“Best Renewable Asset M&A Advisor”- Power Finance & Risk
Investment Bankers for Global Energy and Infrastructure Markets
The Solar Securitization Opportunity
March 2016
Contacts & Disclaimer
2
Ted Brandt Chief Executive Officer
(847) 574-2677 [email protected]
Terry Grant Managing Director
(415) 839-0066 [email protected]
Josh Cornfeld Associate
(847) 574-2698 [email protected]
Marathon Capital, LLC www.marathon-cap.com
This White Paper presentation (“White Paper”) has been prepared by Marathon Capital, LLC and Marathon Capital Markets, LLC (collectively, “Marathon Capital”) solely for discussion and evaluation purposes. The White Paper should not be used as a basis for trading in the securities or loans of the companies named herein or for any other investment decision. This document does not constitute an offer to sell securities and should not be construed as investment advice. The White Paper does not constitute a recommendation or take into account the particular investment objectives, financial situation or particular needs of the investor.
The White Paper is conveyed by Marathon Capital based on our belief that the recipient can independently evaluate investment risks and is using independent judgment in its evaluation process.
Although reasonable care has been taken to ensure that the information given in this White Paper is accurate, it has not been independently verified. Accordingly, no representation or warranty, expressed or implied, is made in relation to the accuracy or completeness of the information and opinions expressed in this White Paper and, to the maximum extent permitted by law, any and all liability in respect of such information and opinions is hereby expressly excluded, including, without limitation, any liability arising from fault or negligence, for any loss arising from the use of this information or otherwise arising in connection with it.
Marathon Capital makes no representation or warranty, express or implied, as to the accuracy or completeness of the information contained in this White Paper.
This material is not for distribution.
About the Authors
3
Ted Brandt Chief Executive Officer
Ted Brandt is co-Founder and Chief Executive Officer of Marathon Capital, a Chicago-based investment banking boutique focused on the global Energy and Infrastructure
markets. The firm provides financial advice in the areas of M&A, structuring and capital raising of debt, equity, project financing and tax equity, and restructuring/recapitalization,
bankruptcy and workout situations. Marathon Capital is a two-time recipient of the “Best Renewable Asset M&A Advisor” award in Power Finance & Risk’s Annual Power
Finance Deals and Firms Awards (2013 & 2014).
Mr. Brandt spends the majority of his time working with his colleagues at Marathon Capital to deliver the Firm’s M&A, structuring and capital raising services to clients and their
Boards. The firm’s recent noteworthy engagements include Advisor to the Board of Managers on the sale of First Wind Holdings to SunEdison and TerraForm, Advisor to Suzlon
on the sale of the 240 MW Big Sky Wind Project to Everpower, Advisor to American Wind Capital on the sale of the company and portfolio to Hannon Armstrong, Advisor to
Rockland Capital on the Tax Equity Financing of the Lakeswind Wind Project, and Advisor to Santander on the Tax Equity financing of the El Centro Solar Project.
Prior to Marathon Capital, Mr. Brandt held various senior management positions within large non-bank finance and leasing companies including: GE Capital, Dana Commercial
Credit, and Transamerica. During this 15-year period Mr. Brandt had start-up responsibility for leasing units, hands-on turnaround assignments, and opportunities to create and
execute a variety of manufacturer vendor programs. Mr. Brandt also actively worked on the buying and selling of specialty commercial finance units during this time.
Mr. Brandt received a BA in Economics from Oberlin College, an MBA from the University of Chicago Booth School of Business, and holds his Series 7, 24, 63, 79 and 99 securities
licenses.
Josh Cornfeld Associate
Josh Cornfeld is an Associate responsible for creating detailed financial models, conducting due diligence, evaluating transactional risk/return parameters, and preparing
investment marketing materials in support of Marathon Capital's senior bankers in their relationship management responsibilities. Prior to joining Marathon, Mr. Cornfeld
worked as a Summer Associate at GTM Research, the leading provider of market intelligence for the solar industry, where he analyzed the impact of proposed state-level solar
policies on industry competitiveness. Mr. Cornfeld was also awarded a Dow Sustainability Fellowship, for which he conducted a project on valuing solar energy in Michigan for
the Michigan Public Service Commission. Prior to business school, Mr. Cornfeld was a Hamilton Fellow at the U.S. Treasury Department.
Mr. Cornfeld graduated with honors from the University of Pennsylvania with a BA in Economics and a concurrent Master of Environmental Studies. Mr. Cornfeld also completed
his MBA at the University of Michigan Ross School of Business where he graduated with High Distinction. Mr. Cornfeld holds his Series 63 and 79 licenses.
