Project Bond Focus U.S. Residential Solar ABS 101 U.S. Residential Solar ABS 101 ABC Introduction and PPAs contracts is typically responsible for the installation and maintenance of the solar equipment throughout the term of the contract. Asset-backed securities (ABS) secured by residential solar financing contracts continue to emerge as a new sector of Leases the U.S. securitization market. The key drivers of expansion are the overall growth of the U.S. rooftop solar market, as Customers pay a fixed amount per month, generally well as institutional investors' increasing comfort for this escalating every year and benefiting from the production of new asset class. the panels installed by the developer providing the lease, regardless of actual consumption. The contracts typically The residential solar sector has experienced solid growth in include a minimum production guarantee to mitigate the risk recent years, with a peak of more than 2.5GW of capacity of equipment underperformance. The minimum production installed in 2016, representing approximately 325 thousand guarantee payments are typically made by the installers to households. After a 16% decrease in installation in 2017 the homeowner and do not reduce lease payments (no due to lower customer acquisition in California and netting). In some contracts, true-up payments at year-end Northeastern states, as well as regulatory uncertainty in may be required for over/under performance. Nevada, the residential solar market grew by 7% in 2018. Historically leading states seem to be transitioning to more PPAs stable growth rates, while Texas, Florida and Nevada are Homeowners pay every month for the actual solar energy experiencing higher growth. consumed with a cost per kilowatt-hour, typically escalating every year. In addition, PPAs often also include a US PV Installations GW (left), Number of Households (right) production guarantee where the homeowner is compensated if production falls below a certain threshold. 3,000 350,000 Solar Loans 300,000 2,500 Homeowners enter into loans to finance the purchase of 250,000 2,000 equipment as well as installation. Unlike leases and PPAs, 200,000 the customer owns the equipment and can claim associated 1,500 tax credits. Solar loans can be structured with payments 150,000 that mimic PPAs, where monthly payments are tied to 1,000 100,000 production but are typically structured with mortgage-style 500 amortization. Loans are usually structured with the 50,000 assumption that within 18 months after installation, the 0 - homeowner would have claimed the associated tax credits 2010 2011 2012 2013 2014 2015 2016 2017 2018 Source: GTM Research, Wood Mackenzie Power & Renewable, CA CIB and would prepay to solar loan in an amount equal to the tax credit received. Solar power generation only accounts for 1.9% of US Under leases and PPAs, the customer does not own the electricity generation in 2017, which underpins a potential solar equipment, which remains the property of the for significant growth in the coming years. As equipment developer or one of its affiliates. These contractual costs continue to go down and battery storage technology arrangements, referred to as Third-Party Ownership improves, electricity from solar sources is becoming more (“TPO”), allow the sponsor to monetize Investment Tax competitive, supporting growth in the coming years Credits (“ITC”) and accelerated depreciation associated irrespective of tax reform and the Investment Tax Credit with the equipment. TPO accounts for approximately 63% (ITC) sunset. of current installations in the US. Solar Contracts In all forms, the fundamental nature of the arrangement is a long-term payment obligation from the rooftop owner that Given the up-front costs associated with installing solar results in cash flow streams appropriate for securitization rooftop systems, homeowners typically obtain solar when aggregated in a sufficiently-diversified pool. In equipment through long-term contracts in the form of either addition, TPO has allowed Sponsors to finance their lease agreements, power purchase agreements (“PPAs”), portfolio with Tax Equity investors willing to monetize ITC or solar loans. These contracts are for 10 to 25 years with and/or accelerated depreciation. options to renew. The solar developer offering these leases May 2019 1 Confidential Project Bond Focus U.S. Residential Solar ABS 101 Tax Equity Solar ABS Tax Equity remains the primary source of financing for 2018 was a record-breaking year for Solar ABS with leases and PPA-based distributed solar in the U.S. with approximatively $2.21BN, up from $1.45BN in 2017. Solar more than $12BN worth of Tax Equity funds publically ABS continues to establish itself as a reliable source of debt announced since 2008. financing for the residential solar industry. 