Solar-backed securities: opportunities, risks, and the specter of the subprime mortgage crisis.

• Author: Jacoby, Samantha

INTRODUCTION I. SOLAR FINANCING AND THE LEASE/POWER PURCHASE AGREEMENT MODEL A. Solar Market Background and Trends B. Solar Finance and Policy C. Solar Leasing Model 1. Solar Leasing Market 2. Potential Limitations of the Solar Leasing Model II. SOLAR-BACKED SECURITIES: OPPORTUNITIES AND RISKS A. Background on Securitization B. Potential Benefits of Solar Securitization for Lease Providers C. Potential Risks of Securitization 1. Solar-Specific Risks 2. Broader Market and Regulatory Risks III. RECOMMENDATIONS AND FUTURE OUTLOOK INTRODUCTION

Existing project financing structures utilizing the Investment Tax Credit (ITC) and depreciation benefits have helped spur growth in the solar industry but are insufficient on their own to enable the residential solar sector to scale up and become a mainstream energy source. In the span of only a few years, the solar market has grown from a fledgling niche industry to an important global player. Solar installations in the United States grew at an annual rate of 70% between 2005 and 2012. (1) Federal tax incentives and state-level subsidies have largely driven this growth. However, for reasons I explore in this Comment, these tax incentives and subsidies will be unable to sustain such rapid growth in the coming years, especially in the residential sector. If the solar industry is to continue to grow and become competitive with other energy sources, innovative private financing mechanisms are needed to allow residential solar developers to tap into capital markets and access new classes of investors (e.g., mutual funds, pension funds, and other institutional investors).

The securitization of solar leases presents a promising solution to this problem, but a variety of barriers currently prevent solar companies from securitizing these assets successfully. This Comment identifies and assesses these barriers and recommends strategies to promote low-cost securitization of residential solar leases while minimizing the potential risks that such securitization poses.

In Part I, I introduce the solar market, emphasizing in particular the current mechanisms to finance solar systems, the existing policies promoting solar energy, and the residential solar leasing model. In Part II, I present an overview of the asset-backed securitization process, outline how it might apply to solar leasing, and assess the risks and benefits of solar lease securitization. Finally, in Part III, I recommend strategies to reduce the risks posed by solar lease securitization and offer some predictions for the sector going forward. This Comment focuses primarily on residential solar systems but will also address some concepts common to commercial and utility-scale solar systems. Ultimately, I argue that while securitization is not a quick fix, it is a valid option for increasing liquidity and attracting new sources of capital to the solar leasing market.

1. SOLAR FINANCING AND THE LEASE/POWER PURCHASE AGREEMENT MODEL

   1. Solar Market Background and Trends

      Although the solar market consists of multiple technologies that harness the sun's energy in different ways, this Comment focuses specifically on solar photovoltaic (PV) technology. PV technology is used in three distinct market segments that generate power for different classes of customers: residential, commercial, and utility-scale end users. (2) Solar PV has traditionally accounted for a very small percentage of the total amount of electricity generated, but the PV industry has experienced rapid growth in the last few years and is expected to continue this trajectory through 2016. (3)

      In 2005, only 79 megawatts (MW) of solar PV were installed in the United States. (4) That number grew to 848 MW installed in 2010 and 3313 MW installed in 2012. (5) Annual installations for 2013 are expected to grow to 4300 MW (approximately 29% more than in 2012) and to more than 5000 MW in 2014. (6) The PV industry is projected to continue to grow rapidly through 2016--reaching nearly 9000 MW of installations in 2016--which indicates that the domestic solar market will expand by roughly 28% in each of the next three years. (7) By 2016, the United States will account for nearly 15% of global PV market share, up from about 7% in 2011. (8) Of the three market segments, the residential sector has shown the most consistent growth patterns--increasing by a steady but modest pace each quarter--and is expected to more than triple in size by 2016. (9) The following graph shows actual and projected annual installations by market segment from 2010 through 2016.