Terry Grant Managing Director
Terry Grant is Managing Director based in San Francisco, focusing on the power, alternative energy and energy technology sectors – he leads the solar market practice for
Marathon Capital. Prior to joining Marathon Capital, Mr. Grant was a Managing Director with FBR Capital Markets focused on alternative energy and power portfolio
restructurings in the Energy Group. Mr. Grant originally joined FBR in 1997 and founded the equity research practice in energy, covering the IPP and non-utility generation sub-
sectors. From 2000-2005, Mr. Grant was involved in energy technology investment ventures both investing, and offering financial advisory services for energy technology and
power asset companies. He founded and served as Portfolio Manager in a hedge fund focused on the energy sector. Prior to FBR, Mr. Grant held a variety of positions at US
Generating Company – a PG&E and Bechtel partnership in the energy sector. He was involved in project financings totaling over $2 billion, corporate M&A work, and was
responsible for project development for the South Western Region of the United States.
Mr. Grant received his BA from Wake Forest University and his MBA from the Babcock Graduate School of Business at Wake Forest University. Mr. Grant holds Series 7, 24, 63
and 79 licenses.
4
Table of Contents
Sections
I. Executive Summary 5
II. Marathon Capital Overview 10
III. Solar Securitization Primer 13
IV. Market Activity Review 18
V. Process Considerations 24
VI. The Future of Solar Securitization 32
Section I
Executive Summary
White Paper Outlook
The age of solar securitization has arrived: 2015 was the first year that multiple distributed solar financiers
attempted issuances. While most issuances closed, others are on hold or have failed
Distributed solar financiers are now weighing whether to adopt securitization as the terminal financing
strategy for monetizing cash equity positions as opposed to outright asset sales
In this White Paper, Marathon Capital seeks to use its unique position in the renewables financing market
to simplify the future of solar securitization with an overarching goal of exploring how distributed solar
financing trends are impacted by its emergence
– Solar Securitization Primer explores securitization financing, evaluates its pros and cons and describes
an issuance’s general cashflow profile. This section also examines considerations developers should
weigh as well as obstacles to overcome before pursuing a securitization strategy
– Market Activity Review summarizes the key characteristics of completed transactions and examines the
factors that influence issuance pricing and advance rates
– Process Considerations examines several prerequisite characteristics for originators, including minimum
issuance sizes, tax equity considerations, process timeframe, rating agency criteria, transaction fees and
accounting impacts
– The Future of Solar Securitization presents analysis on the short-term and long-term outlook for solar
securitization and reviews the critical obstacles that the industry must work together to overcome for
solar securitization to reduce costs, increase leverage and become more efficient
6
The Solar Securitization Opportunity
1. ITC extension should enable an extended, profitable growth period for U.S. distributed solar
– Bloomberg New Energy Finance expects U.S. distributed solar new build to increase from ~3 GW annually in 2015 to over 6 GW by 2020, a CAGR of 47%
2. The securitization financing mechanism is a mature, 30+ year old, terminal financing strategy that across other asset classes has enabled originators to secure
the lowest possible cost of capital and establish an ongoing, cost-effective, large-volume financing strategy
3. However, solar securitization is a novel asset class that is still evolving and is facing growing pains due to the long tenor and unsecured nature of the assets as
well as a limited operating history
– Capital raised from securitizations has increased by over 6x from 2013 to 2015 but only accounted for 7% of MW installed in 2015
4. Nevertheless, 2016 is positioned to be the year solar securitization should become a mainstream financing option with multiple distributed solar financiers
planning to issue asset backed securities
– Only SolarCity and Sunrun have completed issuances but several other distributed solar financiers, such as SunPower, are reported to be now considering
securitizations
7
Source: Bloomberg New Energy Finance; Yes, US Clean Energy, There is a Santa Claus; 2015-12-18
Solar Securitization an Immediate Opportunity
ITC Extension Impact on U.S. Distributed Solar
Source: Company Filings, Bloomberg New Energy Finance
U.S. Solar Securitization Growth
0
1
2
3
4
5
6
7
2014 2015 2016 2017 2018 2019 2020 2021
GW
New Build with ITC Extension New Build without ITC Extension
54
272 234 235
100
0%
1%
2%
3%
4%
5%
6%
7%
8%
0
100
200
300
400
2013 2014 2015 2016 YTD
Sec
uri
tiza
tio
n S
har
e o
f
Dis
trib
ute
d S
