their system. That is, it may cost a homeowner less, on a monthly basis, to service his/her solar loan than it would to pay the utility for all his/her electricity. This stands in contrast to some other types of consumer debt (such as credit cards or auto loans), where savings are not often part of the decision to assume an obligation.</p> <p>As the cost of residential solar energy declines and as more markets open up, it will become ever more critical for the solar and mortgage industries to work together to avoid costly legal encounters and patchwork solutions.</p> <h3 id="references" style="margin-top:50px;">References and Notes:</h3> <p>[1] Solar Energy Industries Association &amp; Greentech Media Research. (2015). U.S. Solar Market Insight 2014 Year in Review.</p> <p>[2] Solar Energy Industries Association &amp; Greentech Media Research. (2014). U.S. Solar Market Insight 2013 Year in Review.</p> <p>[3] The Solar Foundation. (2015). National Jobs Census 2014. Available at: <a href="http://www.thesolarfoundation.org/national-solar-jobs-census-2014/">http://www.thesolarfoundation.org/national-solar-jobs-census-2014/</a></p> <p>[4] Filing a UCC-1 is not the only way to perfect a security interest, though it is the most common. For example, sometimes a security interest can be perfected &quot;automatically,&quot; i.e. without any filings or actions on the part of the creditor.</p> <p>[5] Cornell University Law School. &quot;Uniform Commercial Code: &sect; 9-102. Definitions and Index of Definitions.&quot;&nbsp; Available at: <a href="https://www.law.cornell.edu/ucc/9/9-102">https://www.law.cornell.edu/ucc/9/9-102</a></p> <p>[6] Section 9-301 (3) of the UCC states that the &quot;local law of that jurisdiction&quot; (i.e. state realty law) governs perfection of a security interest by filing a fixture filing. In other words, the determination of whether or not a solar system is a fixture or personal property will be made on a state-by-state basis.</p> <p>[7] A UCC-1 Financing Statement can be used for a &quot;fixture filing.&quot; However, it is important to note that a fixture filing in the real property records does not, in and of itself, necessarily characterize the items affixed to the home as fixtures</p> <p>[8] However, there has been case law where solar water heaters were held to be fixtures under the UCC. See re Arlett, 22 B.R. 732, 732-35 (Bankr. E.D. Cal. 1982), and Energy Control Services v. Arizona, 658 P.2d 820 (1982).</p> <p>[9] Hoen, B.; Wiser, R.; Thayer, M.; Cappers, P. (2012). Residential Photovoltaic Energy Systems in California: The Effect on Home Sales Prices. Berkeley, CA: Lawrence Berkeley National Laboratory. Available at: <a href="http://emp.lbl.gov/sites/all/files/lbnl-5901e_0.pdf">http://emp.lbl.gov/sites/all/files/lbnl-5901e_0.pdf</a></p> <p>[10] Hoen, B.; Adomatis, S.; Jackson, T.; Zivin-Graff, J.; Thayer, M.; Klise, G.; Wiser, R. (2015). Selling into the Sun: Price Premium Analysis of a Multi-State Dataset of Solar Homes. Berkeley, CA: Lawrence Berkeley National Laboratory. Available at: <a href="http://emp.lbl.gov/sites/all/files/selling-into-the-sun-jan12.pdf">http://emp.lbl.gov/sites/all/files/selling-into-the-sun-jan12.pdf</a></p> <p>[11] Desmarais, L. (2013). The Impact of Photovoltaic Systems on Market Value and Marketability: A Case Study of 30 Single‐Family Homes in the North and Northwest Denver Metro Area. Colorado Energy Office. Available at: <a href="http://www.colorado.gov/cs/Satellite%3Fblobcol%3Durldata%26blobheadername1%3DContent-Disposition%26blobheadername2%3DContent-Type%26blobheadervalue1%3Dinline%3B%2Bfilename%253D%2522PV_Case%2BStudies.pdf%2522%26blobheadervalue2%3Dapplication/pdf%26blobkey%3Did%26blobtable%3DMungoBlobs%26blobwhere%3D1251900073057%26ssbinary%3Dtrue">http://www.colorado.gov/cs/Satellite%3Fblobcol%3Durldata%26blobheadername1%3DContent-Disposition%26blobheadername2%3DContent-Type%26blobheadervalue1%3Dinline%3B%2Bfilename%253D%2522PV_Case%2BStudies.pdf%2522%26blobheadervalue2%3Dapplication/pdf%26blobkey%3Did%26blobtable%3DMungoBlobs%26blobwhere%3D1251900073057%26ssbinary%3Dtrue</a></p> <p>[12] The U.S. Department of Housing and Urban Development. (2015). FHA Single Family Housing Policy Handbook. II.A.2.a.v.(C), pg. 114. Available at: <a href="http://portal.hud.gov/hudportal/documents/huddoc?id=40001HSGH.pdf">http://portal.hud.gov/hudportal/documents/huddoc?id=40001HSGH.pdf</a></p> https://financere.nrel.gov/finance/content/residential-solar-and-uniform-commercial-code-primer-solar-financiers-rights-home-foreclosur#comments Tue, 14 Apr 2015 22:44:18 +0000 Travis Lowder 4124 at https://financere.nrel.gov/finance Best Practices Guides Now Available https://financere.nrel.gov/finance/content/best-practices-guides-now-available <div class="field field-type-text field-field-blog-ss-title"> <div class="field-items"> <div class="field-item odd"> Best Practices Guides Now Available </div> </div> </div> <div class="field field-type-text field-field-blog-ss-teaser"> <div class="field-items"> <div class="field-item odd"> Best practices guides in System Installation and Operations &amp; Maintenance now available for download. </div> </div> </div> https://financere.nrel.gov/finance/content/best-practices-guides-now-available#comments Thu, 02 Apr 2015 23:08:27 +0000 financewebadmin 4123 at https://financere.nrel.gov/finance SAPC Mock Term Sheet Available https://financere.nrel.gov/finance/content/sapc-mock-term-sheet-available <div