      However, it should be noted that the national data masks important state-level trends. Perhaps most important, states vary significantly in their levels of solar adoption. For instance, California has been the consistent market leader in the solar industry, with Arizona, New Jersey, Nevada, and Massachusetts rounding out the top five states for solar installations in 2012. (11) California also has the largest residential market, yielding a residential solar market more than three times the size of the residential market in the next largest state, Arizona. (12) Figure 2 depicts installed capacity in the top ten leading state markets.

   2. Solar Finance and Policy

      A number of federal tax incentives support the financing of renewable energy systems, which are still, in general, more expensive than traditional energy sources. (14) The primary driver of growth in the solar industry has been the Investment Tax Credit (ITC), which is a federal income tax credit worth 30% of the cost of solar energy systems. (15) To take advantage of the credit, however, solar developers must have some tax liability, but most solar developers lack sufficient tax liability to fully utilize the credit. (16) Unless modified, the 30% ITC will remain in effect until the end of 2016, when it will revert to a permanent 10% credit. (17) There is a similar 30% credit available for residential consumers who install on-site solar systems. (18)

      Businesses investing in renewable energy projects may also claim accelerated depreciation deductions. Under the Modified Accelerated Cost Recovery System (MACRS), businesses may recover investments in solar energy property through depreciation deductions on an advanced five-year schedule. (19) Solar systems are also eligible for 50% bonus depreciation until the end of 2013. (20) Bonus depreciation allows businesses to recover 50% of the project cost in the first year of service, with the remaining 50% deducted over the ordinary MACRS schedule. (21) These federal tax incentives-including both the ITC and MACRS--can provide a tax benefit that amounts to more than half of the upfront installed cost of a solar system. (22)

      Furthermore, a variety of state-level incentives exist to assist homeowners with upfront installation costs. (23) With few exceptions, (24) the states with significant solar markets are the ones that offer meaningful solar policies such as renewable portfolio standards, cash or tax incentives, and favorable regulatory environments. (25)

      Because most developers cannot utilize the tax credits and depreciation benefits themselves, they must incorporate third-party investors into the deals. (26) This type of equity financing (known as "tax equity financing") is primarily provided by banks, insurance companies, and a few large corporations, which provide upfront capital in exchange for the tax credits and depreciation deductions associated with the development of solar energy projects. (27) The tax equity financing model has given rise to a number of creative but complex structures that allow tax equity investors to achieve their desired returns and then return ownership to the developer, usually after five to seven years. (28)

      After the 2008 financial crisis, however, the number of institutions providing tax equity for renewable energy projects plummeted--from fourteen major providers to only five--as few companies retained the high tax liabilities necessary to make the tax credits attractive. (29) As a result, the renewable energy industry faced a liquidity crisis and entered an environment characterized by few tax equity investors and constrained global debt markets. (30) The tax equity funding available for renewable energy projects dropped from $6.1 billion before the financial crisis to $1.2 billion in 2009, severely limiting the ability of developers to finance new projects. (31)

      The American Recovery and Reinvestment Act (ARRA) attempted to ameliorate the effects of the financial crisis on the energy sector by creating the 1603 Treasury Program, designed to help renewable energy developers obtain financing without having to rely on scarce third-party tax equity financing. (32) This program, which was administered by the Treasury Department, allowed eligible renewable energy system owners to take a 30% upfront grant, rather than a tax credit. (33) The effect of this program was that any business that developed a renewable energy system could receive the grant--regardless of the business's tax liability. To date, the Treasury Department has allocated more than $19.3 billion in grant awards, including $4.7 billion for solar electric projects. (34)

      In general, financing has improved since the years immediately following the financial crisis. As noted above, the 1603 Treasury Program helped fill the gap left by the post--financial crisis tax equity shortage. (35) Additionally, the Department of Energy (DOE) Loan Guarantee Program (LGP), also an ARRA provision, was implemented to mitigate the effect of tightening credit markets. (36) The LGP provides loan guarantees for two distinct classes of clean energy projects: commercialized energy generation projects and innovative, precommercial manufacturing and generation facilities. (37) To date, $34.4 billion in loan guarantees have been issued to clean energy projects under the LGP, including $1.28 billion for four solar manufacturing facilities and...