ola
r M
W I
nst
alle
d
Am
ou
nt
Rai
sed
($M
M)
Closed Announced Solar Securitization Market Share
0
5
10
15
20
25
LMC II LMC III LMC IV Callisto LMC V
Yea
rs
Expected Maturities of Solar
Securitization vs. Contract Terms
Weighted Average Customer Agreement
Remaining Initial TermSecuritization Expected Maturity
8
Summary of Key Findings
1. While securitization offers a compelling value proposition, it is not always the optimal cash equity monetization strategy for all distributed solar financiers
2. Reliance on third party tax equity financing restricts the maturity and advance rate of solar securitizations, affecting virtually all current participants
− Originators have a clear incentive to refinance after the tax equity flip and probable buyout increases their cashflow
3. The increase in solar securitization yields in early 2016 was primarily due to weak macro credit conditions but the Nevada PUC net metering decision may have increased perceived policy risk for distributed solar securitizations
− Ongoing reversal in high yield markets will likely lead to near-term reduction in cost of capital
Marathon Observations
1. Pros & Cons of
Solar Securitization
3. Weakening Macro Credit Conditions
Increasing Solar Securitization Yields
2. Tax Equity Financing Limits Solar
Securitization Maturities & Advance Rates
Pros Cons
Typically Lowest Cost of Capital
Equity Reliance on Retained Value
• Concentration Risk Diversification
Restricted Cash Flow Eligibility
• Illiquidity Discount Reduction
High Initial Transaction Costs
• Sponsor Bankruptcy Risk Mitigation
Warehousing Margin Drag and Interest Rate Risk Exposure
• Investor Base Expansion
Repurchase Obligation on Default
Maximize Financing Velocity
Replacement as Servicer
Fixed Interest Rate Eventual Compliance Reporting
0%
2%
4%
6%
8%
LMC I LMC II LMC III LMC IV LMC V
Yields for SolarCity Lease & PPA
Securitizations
Pre-Nevada PUC Ruling Post-Nevada PUC Ruling
U.S. Corporate BBB U.S. Corporate BB
Typical Tax Equity Flip Period
Summary of Key Findings (Cont’d)
4. In the long-term, solar securitizations will generally have a higher cost of capital and lower advance rate than traditional securitized
asset classes due to greater expected loss given default, even after the asset class develops a proven track record
− While Originators report recovery rates above 90% when homes are transferred to new owners, in the long-term the primary
investor consideration for expected loss given default will likely be the sustainability of electric bill savings to the offtaker
5. However, achievable actions over time should both reduce the current cost of capital and increase the advance rate, making
securitizations of distributed solar assets increasingly efficient
9
Marathon Observations
4. Comparing Solar Securitizations to Traditional Securitized Asset Classes
5. Potential Actions for Improving Solar Securitization Advances Rate & Cost of Capital
Challenge Rationale Potential Mitigating Actions
Provide transparent operating data Reduce uncertainty premium Publish third party verified historic degradation rate analyses
Diversify geographically Reduce geographic concentration risk Alter tax equity fund underwriting criteria to mandate increased diversification
Resolve policy uncertainty Reduce policy risk Adoption of value of solar tariffs Securitize solar-plus-storage assets
Increase secondary market liquidity Reduce illiquidity premium Increase issuance sizes Issue under SEC Regulation AB
Develop a backup servicer Reduce sponsor default risk & impact Strategic investment in NewCo
Default Recovery Process Residential Solar Leases & PPAs Commercial Solar Residential Mortgages Auto Loans & Leases Credit Card Loans
Collection • Alternative Power Supplier • Alternative Power Supplier • Moving Extremely Costly • Public Transit Option • Discretionary Goods
Renegotiation • Price to Ensure Electricity
Bill Savings • Price to Ensure Electricity
Bill Savings • Limited by Foreclosure
Option • Limited by
Repossession Option • Collection Agencies • Debt Consolidation
Contract Assignability • >95% of Contracts Assigned
to New Homeowner • Commercial Real Estate
Market Friction • Limited by Foreclosure
Option • Limited by
Repossession Option • Assignment Unlikely
Foreclosure
• Depreciable Asset • Removal Costly • Technology Improvements
Restrict Resale Value
• Depreciable Asset • Removal Costly • Technology Improvements
Restrict Resale Value
• Potential Value Appreciation
• Transfer Asset to New Homeowner
• Liquid Used Automobile Market
• Depreciable Assets • Consumer Goods
Difficult to Seize
Expected Loss Given Default Primary Consideration
• Value Proposition Sustainability (Electricity Bill Savings)
• Value Proposition Sustainability (Electricity Bill Savings)
• Real Estate Market Prices
• Used Automobile Market Prices
• Collection Agency Success
Section II
Marathon Capital Overview
Marathon Capital Overview
11
Overview Power Asset M&A Advisor Rankings
Marathon Capital is a leading advisor and investment banker