class="field field-type-text field-field-blog-ss-title"> <div class="field-items"> <div class="field-item odd"> SAPC Mock Term Sheet Available </div> </div> </div> <div class="field field-type-text field-field-blog-ss-teaser"> <div class="field-items"> <div class="field-item odd"> Developed by the SAPC Legal Team, this term sheet proposes an innovative structure that incorporates securitization debt with tax equity investment. </div> </div> </div> https://financere.nrel.gov/finance/content/sapc-mock-term-sheet-available#comments Fri, 06 Feb 2015 21:19:25 +0000 financewebadmin 4119 at https://financere.nrel.gov/finance Loans vs. Leases https://financere.nrel.gov/finance/node/4118 <div class="field field-type-text field-field-blog-ss-title"> <div class="field-items"> <div class="field-item odd"> Loans vs. Leases </div> </div> </div> <div class="field field-type-text field-field-blog-ss-teaser"> <div class="field-items"> <div class="field-item odd"> Two new NREL analyses look at the benefits, challenges, and tradeoffs of financing solar installations with loans vs. third-party contracts. </div> </div> </div> https://financere.nrel.gov/finance/node/4118#comments Fri, 30 Jan 2015 21:34:23 +0000 financewebadmin 4118 at https://financere.nrel.gov/finance CREST Unlocked! https://financere.nrel.gov/finance/content/crest-unlocked <div class="field field-type-text field-field-blog-ss-title"> <div class="field-items"> <div class="field-item odd"> CREST Unlocked! </div> </div> </div> <div class="field field-type-text field-field-blog-ss-teaser"> <div class="field-items"> <div class="field-item odd"> All Cost of Renewable Energy Spreadsheet Tool models are now available without password protection and can be freely modified </div> </div> </div> https://financere.nrel.gov/finance/content/crest-unlocked#comments Solar Wind Biomass Geothermal Fri, 23 Jan 2015 18:55:24 +0000 financewebadmin 4117 at https://financere.nrel.gov/finance A Deeper Look into Yieldco Structuring https://financere.nrel.gov/finance/content/deeper-look-yieldco-structuring <div class="field field-type-text field-field-blog-ss-title"> <div class="field-items"> <div class="field-item odd"> Yieldcos: A Deeper Dive </div> </div> </div> <div class="field field-type-text field-field-blog-ss-teaser"> <div class="field-items"> <div class="field-item odd"> A close look into these voguish renewables financing structures </div> </div> </div> <p>By: Marley Urdanick</p> <p>Yieldcos seem to be the renewable energy financing mechanism in vogue lately. As the newest 2014 headliners, TerraForm Power and NextEra Energy attract media attention, and NRG Yield continues to exceed expectations, many industry stakeholders are asking: what is a yieldco and why is it attractive from an investment and finance perspective? To answer these questions, this article summarizes key elements of the yieldco structure and provides an overview of the current U.S. market.</p> <h2>The Basics</h2> <p>A yieldco is a dividend growth-oriented public company, created by a parent company (e.g., SunEdison), that bundles renewable and/or conventional long-term contracted operating assets in order to generate predictable cash flows. Yieldcos allocate cash available for distribution (CAFD) each year or quarter to shareholders in the form of dividends. This investment can be attractive to shareholders because they can expect low-risk returns (or yields) that are projected to increase over time. The capital raised can be used to pay off expensive debt or finance new projects at rates lower than those available through tax equity finance, which can exceed 8%.</p> <p>The case for yieldcos can be compelling, especially as an alternative to master limited partnerships (MLPs) and real estate investment trusts (REITs). Yieldcos, sometimes referred to as &quot;synthetic MLPs,&quot; are structured to simulate the avoided double-taxation benefit of MLPs and REITs. This means that rather than taxation taking place twice (once at the corporate level and again at the shareholder level), the yieldco is able to pass its untaxed earnings through to investors [<a href="#references">1</a>]. This is achieved by matching strong positive cash flows (income from assets) with losses that exceed taxable income (losses due to renewable asset depreciation and expenses). These &quot;net operating losses&quot; reduce the company's taxable income so that the company is taxed on lower annual earnings, or may not even owe taxes at all. Net operating losses can &quot;carry forward&quot; for future taxable events and therefore, many yieldcos do not expect to pay significant income tax for a period of years. Additionally, dividends may also receive favorable tax treatment at the shareholder level if the returns are treated as return <em>of</em> the original investment, as opposed to return <em>on</em> investment. When earnings are taxed at only one level, the company is able to raise capital from shareholders more affordably [<a href="#references">2</a>]. Class A Common Stock shareholders typically receive a 1099-DIV form for tax purposes, rather than the K-1 form associated with MLPs. This is good news for many investors accustomed to the K-1, which can be cumbersome across multiple states and have limitations on utilization in a tax return [<a href="#references">3</a>].