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Solar Securitization: Leveraging Alternative Financing Without Jeopardizing Existing Investor Tax Breaks

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1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific TUESDAY, MAY 2, 2017

Gary P . Blitz, Esq., Senior Managing Director, Aon Transaction Solutions, New York Andrew C. Coronios, Partner, Chadbourne & Parke, New York Matthew Brand, Director, Credit Suisse Securities, New York

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Solar Securitizations: Leveraging Alternative Financing Without Jeopardizing Existing Investor Tax Breaks

Andrew Coronios, Partner, Chadbourne & Parke LLP Matthew Brand, Director, Credit Suisse Securities Gary Blitz, Senior Managing Director, AON Transaction Solutions

Agenda

• Solar Financing Landscape
• Role of Securitization
• Basics of a Securitization
• Key Requirements
• Securitizations without Tax Equity
• Securitizations with Tax Equity
• Asset and structure risks
• Tax Insurance
• Future of Solar Securitizations

6

Solar Financing Landscape

• Distributed solar (both residential and commercial & industrial) was largely

deployed in the US with a third party ownership model

• No money down 20 year contracts with homeowner (lease or PPA)
• Developer retains ownership of the PV systems and related tax benefits (30%

ITC and accelerated/bonus depreciation)

• ITC was extended in late 2015
• 2016 – 2019, the ITC remains at 30%
• 2020, the ITC steps down to 26%
• 2021, the ITC steps down to 22%
• 2022 and later, the residential credit drops to zero and the commercial and utility credit

steps down to a permanent 10%.

• Developer typically retained O&M responsibility for life of contract
• Monetizing tax benefits requires tax equity structures
• Partnership flip
• Lease pass-through or inverted lease
• Sale-leaseback

7

Solar Financing Landscape (Cont’d)

• In residential distributed solar, systems are increasingly financed through

solar loans

• Homeowner/borrower uses tax credits – often with option to prepay loan with

tax savings

• Homeowner responsible for O&M although some installers offer extended

warranties or service contracts (directly or through third-parties)

• Estimates vary but market participants have estimated loans to account for

30%-50%+ of the residential solar market

8

Solar Financing Landscape (Cont’d)

• Optimal capital structures in solar financings often involve non-recourse

financing at entity above the tax equity (i.e.,back-leverage)

• Back-leverage does not subordinate tax equity
• Does not risk ITC recapture;
• Transfers
• Entity Foreclosure
• Avoids complex inter-creditor terms and attracts more tax equity sources;
• Back-leverage is non-recourse debt secured by the developer’s cash

equity position in a solar system;

• More expensive than project level debt
• Shorter tenors (7-10 years)
• Still involves negotiation with Tax equity provider

9

The Securitization Markets

• Securitization is a technique to pool assets (usually financial receivables)

into a special purpose vehicle which then issues securities to investors

• Auto loans
• Credit card receivables
• Home mortgage loans
• A securitization vehicle has a number of advantages:
• Cheaper cost of capital
• Risk diversification to investors
• Public rating increases pool of investors
• Tends to work best with assets that have/are:
• Predictable cash flows
• Long and Successful track record
• Easy to administer
• Highly fungible

10

How it works: basic securitization structure

be Originator Obligors

True sale

• f assets

Issuer

(SPE)

Contracts creating assets (e.g., leases, loans)

Issue $$

Indenture Trustee ABS Investors

Notes Notes

Servicing Agreement Pledge of all assets

Issuer Lockbox

Obligor Payments $$ Cash Sweep $$

Issue $$

P+I Payments Excess Cash Flow $$ Excess Cash Flow $$

Custodian

Delivery of Contracts

Back-up Servicer

Back-up Servicing Agreement Issue $$

11

Solar Securitizations

• Securitizations in solar are primarily aimed at leveraging cash flows from

cash equity or customer loans

• Focused on the residential solar market
• Fungible assets
• Standardized documents
• Financing easily fits consumer receivables;
• Solar C&I segment continues to explore use of this financing vehicle
• Can be viewed as a alternative to term back-leverage debt

12

Solar Securitizations to Date

• 10 solar securitizations have been executed into the ABS capital markets
• All transactions have been comprised of all or mostly residential solar

assets

• Nearly $1.1bn raised
• Close to 660MW
• Some transactions have incorporated multi-tranche structures, including

up to 3 classes of notes offered

• Advance Rates to the senior investment grade tranche ranging from mid

~60’s to high ~70’s

• Blended yields to the senior investment grade tranche of mid/high 4’s,

depending upon the tenor

• Minimum Fico Scores in underlying contracts well over 700
• Maturity less than 10 years across recent deals.