to investors, developers, owners and operators in the energy &
infrastructure markets
– Headquartered in Chicago with representative offices in San
Francisco, New York and Canada
– Experienced staff of 26 investment banking professionals
Actively engaged on transactions across a range of sectors
within renewable energy and power
Closed more than 50 energy transactions in the past five years
SNL Power Asset M&A Transactions from 2011-2015
Source: SNL League Table Rankings – Power Asset M&A in North America from 2010-12-30 to 2015-12-31
Rank Firm # of Deals
1 Marathon Capital, LLC 26
2 Citigroup Global Markets Inc. 23
3 Morgan Stanley 21
4 Barclays Capital Inc. 18
5 Credit Suisse (USA), Inc. 15
6 Bank of America Merrill Lynch 11
7 J.P. Morgan Securities LLC 9
7 Goldman, Sachs & Co. 9
9 CIBC World Markets Corp. 8
10 Scotia Capital Inc. 7
11 RBC Capital Markets LLC 5 Two-Time Recipient
“Best Renewable Asset M&A Advisor” Power Finance & Risk
Select Recent Marathon Capital Solar Transactions
Marathon Solar Practice History
12
Section III
Solar Securitization Primer
Solar Securitization Overview
Securitization: Process by which illiquid assets are pooled and processed into financial vehicles, which then issue certain securities to investors known as asset backed securities (“ABS”)
– Cashflows generated through long-term contracts for assets are collateral for asset backed securities
– Securities are issued from a bankruptcy remote special purpose vehicle (“SPV”), known as an Issuer
– Cross-collateralization of assets
Asset Characteristics:
– Long-Term Contracted Revenue: In a solar securitization, leases, loans or power purchase agreements (“PPAs”) and/or their cashflows to the cash equity investor are collateral
– Easily Measured Counterparty Risk: In a solar securitization, FICO scores are typically used to evaluate counterparty risk for residential offtakers while credit ratings or specific formal credit rating techniques are typically used to evaluate counterparty risk for commercial and industrial (“C&I”) offtakers
• Other measures of counterparty risk may also be reviewed, such as homeowner negative/positive equity and sustainability of electric bill savings
– Counterparty Diversification
Security Characteristics:
– Tranching: Issuance of senior and subordinated securities, which are typically rated based on both overcollateralization and subordination of lower tranches
• Overcollateralization: Seeding of Issuer with additional assets that are used to cover potential investor shortfalls under stressed scenarios
• Subordination: In solar securitizations, B tranche receives interest only payments until principal for A tranche is amortized and then all cashflows until fully paid
Key Terms:
– Advance Rate: Principal’s share of the aggregate discounted solar asset balance (“ADSAB”, the NPV of the asset pool’s contracted cashflows)
– Blended Yield: Weighted average cost of capital for securitization reflecting interest rate for each tranche and issuance discount
14
Securitization Overview Securitization Structure Diagram
Source: National Renewable Energy Laboratory, The Potential of Securitization in Solar PV Finance
Originator
Issuer
Investors
Equity in Obligor
Asset Cash Flows
Securitization Parties
Originator: Developer or third-party asset owner
Issuer: SPV controlled by Originator
Obligor: Revenue Sources (e.g. Lease/PPA Offtakers, SREC Counterparties)
Structuring Agent: Structures transaction and executes sale in the marketplace, Interfaces with Rating Agency, Typically an investment bank
Rating Agency: Provides a credit rating for issuance, which is a prerequisite for many investors to purchase
Investors: Acquirer(s) of asset backed securities from Issuer
Servicer: Manages assets post-securitization; Usually the Originator
Trustee: Administers Issuer and manages accounts associated with the transaction
Transition Agent: Identifies a new Servicer if Originator defaults; Typically the Trustee
Illustrative solar securitization structure without tax equity:
ABS Proceeds
ABS Proceeds
Asset Backed
Securities
Obligor (Solar Funds)
Solar Assets Solar Assets
Solar Assets
Asset Cash Flows
Servicer
Trustee Custodial
Agreement
Transition Agent
Solar Securitization Value Proposition for Developers
Securitization potentially offers Lowest Cost of Capital due to:
– Diversification of Concentration Risks: High concentrations of credit, geographic, operating and policy risks increase cost of capital
– Reduction of Illiquidity Discount: ABSs are usually tradable in secondary markets, allowing investors to exit their positions, which reduces upfront cost of capital, particularly in investment-grade A tranche
– Mitigation of Sponsor Bankruptcy Risk: Issuer is a bankruptcy remote special purpose vehicle managed by a Trustee who can identify a new Servicer if Originator defaults or underperforms
– Expansion of Investor Base: Fixed income investor universe significantly larger than traditional energy asset investor universe