</p> <p>Below is a general representation of the yieldco organizational structure, adapted from NRG Yield. The parent company must own a majority share of the yieldco (Class B Common Stock), while public shareholders are entitled to a minority share (Class A Common Stock). &nbsp;The revenue generated from projects owned and/or operated by &quot;operating subsidiaries&quot; is passed through this structure to deliver returns to shareholders.</p> <div style="width:560px; margin:25px auto;"><img width="560" height="480" alt="Bubble chart of a hypothetical yieldco structure showing the relationship between &#039;Parent Company&#039; (upper left), &#039;Public Shareholders&#039; (upper right), &#039;Yieldco Inc.&#039; (middle tier) and &#039;Operating Subsidiaries&#039; (bottom)" src="/finance/files/blog/blog_20140903.jpg" /></div> <p>Renewable energy projects face some uncertainty during the development stage but tend to produce low-risk cash flows once they are operating [<a href="#references">5</a>]. Yieldcos have the potential to unlock the value of these renewable assets. Yieldcos may attract new investors who may otherwise perceive unacceptable risk or lack the appropriate channels to invest capital in renewables. In exchange for the opportunity to invest in relatively low-risk assets, yieldco investors typically receive 3%&ndash;5% returns and long-term dividend growth targets of 8%&ndash;15% [<a href="#references">6</a>] [<a href="#references">7</a>]. For instance, TerraForm Power's prospectus targets a 15% compound annual growth rate in CAFD over a three-year period. &nbsp;Investor return is directly linked to the operating performance of the underlying assets and the resulting CAFD, 70%&ndash;90% of which is distributed as dividends.</p> <p>Each yieldco establishes a dividend policy and method for calculating CAFD; a generalization based on NRG's CAFD calculation is illustrated in Figure 2 below [<a href="#references">4</a>]. Generally, a yieldco will distribute quarterly earnings (in the example below, $40M), less: interest and tax paid, maintenance capital expenditures, and principal payments on existing debt ($26M), and reserves for prudent conduct of business ($3M). About 70 - 90% of the remaining CAFD ($11M) is paid out shareholders.</p> <div style="text-align:center" class="calloutwide"> <p>CAFD = [Quarterly Earnings] &ndash; [Interest and Tax paid + Maintenance and CapEx + Principal Payments] &ndash; [Reserves]</p> <p>CAFD = [$40 M] - [$26 M] &ndash; [$3 M] = $11 M</p> <p><strong>Figure 2. Generalized CAFD Calculation (in millions)</strong></p> </div> <h2>Which Companies Can Use The Yieldco Model?</h2> <p>To date, Yieldcos have been spinoffs of large industry players with the capital necessary to purchase third-party assets or build projects themselves [<a href="#references">8</a>]. They can emerge from unregulated arms of large utilities that own a mix of renewable and traditional generating assets (e.g., NextEra), independent power producers (IPPs), and pure-play solar or wind developers [<a href="#references">9</a>]. Currently, six renewable energy yieldcos operate in the US market: NRG Yield Inc., Pattern Energy Group, Inc. (NASDAQ:PEGI), TransAlta Renewables, Inc. (TSE:RNW), Abengoa Yield Plc (NASDAQ:ABY), Next Era Energy Partners, LP (NYSE:NEP), and TerraForm Power, Inc. (NASDAQ:TERP). TerraForm Power closed its initial public offering on July 23, 2014 [<a href="#references">10</a>].</p> <p>Table 1 presents the current landscape of yieldcos in the United States (each yieldco listed has at least one project operating in the United States, but many have projects in their portfolio operating outside the United States as well). Each yieldco's portfolio is assembled according to each parent company's expertise and the desire to balance income with tax benefits. Some yieldcos have chosen to include conventional assets, while others have elected to remain a pure-play renewable. Since 2013, yieldcos have acquired over 8 GW of assets in their portfolios (renewables account for 78%) and have raised a total of $3.8 billion.</p> <table cellpadding="3" class="data"> <caption>Table 1. The Yieldco Landscape</caption> <tbody> <tr class="gray"> <td>&nbsp;</td> <th scope="col">Portfolio</th> <th scope="col">Renewable Assets (MW-electric)</th> <th scope="col">Total Assets (MW)</th> <th scope="col">Total Capital Raised</th> <th scope="col">Market Cap</th> <th scope="col">Yield (Annual)</th> </tr> <tr> <th scope="row">NRG Yield, Inc.&nbsp;</th> <td>Conventional,&nbsp;solar, wind, thermal</td> <td>1401</td> <td>2984</td> <td>$840 million</td> <td>$3.9 billion</td> <td>5.45%</td> </tr> <tr> <th scope="row">Pattern Energy Group, Inc.</th> <td>Wind</td> <td>1932</td> <td>1932</td> <td>$938 million</td> <td>$1.9 billion</td> <td>6.25 %</td> </tr> <tr> <th scope="row">Abengoa Yield Plc.</th> <td>Solar, wind, conventional, electric transmission</td> <td>710</td> <td>1010;<br />1018 mi</td> <td>$829 million</td> <td>$3.0 billion</td> <td>3.6 %</td> </tr> <tr> <th scope="row">TransAlta Renewables, Inc.</th> <td>Wind,hydro</td> <td>1378</td> <td>1378</td> <td>C$346million<br />(US$323)</td> <td>$1.3 billion</td> <td>7.5 %</td> </tr> <tr> <th scope="row">NextEra Energy Partners, LP</th> <td>Wind, Solar</td> <td>989</td> <td>989</td> <td>$406 million</td> <td>$3.1 billion</td> <td>6.25%</td> </tr> <tr> <th scope="row">TerraForm Power, Inc.