The term asset-backed security (ABS) refers to any financial instrument that is collateralized (“backed”) by a pool of cash-flow-generating assets other than real estate and mortgages (Lowder and Mendelsohn 2013). Typically, these instruments are based on consumer receivables, such as payments on auto loans, credit card debts and student loans. Renewable energy leases, power purchase agreements and loan contracts—all of which can generate a steady cash stream from month to month—can be securitized into ABS instruments. However, solar photovoltaic (PV) technology has proven particularly amenable to securitization because it can be deployed in small units across a range of geographies to a range of offtakers. Aggregating these small units into larger portfolios allows for risk diversification that is more difficult to achieve with smaller portfolios of larger projects.
ABS securitization can help companies that own a large pool of assets refinance those assets in the capital markets at a lower cost than their existing financing. For example, consider a company that offers third-party finance options such as a power purchase agreement or lease to consumers to install solar systems on their rooftops. The company retains ownership of the solar assets and collects either lease payments or payments for energy from customers. Once the company amasses enough of these contracts, it can transfer them to a special purpose vehicle and issue securities against the expected value of the future cash flows. Investors purchase these asset-backed securities, essentially lending money to the company in the process; the company can use these funds for various purposes, including refinancing higher cost debt elsewhere in their capital structure or redeploying the capital to build new projects. The consumers who host the solar systems continue to pay their contracts monthly, and this cash is passed through the solar company (the securities “issuer”) to the special purpose vehicle and then ultimately distributed to investors in the form of principal and interest payments.
To offer securities in the capital markets, issuers may be required to meet certain criteria if they wish to seek an “investment grade” rating from the ratings agencies. An investment grade rating will allow the issuer to access debt at a lower interest rate, which will reduce their overall cost of capital. Issuers may also need to meet criteria that may not necessarily impact the rating but will satisfy investors so that the securities will sell. Such criteria could include credit enhancements, deal volume, standardization and market infrastructure
These are structures built into the securitization that protect investors from defaults, underperformance and other events that could affect the portfolio of assets. The stronger the credit enhancement, the higher the rating, though some of the “veteran” asset classes such as student loans and credit card receivables may receive investment grade ratings without as much credit enhancement as newer asset classes like solar ABS may require. Types of credit enhancements include:
- Overcollateralization: Additional assets are placed into a securitization pool, but are not leveraged. In other words, their value is not counted in the overall size of the securities issuance, but they remain in the collateral pool as backup in case the pool underperforms. For example, in the first rated securitization of distributed solar assets in the United States, SolarCity’s Series 2013-I, 38% of the assets in the portfolio were retained as overcollateralization and only 62% was advanced in the market as collateral for securitization debt.
- Reserve Accounts: These are accounts that receive a certain amount of cash from the consumer payments and generally before the ABS investors receive their principal and interest payments.
- Excess Spread: This is the difference between the interest rate on the assets before and after they were securitized. Securitization should offer issuers a lower interest rate than the financing that the company previously used to acquire the assets. This makes the issuer credit positive, theoretically providing them more available cash to step in if the asset pool experiences any distress.
Generally, ABS investors prefer large issuance volumes in the range of $500 million USD to $2 billion USD (Lowder and Mendelsohn 2013). Smaller deal volumes may not offer investors the kind of absolute returns required. Moreover, issuers benefit from larger deal sizes, as they keep transaction costs (e.g., legal fees, financial structuring, securities regulation compliance) proportionally low to the issuance amount. Given these conditions, it is interesting that the six solar ABS deals that have come to market in the United States have ranged in size from $54 million to $201 million (average size is $109 million), which is well below the level at which investors might normally take interest. It is possible that other motivating factors, such as sustainability goals, or fund allowances for “unconventional assets” may be influencing investor decisions in these small solar deals.
Given the limited deployment of solar in most markets around the world, it can be difficult for one issuer to amass a large enough portfolio to make securitization an economical option. It is possible that financial aggregators—in essence, funds that purchase solar assets with the eventual intent of securitizing the portfolio—could act as a pathway to the capital markets for smaller developers. However, this approach has not been widely applied in the marketplace. The existence and success of these aggregators will depend in part on the standardization of (1) contracts (e.g., leases and power purchase agreements, operations and maintenance agreements), (2) project technical evaluation criteria, (4) offtaker creditworthiness assessments and (4) other crucial metrics.
Standardization is one area where policymakers may assist in enabling renewable energy asset developers and owners access to the capital markets through ABS and other instruments. Establishing laws, promulgating best practices and pursuing a unified system of documentation can help ensure that projects can be aggregated and evaluated without a lengthy and costly due diligence process. This is critical to the development of a multi-issuer marketplace, which is how developers in some countries may have to access the securitization markets because of limited renewable energy development or capital markets access in their own. By facilitating project acquisitions, portfolio transparency and the credit ratings process, a strategic push to standardize various aspects of the project development and finance process has the potential to bring a significant amount of liquidity to the renewable energy industry.
The laws, regulations, financial engineering techniques, credit ratings methodologies, investor sophistication and other aspects of the securitization markets are all very well established in the United States after several decades of operation. Several other countries, particularly European countries, have active securitization markets as well, though the total value of outstanding European ABS was less than 0.15% in outstanding U.S. ABS in the first half of 2015 (SIFMA 2015). Other countries, such as China and Singapore have securitization markets as well, but these are similarly dwarfed by activity in the United States.
Without a mature and robust market infrastructure, securitization can be an exceedingly difficult strategy for any issuer—not just renewable energy developers. It is therefore likely that if ABS securitization were to become a viable strategy to term-finance renewable energy assets in emerging economies, that financial aggregators may need to play a significant role by bundling projects and bringing them to the major financial centers of the world.
- SolarCity Completes Industry’s First Securitization of Distributed Solar Energy, 21 January 2016
- SolarCity Announces Pricing of Second Securitization, 3 April 2014
- SolarCity Announces Pricing of Third Securitization, 25 July 2014
- SolarCity Completes Fourth Securitization Offering, 13 August 2015
- SolarCity Plans to Offer Asset-Backed Debt to Retail Investors, 15 January 2014 (subscription required)
- AES Launches Asset-Backed Securities Based on Portfolio of Distributed Solar Generation25 September 2015
Lowder, Travis, and Mendelsohn, Michael. 2013. “The Potential of Securitization in Solar PV Finance.” Golden, CO: National Renewable Energy Laboratory.