– Public Credit Rating: Credit rating by a credit rating agency provides wider access to global capital markets by increasing transparency and liquidity
Maximize Financing Velocity: Standardizable, repeatable process that can potentially reduce timeframe for a financing to less than 8 weeks
Fixed Interest Rate: Securitizations are typically issued with fixed, rather than floating, interest rates, which eliminates interest rate risk
15
Equity Reliance on Retained Value: Minimal cashflows to Originator until tax
equity and asset-backed security investors are compensated
Refinancing Risk: Continuous access to capital markets required for periodic
securitizations, increasing exposure to credit cycle
Restricted Cashflow Eligibility: Only contracted cashflows with high grade
offtakers are used for sizing a securitization
High Initial Transaction Costs: Banking and legal fees for first-time issuers are high
compared to other financing mechanisms
Warehousing Risks: Exposure to interest rate risk and potential margin drag on
assets held in aggregation facilities until sufficient volume collected
Replacement as Servicer: Trustee has authority to replace Originator as Servicer if
Originator’s financial position deteriorates or assets significantly underperform
Compliance Reporting: Rule 144A transactions require the Issuer to start reporting
periodic financial information to the SEC before securities can be traded
Advantages for Developers Disadvantages for Developers
Solar Securitization Strategy Evaluation Process for Developers
Correct Collateral Achievable Due Diligence Sufficient Throughput Proper Motivation
1. Long-Term Contracted Revenue:
Asset pools with a high percentage of
revenue from merchant sources such
as SRECs are generally not suitable
2. Diverse Pool of Credit-Worthy
Offtakers: Geographically diverse
pool of investment-grade or prime
counterparties with sufficient
diversification
3. Tax Equity Structure: Address ITC
recapture and basis risks
1. Measurable Counterparty Risk:
Significant majority of Offtakers
should have high FICO scores or
investment-grade credit ratings
2. Standardized Contracts: Contracts
should have similar terms and be
negotiated by a single developer to
reduce diligence costs
3. Strong Track Record: Similarly
originated assets should have
reliable historic operating data
proving minimal operating risk
4. Asset Management Capabilities
1. Minimum Issuance Size: Covers
high transaction costs for
Originator & ensures sufficient
diversification & potential presence
of a secondary market for
investors
2. High Ongoing Velocity:
Originator should be able to
quickly and repeatedly originate
sufficient assets to meet minimum
issuance size in order to limit
holding costs
1. Willingness to Hold Residual Value:
Originator receives minimal cash until ABSs
have amortized or equity tranche sold
2. Seeking Long-Term Financing Strategy:
Benefits only received through multiple
issuances
3. Established Financial Position:
Minimizes default risk and potential
replacement as Servicer
4. Accounting Concerns: Securitizations
typically treated as debt with no sale of
assets but potential reversal as additional
subordinate tranches are issued
A solar securitization is sized using only contracted cashflows
– Potential post-contract renewal value not used for sizing securitizations and entirely held by Originator’s C corp equity investors
– However, ABS investors have a senior claim on uncontracted cashflows, including renewal value, until investment has amortized
Reserve Accounts: Establishment of interest reserve and major maintenance accounts to ensure coverage of interest payments and expected expenses
Indicative cashflow waterfall:
Securitization Cashflow Profile
16
Cashflow Profile Overview
Indicative Investment Amortization
Indicative Capital Structure
Current capital structure for a securitization of the contracted portion of a
typical solar asset pool is comprised of a Tranche A senior claim held by ABS
investors, a Tranche B subordinate claim held by ABS investors and common
equity held by Originator
Capital structure shares based on present value of contracted cashflows,
not cost to install the system
Source: Kroll Bond Rating Agency
Tranche B is difficult to market because investors receive no principal
payments until Tranche A principal is amortized
Originator holds residual value, including post-contract renewal cashflows
In Rating Agency’s Base Case, B Tranche Investors do not receive principal
payments until Year 13 but are out by Year 15 and protected by 5 years of contracted
cashflows and potential renewals
Originator holds residual value
Taxes, Trustee/Custodian, Insurance, Land Lease,
Brokerage, Senior Operator Fee, Transition Manager
Tranche A, Tranche B
Interest Reserves, Major Maintenance Reserves, Issuer’s
Operating Account, Non-Covered Services Reserves
Tranche A
Tranche B: Typically none until Tranche A fully amortized
Subordinated Operator Fee, Cash Trap Account, Early