</th> <td>Solar</td> <td>523</td> <td>523</td> <td>$500 million</td> <td>$3.0 billion</td> <td>4.5% <br />(expected)</td> </tr> </tbody> </table> <p>All market cap information gathered from Bloomberg on August 1, 2014, unless noted otherwise. Asset, capital raised, and yield data from Kaye Scholer [<a href="#references">11</a>]</p> <p>One detail that a parent company may consider when moving forward with a yieldco is the potential effect on credit rating. When a parent company moves operating assets off of its balance sheet and into the yieldco, it may be left with the same debt liability [<a href="#references">9</a>]. If credit rating agencies perceive this change in assets-to-liabilities as a risk, they could downgrade the parent company's credit rating. However, this has yet to occur.</p> <h2>Portfolio size and structure</h2> <p>For a developer interested in this structure, Martin [<a href="#references">2</a>] suggests that a yieldco hold at least $500 million in operating project value and enough shares sold to raise at least $100 to $200 million in the initial public offering. Diversification of risk related to construction, system operation, offtaker creditworthiness, and geography may strengthen portfolios. For instance, all of the yieldcos listed in Table 1, with the exception of NRG yield, own a combination of U.S. and non-U.S. assets with varying offtaker characteristics. It is good to keep in mind that the portfolio is more likely a function of the yieldco's business model and the parent company's management expertise, and not &quot;one size fits all.&quot;</p> <p>For example, TerraForm Power's portfolio contains many small- to mid-size distributed generation (DG) projects. Two of the most notable assets within TerraForm's initial portfolio are the 46.5 MW &quot;U.S. Projects 2014<em>&quot; </em>and 19.6 MW <em>&quot;</em>Summit Solar Projects<em>.&quot; </em>Each project is a conglomeration of 42 and 50 sites, respectively, with offtakers that include utilities, municipalities, commercial, and governmental entities [<a href="#references">12</a>]. This profile differs from a yieldco portfolio like NRG's, which houses a mix of large, conventional, utility-scale solar and thermal projects.</p> <p>To ensure steady revenue streams, yieldcos may stock their portfolios with a diverse mix of assets. Asset types may include conventional generation, renewable energy (solar, wind, biomass, hydro, thermal, etc.), as well as transmission lines and natural gas pipelines. Abengoa Yield's portfolio includes 86 miles of transmission lines, while TerraForm Power's portfolio holds solar DG projects and is expected to acquire natural gas and hybrid energy assets in the future [<a href="#references">13</a>] [<a href="#references">12</a>]. NRG Yield chose to assemble an initial portfolio of approximately 36% conventional generating assets, 16% renewable, and 48% thermal energy/co-generation. The NRG Yield portfolio contains 25 assets across 10 states [<a href="#references">14</a>].</p> <h2>&quot;Drop downs&quot; Fuel the Yieldco</h2> <p>In order to retain favorable tax benefits and steady yields, the yieldco business model calls for acquisition of new generation assets as initial portfolio assets approach their contract expirations. This pipeline of assets, or &quot;drop downs,&quot; is intended to fuel the yieldco with stable cash flows to deliver above-average dividend growth with below average risk [<a href="#references">7</a>]. This drop-down schedule is critical to maintaining cash-flows and beneficial tax treatment and subsequently, is essential to the yieldcos future growth and viability as a long-term financing structure. To reduce the uncertainty of future cash flows and ensure access to assets, agreements such as right of first offer or call rights are common between the yieldco and the parent company. Yieldcos can continue to schedule drop downs for as long as the company wishes to maintain its tax advantaged status and sufficient supply of new operating assets exist [<a href="#references">15</a>] or until the business strategy dictates otherwise.</p> <h2 id="references">References</h2> <p>[1] Porter, L., Hurley, P., Bradley, D. (2013). &quot;Alternative Investment Structures.&quot; <em>Navigant</em>. Accessed July 29, 2013: <a href="http://www.navigant.com/~/media/WWW/Site/Insights/Energy/Alternative%20Investment%20Structures%20-%20Navigant%2011-13.ashx">http://www.navigant.com/~/media/WWW/Site/Insights/Energy/Alternative%20Investment%20Structures%20-%20Navigant%2011-13.ashx</a></p> <p>[2] Martin, K. (December 2013). &quot;Yield Cos Compared.&quot; Chadbourne &amp; Parke LLP.</p> <p>[3] Settle, E. (August 2014). Personal Communication.</p> <p>[4] NRG Yield, Inc. (February 2014). <em>Form 10-K Annual Report for the Fiscal Year ended December 31, 2013</em>. U.S. Securities and Exchange Commission.</p> <p>[5] Conneally, Tim. (July 2014). &ldquo;SunEdison&rsquo;s Transformative Solar Yieldco.&rdquo; Green Chip Stocks. Accessed July 22, 2014: <a href="http://www.greenchipstocks.com/articles/terraform-power-nasdaq-terp-ipo/2242">http://www.greenchipstocks.com/articles/terraform-power-nasdaq-terp-ipo/2242</a>.</p> <p>[6] Coster, P. (May 2014). <em>Clean Tech: YieldCo Primer</em>. J.P. Morgan North America Equity Research.</p> <p>[7] Goldman Sachs Group, Inc. (May 2014). &quot;YieldCo 101.&quot; Global Investment Research.</p> <p>[8] Rottman, M. (July 2014). Personal Interview.</p> <p>[9] Terzo, G. (November 2013). &quot;Moody's says YieldCos could put bondholders at risk.&quot; SNL.</p> <p>[10] Market Watch. (July 2014). &quot;SunEdison, Inc. and TerraForm Power, Inc Announce Closing of Initial Public Offering.