Presenting a live 90-minute webinar with interactive Q&A Solar Securitization: Leveraging Alternative Financing Without Jeopardizing Existing Investor Tax Breaks TUESDAY, MAY 2, 2017 1pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: 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 The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10.
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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) o ITC was extended in late 2015 o 2016 2019, the ITC remains at 30% o 2020, the ITC steps down to 26% o 2021, the ITC steps down to 22% o 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; o o 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
be How it works: basic securitization structure Contracts creating assets (e.g., leases, loans) Obligors Originator Obligor Payments Cash Sweep Issuer Lockbox Servicing Agreement Pledge of all assets Excess Cash Flow Excess Cash Flow Issue Issuer (SPE) Issue True sale of assets Notes Delivery of Contracts Back-up Servicing Agreement Notes Custodian Back-up Servicer Indenture Trustee Issue ABS Investors P+I Payments 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 SolarCity LMC I $54,425,000 Structure % Resi 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 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+ Structure % Resi 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
16 Solar Securitization Basics
Key Requirements Consistency of assets o Similarities in credit quality, term, documentation Critical mass of assets o o o Securitization require sufficient pool size to justify transaction costs Overcollateralization Repeatable and scalable Structure Requirements o See prior slide regarding SPE status and security/control over cash flow Servicing and O&M Requirements Inspecting Engineer s Report Reporting o 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 o 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 o Additional underwriting requirements O&M provider to cover production and performance guarantees and equipment replacement Reserves o o Liquidity reserve Inverter replacement reserve Debt service coverage ratio o o 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 Host Customers Contracts (20/25 years) Install PV Systems Developer Host Customer Payments Cash Sweep 21 Issuer Lockbox Management Agreement Pledge of all assets Excess Cash Flow Issue true sale of contracts and PV Systems Contracts Custodian Issuer (SPE) Excess Cash Flow Issue Indenture Trustee Notes Delivery of Manager Transition Agreement Notes Issue P+I Payments Transition Manager ABS Investors
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
Host Customer Payments 24 How it works: solar securitization with tax equity inverted lease Maintenance Services Agreement Rent Host Customers Lease Lockbox Lessee Security Agmt Lessee Contracts Install PV Systems Lease / Assgt of Contracts Management Agreement Pledge of all assets Excess Cash Flow Excess Cash Flow Developer Original Lessor Issue Issuer (SPE) Issue Indenture Trustee true sale of lease and lessor rights in contracts and PV Systems Custodian Notes 100% equity Delivery of Contracts Manager Transition Agreement Notes P+I Payments Issue Transition Manager ABS Investors
How it works: solar securitization with tax equity partnership flip Developer ABS Investors Notes P+I Payments Issue Managing Member Distributions Indenture Trustee True Sale (Class A Membership Interests of each Managing Member Notes Excess Cash Flow Issue Excess Cash Flow Issuer (SPE) Sole Member Issue Custodial Agreement Manager Transition Agreement Custodian Transition Manager Managing Member No. 1 Tax Equity Investor No. 1 Managing Member No. 2 Tax Equity Investor No. 2 Managing Member No. 3 Tax Equity Investor No. 3 Managing Member No. 4 Tax Equity Investor No. 4 100% Class A Member 100% Class B Member 100% Class A Member 100% Class B Member 100% Class A Member 100% Class B Member 100% Class A Member 100% Class B Member Managing Member Distributions Financing Fund No. 1 Managing Member Distributions Financing Fund No. 2 Managing Member Distributions Financing Fund No. 3 Managing Member Distributions Financing Fund No. 4 Host Customer Payments Host Customer Payments Host Customer Payments Host Customer Payments Host Customers Host Customers Host Customers Host Customers 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 Scenario 1 Normal cash flow - basis is respected by IRS Tax Equity Investor Issuer Securitization Investor 35% 65% Normal Cash Flow Project Co Normal Cash Flow Note: Percentages are illustrative 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 Tax Equity Investor Issuer Securitization Investor 35% ` 65% Normal Cash Flow Project Co Normal Cash Flow 30
ABS Transaction Mitigate Cash Sweep Scenario 3 Same as Scenario 2, except Issuer fails to indemnify Tax Equity Investor Tax Equity Investor Issuer Securitization Investor Greater than 35% Less than 65% Increased Cash Flow Project Co Decreased Cash Flow due to Cash Sweep 31
ABS Transaction Mitigate Cash Sweep Scenario 4 Same as Scenario 3 except Tax Insurance replacing the Cash Sweep Tax Equity Investor Issuer Securitization Investor Greater than 35% Less than 65% Insurance Policy Proceeds Increased Cash Flow Project Co Decreased Cash Flow to Issuer; insurance proceeds to securitization investor 32
33 Key Risks
Solar Asset Risks Limited historical data Customer default and recovery rates O&M performance o Variability of costs over tenor of transaction o Production and performance guarantees o Panel, inverter and other equipment warranties o Inverter replacement o On-going system maintenance o O&M provider default: back-up or transition servicing Contract rate renegotiation risks selective default risk) o Prevailing utility rates compared to contract escalation provisions o Net metering (excess electricity sold into the grid) o 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