13

Securitizations to Date

Issue Coupon WAL Rating Pricing Date Structure % Resi SolarCity LMC I $54,425,000 4.80% ~7.0yr S&P: BBB+ 11/13/13 Directly owned (Lease/PPA) 71% SolarCity LMC II $70,200,000 4.59% ~6.6yr S&P: BBB+ 04/02/14 Directly owned (Lease/PPA) 87% SolarCity LMC III $201,500,000 4.02% (A) 5.44% (B) ~7.0yr S&P: BBB+ / BB 07/24/14 Inverted lease (Lease/PPA) 86% Sunrun Callisto $111,000,000 4.40% (A) 5.38% (B) ~7.0yr (A) ~7.5yr (B) KBRA: A / BBB 06/30/15 Inverted lease (Lease/PPA) 100% SolarCity LMC IV $123,500,000 4.18% (A) 5.58% (B) ~6yr (A) ~6.5yr (B) KBRA: A / BBB 08/07/15 Partnership flip (Lease/PPA) 100% SolarCity FTE 1 $185,000,000 4.80% (A) 6.85% (B) ~5.8yr (A) ~6.0yr (B) S&P: BBB / NR KBRA: A / BBB- 01/13/16 Directly owned (Solar Loan) 100% SolarCity LMC V $57,450,000 5.25% (A) Retained (B) ~6.0yr (A) ~6.6yr (B) S&P: BBB / BB KBRA: BBB+ / BB+ 02/24/16 Inverted lease & directly owned (Lease/PPA) 100% 14

Securitizations to Date

Issue Coupon WAL Rating Pricing Date Structure % Resi SolarCity FTE 2 $145,000,000 4.97% (A) 6.09% (B) 7.50% (C) ~5.4yr (A) ~5.6yr (B) ~4.2yr (C) KBRA: A- / BBB / BB+ 01/20/17 Directly owned (Solar Loan) 100% Mosaic Solar 2017-1 $138,950,000 4.45% ~4.1yr KBRA: A 02/02/17 Directly owned (Solar Loan) 100% Sunnova 2017-1 $254,750,000 4.94% (A) 6.00% (B) 8.00% (C) ~6.0yr (A) ~6.0yr (B) ~3.8yr (C) KBRA: A / BBB / NR 04/11/17 Directly owned (Lease/PPA) 100% 15

Solar Securitization Basics

16

Key Requirements

• Consistency of assets
• Similarities in credit quality, term, documentation
• Critical mass of assets
• Securitization require sufficient pool size to justify transaction costs
• Overcollateralization
• Repeatable and scalable
• Structure Requirements
• See prior slide regarding SPE status and security/control over cash flow
• Servicing and O&M Requirements
• Inspecting Engineer’s Report
• Reporting
• Servicer reports covering not only financial performance of the assets, but also

defaults, restructurings, casualty, inverter replacement, other repairs, panel performance etc.

17

Basic Terms

• Company infrastructure
• Institutional commitment to build the whole company to support securitization
• Minimum FICO ratings for individual residential customers and investment

grade or equivalent ratings for non-residential customers originated in compliance with consumer finance regulations

• Additional underwriting requirements
• O&M provider to cover production and performance guarantees and

equipment replacement

• Reserves
• Liquidity reserve
• Inverter replacement reserve
• Debt service coverage ratio
• First trigger traps excess cash flow in DSCR reserve
• Second trigger at lower DSCR causes early amortization event – all excess cash flow

applied to pay down principal

18

Basic Terms cont.