&quot; <a href="http://www.marketwatch.com/story/sunedison-inc-and-terraform-power-inc-announce-closing-of-initial-public-offering-of-terraform-power-inc-and-related-transactions-and-exercise-of-underwriters-option-to-purchase-additional-shares-2014-07-23">http://www.marketwatch.com/story/sunedison-inc-and-terraform-power-inc-announce-closing-of-initial-public-offering-of-terraform-power-inc-and-related-transactions-and-exercise-of-underwriters-option-to-purchase-additional-shares-2014-07-23</a></p> <p>[11] Kaye Scholer LLP/Clean Energy Pipeline. (July 2014). U.S. Renewable Energy: Choices &amp; Challenges</p> <p>[12] TerraForm Power, Inc. (May 2014). <em>Form S-1 Registration Statement</em>. U.S. Securities and Exchange Commission.</p> <p>[13] &nbsp;Abengoa Yield, Plc. (April 2014). <em>Form F-1 Registration Statement</em>. U.S. Securities and Exchange Commission.</p> <p>[14] &nbsp;NRG Yield, Inc. (May 2014). &quot;Investor Presentation: Citi Global Energy and Utilities Conference.&quot;</p> <p>[15] Testa, D. (June 2014). &quot;Feed the Beast': YieldCo earnings prospects reliant on supportive renewables policy.&quot; SNL.</p> https://financere.nrel.gov/finance/content/deeper-look-yieldco-structuring#comments Wed, 03 Sep 2014 20:29:46 +0000 4111 at https://financere.nrel.gov/finance 1603 Data Lifts the Veil On PV System Performance https://financere.nrel.gov/finance/content/1603-data-lifts-veil-pv-system-performance <div class="field field-type-text field-field-blog-ss-title"> <div class="field-items"> <div class="field-item odd"> 1603 PV Project Data </div> </div> </div> <div class="field field-type-text field-field-blog-ss-teaser"> <div class="field-items"> <div class="field-item odd"> How are the 1603 program&#039;s PV projects performing? </div> </div> </div> <p>In the world of photovoltaic (PV) finance, historical performance data&mdash;or the lack thereof&mdash;stands as an obstacle to the risk assessment and credit evaluation of solar installations. Investors eyeing solar-backed securities or other investment vehicles might view the asset class cautiously without a firm, data-driven understanding of how solar assets perform (i.e., generate power) in the field and how this affects the cash flows that would ultimately backstop their investment.</p> <p>However, the National Renewable Energy Laboratory (NREL) has a trove of data which suggest that PV systems are, in the aggregate, performing better than expected in the field. These data are from systems installed using &quot;grant&quot; money from the 1603 Section of the American Recovery and Reinvestment Act which allowed for the conversion of investment tax credits into cash rebates. The data describe nearly 50,000 PV systems from 0.5 kW to 25 MW in size (with a median of 6 kW), representing a total of approximately 1.7 GW of installed capacity (see Figure 1 for the geographic distribution of these installations). Data points for each system include predicted yearly production values, actual yearly production values, zip code location, and comments regarding performance issues for each year of production.</p> <div style="width:500px; margin:20px auto;"><img height="384" width="500" alt="map showing geographic distribution of 1603 systems in this analysis" src="/finance/files/blog/20140424_blog1.jpg" /><br /> <p style="text-align:center;" class="caption">Figure 1. Geographic distribution of analyzed installations</p> </div> <p>How much better are these systems performing in the field than they were predicted to by independent engineers and developers? As shown in Table 1, they are producing on average 2% - 5% more energy than their targets.&nbsp;</p> <table cellpadding="3" width="100%" class="data"> <caption>Table 1. Median Ratio of Measured Over Predicted Values for All Data</caption> <tbody> <tr class="gray"> <th style="text-align:left">Median Measured/Predicted</th> <th>Year 1</th> <th>Year 2</th> <th>Year 3</th> <th>Year 4</th> </tr> <tr> <td>All Data</td> <td style="text-align:center">1.04</td> <td style="text-align:center">1.05</td> <td style="text-align:center">1.04</td> <td style="text-align:center">1.02</td> </tr> </tbody> </table> <p>Figure 2 displays the proportion of normal systems to systems that experienced identifiable issues. NREL has classified these issues into four types:</p> <ul> <li><strong>Project:</strong> Includes systems that incurred site-related issues, such as permitting delays, incidents where the PV system had to be removed because the roof was damaged (but not the PV installation), or the sale of a property</li> <li><strong>Hardware:</strong> Denotes systems with equipment problems, such as inverter outages.</li> <li><strong>Weather:</strong> Indicates problems associated with storm-related shutdowns, snow remaining on the systems, etc.</li> <li><strong>Data Collection:</strong> Comprises systems that had issues with the transmission of data and thus do not reflect the actual performance of the installed system.</li> </ul> <p>As shown in Figure 2, these issues affected less than 10% of projects in any given year, and became less prevalent as projects got older. Typically, the incidence of problems&mdash;e.g. project delays, out-of-the-box hardware flaws, and others&mdash;is highest in the initial months of operation. Actual performance-related issues &ndash;those that arose from system functioning and not as a result of initial failures&mdash;total only 1%&ndash;3% of all systems for each year.