The Emergence of a New Funding Structure Leveraging Alternative - - PowerPoint PPT Presentation

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Presenting a live 90-minute webinar with interactive Q&A

Solar Securitization: The Emergence of a New Funding Structure

Leveraging Alternative Financing Without Jeopardizing Existing Investor Tax Breaks

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific WEDNESDAY, APRIL 13, 2016

Andrew C. Coronios, Partner, Chadbourne & Parke, New York Eli M. Katz, Partner, Chadbourne & Parke, New York Gary P . Blitz, Esq., Senior Managing Director, Aon Transaction Solutions, New York Stephen J. Viscovich, Managing Director, Credit Suisse Securities, New York

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Solar Securitizations: Emergence

• f a New Funding Structure

Eli Katz, Chadbourne & Parke LLP Andrew Coronios, Chadbourne & Parke LLP Steve Viscovitch, Managing Director, Credit Suisse Securities Gary Blitz, Senior Managing Directing, AON Transaction Solutions

CPAM: 9290530

Agenda

• Solar Financing Landscape
• Role of Securitization
• Basics of a Securitization
• Securitizations without Tax Equity
• Securitizations with Tax Equity
• Risk Mitigation
• Key Risks
• Future of Solar Securitization

6

General Overview

7

Solar Financing Landscape

• Solar is largely deployed in the US with a third party ownership model
• Tax benefits in solar (30% ITC; accelerated depreciation) require tax

equity structures

• Partnership flips
• Lease Pass-throughs
• Sale-leasebacks
• In the distributed solar sector, systems are increasingly financed through

solar loans

• Borrower uses tax credits
• No third party ownership model necessary

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., 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 substitute for back-leverage debt

12

Key Deal Terms

• 7 solar securitizations have closed so far
• All transactions have been comprised of all or mostly residential solar

assets

• Over $800MM raised
• Close to 450Mw
• Some transactions have contained both A and B Tranches
• Advance Rates ranging from low 60’s to high 70’s
• Blended yields of low 4’s to low 6’s
• Minimum Fico Scores in underlying contracts well over 700
• Maturity less than 10 years across recent deals.

13

Securitizations to Date

Issue Interest Rate Tenor Rating Pricing Date Structure % Resi SolarCity LMC I $54,425,000 4.800% 13 Years S&P BBB+ 11/13/13 Directly owned 71% SolarCity LMC II $70,200,000 4.590% 8 Years ARD S&P BBB+ 04/03/14 Directly owned 87% SolarCity III $201,500,000 4.026% (A) / 5.45% (B) 8 Years ARD S&P BBB+ /BB 07/25/14 Inverted lease 100% SunRun $111,000,000 4.400% (A) / 5.38% (B) 9 Years ARD KBRA A/BBB 07/01/15 Inverted lease 100% SolarCity IV $123,500,000 4.180% (A) / 5.58% (B) 6.5 Years ARD KBRA A/BBB 08/07/15 Partnership flip 100% AES/MS $100,000,000 [TBA]%(A) / [TBA]%(B) [TBA] 10 Years ARD KBRA BBB/B 30% SolarCity FTE 1 $185,000,000 4.80% (A) / 6.85% (B) 6.25 Years ARD S&P BBB+ / NR KBRA BBB / BB 01/13/16 Customer loans 100% SolarCity LMC V $57,450,000 5.25% (A) / 7.50% (B) 6 Years ARD S&P BBB+ / BB KBRA BBB+ / BB+ 02/29/16 Inverted lease / directly owned 100% 14

Solar Securitization Basics

15

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
• Servicing and O&M Requirements
• Structure Requirements
• See prior slide regarding SPE status and security/control over cash flow
• 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.

• Company infrastructure
• Institutional commitment to build the whole company to support securitization

16

Basic Terms

• Minimum FICO ratings for individual residential customers and investment

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

• 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

17

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

18

Securitization Without Tax Equity

19

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 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 $$ 20

Securitization With Tax Equity

21

Interplay with Tax Equity

• Early deals were done with cash grants avoiding issues 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) Sponsor 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 V)

22

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 23

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

24

Risk Mitigation

25

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

26

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

27

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%

28

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%

29

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%

30

Key Risks

31

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
• Prevailing utility rates compared to contract escalation provisions
• Net metering (excess electricity sold into the grid)
• Competitors’ solar contract rates
• Technological
• Casualty risk

32

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

33

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.

34

The Future of Solar Securitization

• Will the product expand beyond residential solar?
• Solar C&I
• Document standardization
• Credit rating of offtakers
• Can the product co-exist in the long term with tax equity?
• Is there a need for the product while back-leverage terms remain

hospitable?

35

Thank You

Eli Katz, Chadbourne & Parke LLP ekatz@chadbourne.com Andrew Coronios, Chadbourne & Parke LLP acoronios@chadbourne.com Steve Viscovitch, Managing Director, Credit Suisse Securities stephen.viscovich@credit-suisse.com Gary Blitz, Senior Managing Directing, AON Transaction Solutions gary.blitz@aon.com

36