• Advance rates from 60’s to 70’s as % of discounted cash flows
• Ratings limitations - because of limited operating history S&P expects

ratings to be constrained to low investment-grade for the near future

19

Securitization Without Tax Equity

20

How it works: solar securitization - no tax equity

Developer Host Customers

true sale of contracts and PV Systems

Issuer (SPE)

Install PV Systems Contracts (20/25 years) Issue $$

Indenture Trustee ABS Investors

Notes Notes Management Agreement Pledge of all assets

Issuer Lockbox

Host Customer Payments $$ Cash Sweep $$ Issue $$ P+I Payments Excess Cash Flow $$ Excess Cash Flow $$

Custodian

Delivery of Contracts

Transition Manager

Manager Transition Agreement Issue $$ 21

Securitization With Tax Equity

22

Interplay with Tax Equity

• Securitizations are not a replacement for tax equity
• Tax equity will generally require (i) some cash flow; (ii) ITC recapture

protection; (iii) protection on tax basis

• Contractual interplay with tax equity is similar to back-leverage lender
• Cash flow sweeps
• Indemnities
• Securitization with certain tax equity structures such as inverted leases can be

structured to avoid issues with tax equity with consent of tax equity (LMC III & LMC V; SunRun)

• Securitizations with other tax equity structures such as partnership flips can be

structured to accommodate existing tax equity requirements (LMC IV)

23

Original Lessor Host Customers

true sale of lease and lessor rights in contracts and PV Systems

Issuer

(SPE)

Install PV Systems Contracts

Issue $$

Indenture Trustee ABS Investors

Notes Notes

Management Agreement Pledge of all assets

Lessee

Host Customer Payments $$ Rent $$

Issue $$

P+I Payments Excess Cash Flow $$ Excess Cash Flow $$

Custodian

Delivery of Contracts

Transition Manager

Manager Transition Agreement Issue $$

Lease Lockbox

Developer

Lease /

Assgt of Contracts

Maintenance Services Agreement

Lessee Security Agmt

100% equity 24

How it works: solar securitization with tax equity – inverted lease

How it works: solar securitization with tax equity – partnership flip

Developer Issuer (SPE)

True Sale (Class A Membership Interests of each Managing Member

Indenture Trustee

P+I Payments Notes Issue $$

Transition Manager Custodian

Manager Transition Agreement Custodial Agreement Issue $$ Notes Managing Member No. 1

ABS Investors

Tax Equity Investor

• No. 1

Financing Fund

• No. 1

Host Customers

Managing Member Distributions $$ Managing Member Distributions $$

Managing Member No. 3 Managing Member No. 2

Tax Equity Investor

• No. 2

Host Customer Payments

Financing Fund

• No. 2

Financing Fund

• No. 3

Financing Fund

• No. 4

Host Customers Host Customers Host Customers Issue $$

100% Class A Member 100% Class A Member 100% Class A Member 100% Class A Member 100% Class B Member 100% Class B Member 100% Class B Member 100% Class B Member Excess

Cash

Flow $$

Excess Cash Flow $$

Managing Member Distributions $$ Managing Member Distributions $$ Managing Member Distributions $$ Host Customer Payments Host Customer Payments Host Customer Payments Tax Equity Investor

• No. 3

Managing Member No. 4

Tax Equity Investor

• No. 4

Sole Member

25

Risk Mitigation

26

Tax insurance

What is tax insurance? Tax liability or tax opinion insurance can help a company reduce or eliminate an unwanted or contingent liability arising from a successful challenge by the I.R.S. or a foreign or state and local tax authority of a company’s tax treatment of a current, pending or historical transaction or investment. What is covered?

• Failure of the insured to achieve the expected tax treatment in a

transaction (M&A, lease, partnership or financing transaction) or an existing/ongoing corporate tax issue

• U.S., state, local or foreign taxes
• Retroactive change in law
• Tax, contest costs, interest, penalties and gross-up

27

Tax insurance – Case Study

Solar Energy ITC/ Protect tax credit equity

The Situation

• A tech company sought to invest in a fund sponsored by a solar energy company that would, in

turn, invest in a portfolio of residential and commercial projects.