</p> <p>Note: the data points for this analysis decrease with each year, which reflects the newness of many of the 1603 systems. Only about 480, or less than 1% of the 48,259 systems in the dataset, have been operational for over four years.</p> <div style="width:800px; margin:20px auto"><img height="349" width="800" alt="Four Pie charts showing the percent of analyzed systems without any issues, and the percent of systems that experienced, Project, Hardware, Weather, or Data Collection issues by operational year" src="/finance/files/blog/20140424_blog2.jpg" /><br /> <p style="text-align:center;" class="caption">Figure 2. Charts of data for systems with and without issues partitioned by type of issue and years after installation</p> </div> <p>Figure 3 shows measured production data versus predicted production data for normal systems (black-filled circles) and for systems with issues (colored symbols). Because data collection issues do not necessarily reflect the performance of the PV system and can have a broad impact range depending on how soon the issue is resolved, they have been excluded. A unity line for the normal-system data is shown as a guide to the eye.</p> <div style="width:750px; margin:20px auto;"><img height="563" width="750" alt="Four scatter plots showing the distribution of system production in analyzed systems and the effect that issues have had on that production" src="/finance/files/blog/20140424_blog3.jpg" /><br /> <p style="text-align:center;" class="caption">Figure 3. Measured production versus predicted production for normal systems (red-filled circles) and for systems with issues (colored symbols). The &quot;Data Collection&quot; category has been excluded from this figure.</p> </div> <p>Project-related data points tend to lie farther away from the unity line. Therefore, although project- or site-specific issues may not occur as frequently as other categories, when they do occur they tend to have a larger impact on production than, for example, weather-related underperformance. In the first year, two-thirds of the project category anomalies are due to delays in permitting and constructions where cash flow has not yet commenced. In subsequent years, delays decrease to inconsequential levels, and the project category becomes dominated by operational issues.</p> <p>In conclusion, the data indicate that the large majority of systems operate under &quot;normal&quot; conditions, and to date these systems overproduce relative to the predicted value. And, at 1.7 GW of capacity&mdash;which is 13% of the roughly 13 GW of total PV U.S. capacity at the end of 2013&mdash;these 1603 projects can reasonably be viewed as a representative cross-section of the U.S. PV market.</p> https://financere.nrel.gov/finance/content/1603-data-lifts-veil-pv-system-performance#comments Solar Treasury cash grants Thu, 24 Apr 2014 15:47:00 +0000 3335 at https://financere.nrel.gov/finance Tapping Underserved Solar Markets: Can We Extend Solar Deployment into Customer Sectors with Lower or No Credit? https://financere.nrel.gov/finance/content/tapping-underserved-solar-markets-can-we-extend-solar-deployment-customer-sectors-lower-or-n <div class="field field-type-text field-field-blog-ss-title"> <div class="field-items"> <div class="field-item odd"> Tapping Underserved Solar Markets </div> </div> </div> <div class="field field-type-text field-field-blog-ss-teaser"> <div class="field-items"> <div class="field-item odd"> Can we extend solar deployment into customer sectors with lower or no credit? </div> </div> </div> <p>Distributed solar deployment is often a game of off-taker credit. That is, behind-the-meter project success depends largely on whether the end-use customer has credit sufficient to support a long-term power contract or lease.</p> <h2>Residential Sector</h2> <p>For residential customers, this often restricts deployment to those who own their home and have a relatively high credit rating, measured as their FICO score (FICO stands for Fair Isaac Corporation). Historically, residential solar adopters have been those with very high credit scores. For example, in the SolarCity securitization that transacted in November 2013 (which included systems installed from 2008 &ndash; 2013), residential customers in the portfolio had a minimum and average FICO of 680 and 762, respectively [1]. SolarCity applies other underwriting criteria as well such as the customer has not filed for bankruptcy within the prior five years. As shown in Figure 1, residential FICO ranges from roughly 300 &ndash; 850; SolarCity average customer score of 762 is near the upper end of the scale [2].</p> <div style="width:800px; margin:20px auto;"><img width="800" height="485" src="/finance/files/blog/fico_bin_ranges.jpg" alt="Bar chart displaying distribution of U.S. consumer FICO scores" /><br /> <p style="text-align:center"><strong>Figure 1: Distribution of U.S. consumer FICO scores</strong></p> </div> <p>Residential contracts represented 71% of the future cash flows aggregated through the SolarCity 2013 securitization, officially referred to Series 2013-1. Based on average cashflows for residential customers, I calculate there are about 4,525 residential systems in the securitization pool. There has been no disclosure on what proportion of the systems are leased vs. those that are on a power purchase agreement (PPA).