Amortization Period Payment
Operating Costs
Interest Payments
Reserve Accounts
Scheduled Principal Payments
Investor Protections
Additional Principal Payments
Deferred Expenses
Originator
Deferred Operating Costs, Deferred Interest (Triggered
by Sequential Interest Amortization Period)
Typically DSCR > 1.25x required for any cash to be
distributed to Originator
Tranche A
~60%
Tranche B
~15%
Equity
~25%
0% 20% 40% 60% 80% 100%
1
1. One period is equal to 6 months
Tranche A
Tranche B: Typically none until Tranche A fully amortized
Case Study: SolarCity Securitization Financing Strategy
17
Financing Strategy Overview Outcome
Source: SolarCity 2015 Analyst Day Presentation; December 2015
1. SolarCity currently receives an additional $0.10/Wdc in project rebates/prepayments, allowing the company to finance over 100% of project costs without cash equity
Corporate DevCo AssetCo: Short-Term AssetCo: Long-Term
Definition
• Permanent capital used to finance corporate overhead and remaining share of solar assets uncovered by DevCo & AssetCO project financing
• Temporary working capital used to finance development of solar assets through construction
• Short-term project finance capital used to warehouse solar assets until long-term project finance capital is obtained
• Long-term, low cost project finance capital for solar assets
Types of Capital
• Corporate Equity • Convertible Debt • Solar Bonds
• Corporate Revolver • Tax Equity • Aggregation Facilities
• Securitization
Investor Return Requirement
• Solar Bonds: 1.5-5.5% • LIBOR + 3.25% • Tax Equity: 7-12% • Aggregation Facilities: LIBOR +
2.75%
• Tranche A: ~4.0-5.5% • Tranche B: ~5.5-7.5%
Term • Corporate Equity: Permanent • Convertible Debt: 5 years • Solar Bonds: 1-15 years
• ~120 days • Tax Equity: 6.5 years • Aggregation Facilities:
~1-2 years
• ~5-15 years
Capital Source Descriptions
DevCo Asset Co: Short-Term AssetCo: Long-Term
Corporate Revolver Tax Equity
Aggregation Facilities Securitization P
roje
ct F
inan
ce
Co
rpo
rate
Fin
ance
Corporate Equity
Solar Bonds
Convertible Debt
120 Days 1-2 Yrs 6.5 Yrs 15 Yrs
2.83 2.74
0.00
1.00
2.00
3.00
4.00
Costs Project Financing Proceeds
$/W
dc
Installation Sales G&A
Tax Equity Aggregation Facilities ABS Proceeds
SolarCity is able to finance over 95% of total project costs through upfront
project financing (tax equity and aggregation facilities)1 with additional project
financing proceeds received from securitization
Section IV
Market Activity Review
Solar Securitization Market Activity
Only two companies – SolarCity (“SCTY”) and Sunrun (“RUN”) – have completed issuances. However, according to industry experts, other companies are
either attempting issuances or have tried and failed
Securitizations of residential solar lease & PPA portfolios priced at blended yields for A & B tranches below 4.5% with advance rates above 70% through
summer 2015. However, recent securitizations have priced at a significantly higher blended yield of 6.25%
– Pricing primarily impacted by macroeconomic credit conditions, investor appetite for yield, net metering risk, offtaker credit quality, leverage, duration of
underlying collateral contracts, tax equity structure and collateral type
No securitization has been completed yet that is collateralized primarily by C&I solar assets
– First C&I securitization attempted is AES Aurora, which according to industry experts is on-hold
19
Marathon Observations
Sources: S&P, Kroll Bond Rating Agency
1. SCTY FTE Series 1 and LMC Series V rated by both Kroll Bond Rating Agency and S&P
Transaction Summary
Solar Securitization LMC Series I LMC Series II LMC Series III LMC Series IV Callisto FTE Series 1 LMC Series V Aurora
Originator SolarCity SolarCity SolarCity SolarCity Sunrun SolarCity SolarCity AES
Closing Date Nov. 2013 Apr. 2014 Jul. 2014 Aug. 2015 Aug. 2015 Jan. 2016 Mar. 2016 TBD
Rating (A & B Tranches)
A: BBB+ A: BBB+ A: BBB+
B: BB A: A
B: BBB A: A
B: BBB A1: BBB, BBB B1: BB, N/A
A1: BBB+, BBB B1: BB+, BB
A: BBB B: B
Installed Capacity 44 MW 47 MW 118 MW 108 MW 56 MW 64 MW 36 MW 43 MW
Amount Raised $54.4 million $70.2 million $201.5 million $123.2 million $110.9 million $185.0 million $49.6 million TBD
Blended Yield 4.80% 4.59% 4.32% 4.42% 4.50% 5.81% 6.25% TBD
Advance Rate 62% 66% 73% 68% 76% 74% 75% 78%
Expected Maturity N/A 8 years 8 years 6.5 years 9 years 7 years 6.5 years 10 years
Avg. FICO Score 762 767 763 742 759 733 750 768
Avg. Customer Term 19 years 20 years 20 years 20 years 20 years 30 years 20 years 24 years
Collateral Type Leases & PPAs Leases & PPAs Leases & PPAs Leases & PPAs Leases & PPAs Loans Leases & PPAs Leases & PPAs
Tax Equity Structure 1603 Projects 1603 Projects Inverted Lease Partnership Flip Inverted Lease - Inverted Lease Unknown
Residential Share 71% 87% 86% 100% Unknown 100% 100% 30%
Securitization Pricing Factors Review
Pricing benchmark for solar securitizations A tranches
are generally 7 year interest rate swaps
– Benchmark for asset backed securities are interest