• The sponsor provided standard warranties and indemnities to the tech company
• Because the investment was outside its core business, the tech company required additional

protection that the projected investment tax credit and other tax benefits would be received and not lost due to a recapture event. The Solution

• Tax Insurance was used to assure the investor that:
• the investment vehicle would be respected as a pass-through entity,
• that the solar facilities would qualify for the investment tax credit and the tax basis would

be respected, and

• that there would not be a tax loss due to recapture.
• The Tax Insurance policy has a limit equal to the amount of projected tax benefits and provides

coverage through the end of the recapture period. NOTE: In Rev. Proc. 2014-12, Treasury advised that tax insurance is a preferred means of protecting the investor over sponsor guarantees.

28

ABS Transaction – Mitigate Cash Sweep

Project Co Tax Equity Investor Issuer Normal Cash Flow Normal Cash Flow Securitization Investor 65% 35% Note: Percentages are illustrative

Scenario 1 – Normal cash flow - basis is respected by IRS

29

ABS Transaction – Mitigate Cash Sweep

Scenario 2 – Same as Scenario 1 except Basis is not respected by IRS (Final Adjudication); Issuer indemnifies Tax Equity Investor

Project Co Tax Equity Investor Issuer ` Normal Cash Flow Normal Cash Flow Securitization Investor 65% 35%

30

ABS Transaction – Mitigate Cash Sweep

Scenario 3 – Same as Scenario 2 , except Issuer fails to indemnify Tax Equity Investor

Project Co Tax Equity Investor Issuer Increased Cash Flow Decreased Cash Flow due to Cash Sweep Securitization Investor Less than 65% Greater than 35%

31

ABS Transaction – Mitigate Cash Sweep

Scenario 4 – Same as Scenario 3 except Tax Insurance replacing the “Cash Sweep”

Project Co Tax Equity Investor Issuer

Increased Cash Flow Decreased Cash Flow to Issuer; insurance proceeds to securitization investor

Securitization Investor

Insurance Policy Proceeds

Greater than 35% Less than 65%

32

Key Risks

33

Solar Asset Risks

• Limited historical data
• Customer default and recovery rates
• O&M performance
• Variability of costs over tenor of transaction
• Production and performance guarantees
• Panel, inverter and other equipment warranties
• Inverter replacement
• On-going system maintenance
• O&M provider default: back-up or transition servicing
• Contract rate renegotiation risks selective default risk)
• Prevailing utility rates compared to contract escalation provisions
• Net metering (excess electricity sold into the grid)
• Competitors’ solar contract rates
• Technological obsolescence
• Casualty risk

34

Structure Risks

• Learning curve for investors
• Concentration risks
• Residential - market
• C&I – obligor and market
• Tax Equity – Inverted Lease
• Liens on assets
• Investors more easily understand lessee risks (e.g., bankruptcy of lessee)
• Subordination of tax basis adjustment risk to securitization (SolarCity III and

SunRun)

• Tax Equity – Partnership Flips
• No liens on assets – structural subordination
• Bankruptcy risks of partnership and managing member
• Obligations between tax equity investor and developer managing member
• Tax basis adjustment risk - mitigated through tax loss insurance policy
• Flip dates / option to purchase tax equity investor’s interest
• Liquidity risks

35

Pros/Cons - Securitization

• Lower advance rate than back-leverage debt
• Credit standards are tighter
• Lower cost of capital
• More flexibility to spread risk through tranching mechanics
• Larger pool of investors
• Priming pump for when ITC expires

36

The Future of Solar Securitization

• Can the product co-exist in the long term with tax equity?
• Is there a need for the product while back-leverage terms remain

favorable?

• PACE
• Will the product expand beyond residential solar?
• Solar C&I
• Document standardization
• Credit rating of offtakers

37

Thank You

Andrew Coronios, Partner, Chadbourne & Parke LLP acoronios@chadbourne.com Matthew Brand, Director, Credit Suisse Securities matthew.brand@credit-suisse.com Gary Blitz, Senior Managing Directing, AON Transaction Solutions gary.blitz@aon.com

38