</p> <p>One primary concern raised by rating agencies in the securitization of solar cash flows is whether the contracted payment (either through a lease or PPA) would continue to be paid for if there are homeowner changes, <em>e.g. </em>through a home sale, or in stress-related events such as death, divorce, or foreclosure. Even with the relatively high FICO scores represented in Series 2013-1, Standard &amp; Poor's (S&amp;P) &ndash; in it's presale ratings report &ndash; raised the issue of limited &quot;customer performance history,&quot; suggesting customers may stop paying for their old solar systems if they have the opportunity [1].</p> <p>However, the S&amp;P ratings report offers some insight into this risk. According to the report, 99% of contracted cashflows were recovered during normal sale events and 91% during all other events [1]. Normal sales represent 82% of all contract reassignments. Overall, <em>97% of cash flows from reassigned contracts were recovered</em>.</p> <p>But what will be the effect on asset recovery as solar developers sign lease or PPA contracts with residential customers who hold lower credit quality? Will the aggregated cash flows be more risky, and how will that impact the accessibility of capital market investment via securitization and other vehicles? In the SolarCity securitization referenced above, S&amp;P modeled several highly stressed scenarios including one where assumed residential customer defaults increased from 25% to 50% [1]. Even the reference assumption at 25% default rate is roughly 8x historical levels of default. Under the stressed case, S&amp;P's model indicated that the transaction could pay &quot;timely interest and full principal by rated final maturity&quot; of the debt securitization [1]. In other words, there was enough extra cash in the deal to pay off the interest on schedule and the principal by the end of the debt securitization period even if every other residential customer defaulted.</p> <p>Does that suggest that securitization offers a mechanism to expand the deployment of solar assets into customer segments with lower credit quality? It would appear there is sufficient integrity in the SolarCity securitization to withstand higher rates of default and continue full payment of the bonds. Clearly, the diversity of the pool offers a valuable credit enhancement to the overall repayment of the debt.</p> <p>Unfortunately, investors and rating agencies apply &quot;doomsday&quot; scenarios on credit defaults, inverter replacements, electricity price trends, and other uncertainties wherever data may be lacking to prove otherwise. The NREL-led initiative known as the <a href="https://financere.nrel.gov/finance/solar_securitization_public_capital_finance">Solar Access to Public Capital (SAPC</a>) working group is currently developing a dataset that illuminates the credit quality of solar as an investment asset class. Hopefully, the dataset will provide the necessary insight to attract a widening pool of investors.</p> <p>Importantly, solar is unique among securitized asset classes as, unlike credit cards and auto leases, solar systems allow customers to offset other costs. According to Danny Abajian, Senior Director, Project Finance for Sunrun, solar companies apply additional indirect forms of underwriting by ensuring customers are projected to save money in year one of the contract, and that contract escalators do not exceed historical increases in utility rates. If the solar contract is more expensive than utility power, Abajian notes, &quot;we do not underwrite that contract, or [we] require the customer to buy down their monthly rate by increasing their down payment. By doing this, we are creating a high likelihood of there being a system with an in-the-money contract regardless of the homeowner.&quot;</p> <h2>Commercial Sector</h2> <p>For commercial customers, there is no universal score akin to FICO, and this makes it difficult to assess their ability to pay back the expected contract payments. Most commercial entities do not have rated credit&mdash;when they borrow, the loan is secured by the various assets of the business such as the machinery and inventory. Most small-scale businesses&mdash;and even some large ones&mdash;do not have a credit rating from a national rating agency such as Standard &amp; Poor's, Moody's, or Fitch Ratings. Now consider the multitude of small-scale entities across our shopping centers, malls, restaurants, and other retail and wholesale enterprises, and it is easy to comprehend why solar has not proliferated broadly across the commercial sector.</p> <p>Commercial property is generally distinguished into four components by the real estate industry [3]:</p> <ul> <li>Office</li> <li>Retail</li> <li>Industry</li> <li>Multi-family housing</li> </ul> <p>The problem with placing solar on these properties is several-fold. First, there is credit. As mentioned above, small businesses don't have rated credit because they are not in the public markets for debt. The SolarCity securitization referenced above included only commercial and governmental customers with an investment-grade rating from a nationally recognized rating agency or it's equivalent [1].