rate swaps
– Duration for interest rate swap benchmark
determined by securitization’s anticipated
repayment date
• Completed securitizations have expected
durations of 6.5 to 9 years
Yields on interest rate swaps are impacted by macro
credit environment factors including the Federal
Funds Rate and Yield Curve
Benchmark rates have fallen significantly since
summer 2015 from ~2% to ~1.25% in February 2016
but have since rebounded to ~1.5% in March 2016
20
Sources: CapitalIQ, Company Filings
Macro Credit Environment
Benchmark Rate vs. Cost of Capital
Net Metering Risk
Source: Company Filings
Yield for SCTY Lease & PPA Securitizations
2.7% 2.2% 1.8% 2.1% 2.3%
3.1% 3.9%
0%
1%
2%
3%
4%
5%
6%
LMC I LMC II LMC III LMC IV Callisto FTE 1 LMC V
Spread 7 Year Interest Rate Swap A Tranche Yield
If tariff structures are altered to reduce value of distributed solar, then there is a risk that some customers may either default or attempt to renegotiate contracts, reducing cashflows to ABS investors
– Distributed solar assets benefit from net metering (“NEM”), which allows sale of excess electricity back to grid at retail rate
Perceived net metering risk has increased as a result of Nevada PUC’s decision not to grandfather existing customers into new tariff structure that increases mandatory fixed charges and reduces compensation rate for excess generation
– Nevada assets account for an immaterial share (
Securitization Pricing Factors Review (Cont’d)
Credit quality of offtakers strong indicator of future default risk
Investor Credit Quality Measurement Criteria
– Residential: FICO Score (Prime>700)
– Commercial: Rating* (Investment Grade>BBB-)
Review of Issued Securitizations
– Residential:
• Weighted Average FICO Score: >730
• Non-Prime Offtakers: LMC Series IV and Callisto first to include
• Non-Prime Share of ADSAB: SCTY LMC Series IV and FTE Series 1 >30%
– Commercial
• AES Aurora Weighted Average Commercial Credit Rating: A+
Other measures of offtaker credit quality, such as negative/positive home equity, also considered
21
4%
5%
6%
7%
8%
700
720
740
760
780
800
LMC I LMC II LMC III LMC IV Callisto LMC V
Ble
nd
ed Y
ield
FIC
O S
core
Avg. FICO Score Blended Yield
Issuer’s advance rate determines share of losses borne by Originator’s first-loss equity position
– Increasing leverage decreases overcollateralization ratios, exposing ABS investors to potential losses, leading to higher cost of capital
– A Tranche investors also protected by B tranche
Leverage Review of Issued Securitizations
– Initial Issuances: SCTY LMC Series I & II issued with just an A Tranche leading to advance rates below 66%
– Subsequent Issuances: Issued with A & B Tranches leading to advances of ~75%
Implied debt service coverage ratios have declined from ~1.6x to ~1.3x
– ABS investors also protected by contracted cashflow beyond expected maturity date and potential renewals
Credit Quality Expected Maturity Leverage
FICO Score vs. Cost of Capital Advance Rate vs. Cost of Capital Contract Term vs. Cost of Capital
Cost of capital increases with duration and leverage because delayed amortization increases investor exposure to risks that may lead to default
– Expected maturity currently determined by tax equity target flip date because post-flip, additional cashflow expected to be available, leading to refinancing opportunity
– Origination speed and volume determines spread between solar securitization expected maturity and tax equity flip date
In the long-term, underlying contract duration will likely determine target maturity because generally an Originator's goal is to maximize leverage, leaving behind a minimum investment
– Residential Leases & PPAs: Industry generally settled on standardized 20 year contract term
– Residential Loans: SCTY MyPower loan had 30 year term but other loan securitizations likely to have shorter durations of 10-20 years
– Commercial PPAs: 10-30 year terms
4%
5%
6%
7%
8%
0%
10%
20%
30%
40%
50%
60%
70%
80%
LMCI LMCII LMCIII LMCIV Callisto LMC V
Ble
nd
ed Y
ield
Ad
van
ce R
ate
Advance Rate Blended Yield
4%
5%
6%
7%
8%
15
20
25
30
35
LMCI LMCII LMCIII LMCIV Callisto FTE1 LMCV
Ble
nd
ed Y
ield
Yea
rs
Avg. Customer Agreement Initial Term
Blended Yield
*Typically ~5-20% of ADSAB can be derived from unrated or sub-investment grade offtakers that are underwritten using established bank criteria
Securitization Pricing Factors Review (Cont’d)
Tax equity structure determines how exposed tax equity investors are to ITC recapture and basis risk if IRS contests asset fair market value
– Inverted Leases: ITC initially transferred to tax equity investor under pass-through election in IRS code and less exposed to recapture if sold or FMV contested
– Partnership Flips: Tax equity investor partner in fund until flip date and therefore at risk if assets are contested or deemed ineligible
In response, tax equity investors demand costly protection reducing cashflow available to be assigned to ABS investors