25 precedent Solar ABS transactions have been successfully closed Market participants have become familiar with Tax Equity since 2013, for an aggregate issuance volume of over structures, and both warehouse facilities and Term ABS $4.9BN across offerings of different sizes, tenors and have been successfully structured on the back of these ratings. Market highlights include: arrangements (i.e. “Back-Leverage”). Transaction sizes in the $50-400 million range. Tax Equity structures can be fairly complex but usually rely . Credit enhancement provided by a mix of on one of the three structures below: subordinated debt and sponsor equity resulting in an Partnership Flip average overcollateralization of 20% for senior tranches. A partnership is formed between the Tax Equity investor and sponsor in which the cash flow allocation varies over . Senior tranches rated in the BBB to AA range. time. The partnership is structured such that the Tax Equity . Subordinated tranches rated in the BBB+ to BB investor receives the majority of cash flows, and thus the range. ITC and accelerated depreciation benefits, for at least the . Mostly-residential portfolios (i.e. ~98% vs. 2% first five years of the transaction. The five-year period is the industrial) with average FICO scores in the range of typical minimum recapture period. After this period, once 730-770. the tax benefits have been fully monetized, the partnership “flips” and the sponsor receives the majority of the cash . Securitized contracts have mostly been a mix of flows. Solar Leases and PPAs (57% of the market). Below we discuss the above overarching trends in further Inverted Lease (Lease Pass-Through) detail. The simplest explanation is that the TPO provider leases the system to the Tax Equity investor, which then subleases Solar ABS (Volume in millions USD from 2013 to YTD 2018) the system to the homeowner. The TPO provider is able to pass through the ITC benefits to the Tax Equity investor, which provides the majority of the upfront capital and receives the ITC benefits and initial years’ customer cash flows, while the TPO provider receives customer cash flows in the out years. Sale-Leaseback In this structure, the Sponsor sells the solar systems in their entirety to the Tax Equity investor and then leases back the systems. The Tax Equity investor can fully monetize tax benefits associated to the systems since it is the actual owner of the equipment. The Sponsor then leases back the Source: CACIB and Kroll systems to the consumer. Historically, partnership flips have been the most common Transaction Size structure used in residential solar but inverted leases have As solar installations accelerate and portfolios grow, become more widely used in recent years. transaction sizes of Solar ABS have generally increased since the first transaction in 2013. Investors have also Given the relative complexity of the structures and the legal become more experienced with the asset class and larger costs associated with them, Tax Equity investors usually issuances can now be placed in the Capital Markets. Of require a minimum investment size between $50MM and note, transactions above $400MM have recently been $100MM, which makes this source of financing unsuited for placed. smaller portfolios. The majority of Tax Equity investors include banks and large corporations. May 2019 2 Confidential Project Bond Focus U.S. Residential Solar ABS 101 Solar ABS Solar ABS Transaction Size ($MM) Average FICO Score 500 Vivint 770 SolarCity 450 SunStrong 765 SolarCity 400 Sunrun Mosaic Tesla Mosaic 760 Vivint 350 SolarCity Dividend SunStrong Mosaic Sunrun 755 SolarCity 300 Dividend Loanpal Sunnova Mosaic Mosaic Dividend Mosaic 750 Tesla 250 SolarCity SolarCity CT Green Bank Average Sunnova Loanpal 745 200 Average SolarCity Mosaic 740 150 SolarCity 735 Mosaic Mosaic SolarCity Tesla Sunnova Sunrun 100 Sunrun SolarCity Dividend Dividend Sunnova SolarCity Dividend 730 SolarCity Tesla 50 SolarCity CT Green Bank 725 SolarCity - Nov-13 May-14 Nov-14 May-15 Feb-16 May-16 Nov-16 Feb-17 May-17 Aug-17 Feb-18 Aug-18 Feb-19 Aug-14 Feb-15 Aug-15 Nov-15 Aug-16 Nov-17 May-18 Nov-18 Feb-14 720 Feb-19 Nov-18 Aug-18 May-18 Feb-18 Nov-17 Aug-17 May-17 Feb-17 Nov-16 Aug-16 May-16 Feb-16 Nov-15 Aug-15 May-15 Feb-15 Nov-14 Aug-14 May-14 Feb-14 Nov-13 Source: CACIB and Kroll Source: CACIB and Kroll Advance Rate Portfolio Composition The advance rate represents the total debt raised as a percentage of the net present value of the contracted solar Portfolio Composition by Customer Type cash flows, or aggregate discounted solar asset balance Residential contracts account for the vast majority of (ADSAB) providing a liquidity cushion through portfolios financed with Solar ABS. While