</p> <p>Second, there is long-term occupancy expectations. Businesses generally lease their space, and do so over relatively short time frames. The national average lease term for offices and industrial properties is 4 &ndash; 5 years [4], far shorter than the timeframe necessary for solar equipment cost recovery. Of course, this is true for real estate in general. But real estate is its own security &ndash; the asset can be resold with minimal loss in value. Solar property, however, is generally considered &ldquo;unsecured&rdquo; because much of the value is in the installation process. The conventional wisdom is that the cost to remove the panels and inverters and re-use them on another property is too high and thus not an economic alternative if systems are not paid for.</p> <p>Third, a large percentage of commercial property owners do not pay electricity costs associated with their properties. Commercial properties are contracted under what are called &quot;triple-net leases&quot; &ndash; whereby the tenants pay for taxes, insurance and interior maintenance &ndash; or other contractual structures that pass the cost of power to the tenant [5]. In these cases, solar installations only directly benefit the tenant and provide no direct incentive for the property owner. But tenants are not likely to purchase systems where they do not own the property and are uncertain of their tenancy over time.</p> <p>So, if solar-adopting end-users are not expected to remain in the properties, does it really matter if they have rated credit? Or alternatively, is there a better metric to evaluate whether a solar system on a commercial rooftop will produce cash flow as predicted? And last, if a solar system is expected to reduce power bills for the tenant, is it reasonable to assume it will do the same for the next tenant so long as the general usage doesn't change?</p> <p>With those questions in mind, I researched national and regional vacancy rates for commercial properties. According to the National Association of Realtors, the following vacancy rates (shown in Table 1) are projected for 2014 and 2015 and a few top markets in each category [3]:</p> <table cellspacing="0" cellpadding="3" class="data"> <caption>Table 1: Projected Vacancy Rates by Commercial Property Type 2014 &ndash; 2015, with Vacancy Rates for Top Markets in Q1 2014</caption> <tbody> <tr> <td> <p>&nbsp;</p> </td> <th scope="col">2014</th> <th scope="col">2015</th> <th colspan="3" scope="col">Top Markets &ndash; Q1, 2014</th> </tr> <tr> <td>Office</td> <td>15.7%</td> <td>15.5%</td> <td>Washington, D.C. (10.2%)</td> <td>New York City (9.5%)</td> <td>Little Rock, AR (11.6%)</td> </tr> <tr> <td>Industrial</td> <td>8.9%</td> <td>8.7%</td> <td>Orange County, CA (3.7%)</td> <td>Tampa / St. Pete. (7.5%)</td> <td>Miami, FL (5.8%)</td> </tr> <tr> <td>Retail</td> <td>10.0%</td> <td>9.8%</td> <td>San Francisco, CA (3.1%)</td> <td>Fairfield County, CT (3.8%)</td> <td>Long Island, NY (4.8%)</td> </tr> <tr> <td>Multi-family</td> <td>4.0%</td> <td>4.1%</td> <td>New Haven, CT (2.1%)</td> <td>Suburban, VA (3.6%)</td> <td>New York City (2.3%)</td> </tr> </tbody> </table> <p>All categories of commercial real estate are improving, and default rates in the best geographic regions are frequently in the low single digits. Interestingly, some of the areas listed in Table 1 are also some of the most active solar development regions as well.</p> <p>So here's the $64 million question: can commercial solar portfolios be designed for securitization whereby low vacancy rates and high economic value of the solar energy represents a material credit enhancement to the security?&nbsp; And if real estate can be developed without tenancy certainty over the life of the asset, can a solar facility with near zero operating costs be afforded the same benefit?</p> <p>REFERENCES:</p> <p>[1]: Standard and Poor's Rating Services, Ratings Direct. (2013). <em>Presale: SolarCity LMC Series I LLC (Series 2013-1) (2013)</em>. <a href="http://www.standardandpoors.com/spf/upload/Ratings_US/SolarCity_LMC_11_11_13.pdf">http://www.standardandpoors.com/spf/upload/Ratings_US/SolarCity_LMC_11_11_13.pdf</a></p> <p>[2]: Hyunh, F. (2014). &quot;US Credit Quality Continues to Inch Forward.&quot; <em>Banking Analytics Blog</em>. <a href="http://bankinganalyticsblog.fico.com/2014/02/us-credit-quality-continues-to-inch-forward.html">http://bankinganalyticsblog.fico.com/2014/02/us-credit-quality-continues-to-inch-forward.html</a></p> <p>[3] National Association of Realtors. (2014). <em>Commercial Real Estate Outlook, February 2014</em>. <a href="http://www.realtor.org/sites/default/files/commercial-real-estate-outlook-2014-02-28.pdf">http://www.realtor.org/sites/default/files/commercial-real-estate-outlook-2014-02-28.pdf</a> Sometimes, hotels are listed as an additional commercial property sector.</p> <p>[4] Rhowmine, A. (2009). &quot;Average Commercial Lease Term is Dropping.&quot; <a href="http://realestateambassador.com/2009/07/06/average-lease-term-is-dropping-commercial-real-estate-wausau-wisconsin/">http://realestateambassador.com/2009/07/06/average-lease-term-is-dropping-commercial-real-estate-wausau-wisconsin/</a></p> <p>[5] Biershenk, L.; Bierschenk, K.; Bierschenk, W. (2013). &quot;Singling Out Triple Net Leases.&quot; <em>Certified Commercial Investment Manager Institute (CCIM)</em>. <a href="http://www.ccim.com/cire-magazine/articles/singling-out-triple-net-leases">http://www.ccim.com/cire-magazine/articles/singling-out-triple-net-leases</a></p> https://financere.nrel.gov/finance/content/tapping-underserved-solar-markets-can-we-extend-solar-deployment-customer-sectors-lower-or-n#comments Solar Tue, 08 Apr 2014 17:32:37 +0000 Michael Mendelsohn 3334 at https://financere.nrel.gov/finance