Tax equity structure key difference between SCTY LMC Series III & IV securitizations
– For LMC Series IV, SCTY purchased a tax loss insurance policy, which covered up to 35% of the value of the ITC
22
4.8% 4.6% 4.3% 4.4% 4.5%
6.3% 5.8%
0%
1%
2%
3%
4%
5%
6%
7%
LMC I LMC II LMC IIILMC IVCallisto FTE 1 LMC V
Ble
nd
ed Y
ield
Leases & PPAs Loans
First securitization of solar loans, SCTY’s FTE
Series 1, priced at a yield of 5.81%, higher than
prior securitizations of leases & PPAs
– Higher cost of capital may be partly due to
collateral type, though primarily due to weak
macro economic credit conditions
Loans are perceived as riskier collateral due to:
– Increased Operating Risk: O&M provider no
longer owns assets and therefore has lesser
incentives to both operate assets efficiently
and minimize operating costs
– Lesser Cashflow Profile: Loan products not able
to utilize accelerated depreciation benefits,
leading to backdated cashflows
– Legal Risk: Uncertainty about the collateral
coverage in a mortgage foreclosure
Tax Equity Structure Offtaker Type Collateral Type
Term LMC Series III LMC Series IV
Tax Equity Structure
Inverted Lease
Partnership Flip
Interest Rate
Yield 4.32% 4.42%
Tranche A 4.03% 4.18%
Tranche B 5.45% 5.66%
Advance Rate
Total 73% 68%
Tranche A 58% 57%
LMC Series III & IV Comparison Collateral Type vs. Cost of Capital Securitization Offtaker Segmentation
Securitization Residential
Share Commercial
Share
SolarCity
LMC Series I 71% 29%
LMC Series II 87% 13%
LMC Series III 86% 14%
LMC Series IV 100% 0%
FTE Series 1 100% 0%
LMC Series V 100% 0%
Sunrun Callisto N/A N/A
AES Aurora 29% 71%
No securitization has been completed yet that is
collateralized primarily by C&I solar assets
– AES attempting first C&I securitization,
which was rated in Sep. 2015 but yet to close
C&I portfolios have several additional, material
challenges that increase cost of capital
– Concentrated Offtakers: C&I projects are larger,
reducing counterparty diversification benefits
– Unrated Offtakers: Many C&I assets have
unrated offtakers, making credit evaluation
more difficult
– Non-Standardized Contracts: C&I PPAs are
both negotiated on a case-by-case basis and
often acquired from multiple early-stage
developers, increasing legal diligence costs
Exploring Recent Market Price Movements
Blended yields likely increased from ~4.5% to ~6% in early 2016 primarily due to weakening macro credit conditions. However, enhanced investor scrutiny on net energy metering in-light of the Nevada PUC decision may also play a role
Significant majority of increase due to reduced investor appetite for non-governmental debt in widespread investor flight to quality
– Tranche A: U.S. Corporate BBB Bond spread over 7 Year Interest Rate Swaps increased from 180 bps in August 2015 to 300 bps in February 2016
– Tranche B: U.S. Corporate BB Bond spread over 7 Year Interest Rate Swaps increased from 300 bps in August 2015 to 480 bps in February 2016
However, solar securitization spreads over U.S. corporates have also increased, especially for the B tranche, indicating solar securitization specific factors may have additional impact on pricing
– Tranche A: Initially priced at 80-90 bps over BBB corporate bonds Compressed to 30-60 bps in 2014-15 Rebounded to ~90 bps in early 2016
– Tranche B: Initially priced at 100 bps over BB corporate bonds Compressed to 30-60 bps in 2015 Significant increase to >300 bps in early 2016
An increase in perceived net metering risk may account for a part of the increase in solar securitization blended yields
– Supportive: Nevada PUC ruling may set a precedent that enables other states to adopt NEM reforms without grandfathering existing customers
– Against: Nevada assets only account for 0.3% of ADSAB for LMC Series V, California NEM 2.0 ruling preserves traditional net metering in largest solar market
Macro credit conditions have improved in March 2016 suggesting that yields for future solar securitizations will likely decline
– Yields for U.S. Corporate BBB and BB bonds have declined by ~0.25% and ~1.25% respectively since February 2016
23
Sources: Capital IQ, Bank of America Merrill Lynch, Company Filings 1. Tranche-specific yields for SCTY LMC Series V securitization are unavailable so to be conservative, charts assume Tranche A was issued at the coupon rate of 5.25% and Tranche B was issued at the 10% yield of the FTE Series 1 Tranche B. The actual pricing for each LMC Series V tranche is likely higher because the Blended Yield of LMC Series V was 6.25% vs. 5.81% for FTE Series 1
Marathon Observations
Solar Securitization Tranche A Yield Composition Solar Securitization Tranche B Yield Composition
2.2% 2.4% 2.2% 2.1% 2.1% 1.9% 1.3%
1.8% 1.4% 1.2% 1.8% 1.8% 2.5%
3.0%
0.8% 0.9% 0.6% 0.3%
0.5% 0.5% 1.0%
0%
2%
4%
6%
8%
10%
12%
LMC I
Nov. 2013
LMC II
Apr. 2014
LMC III
Jul. 2014
LMC IV
Aug. 2015
Callisto
Aug. 2015
FTE 1
Jan. 2016
LMC V
Mar. 2016
Yie
ld
Solar Securitization Tranche A Spread over U.S. Corporate BBB Bonds
U.S. Corporate BBB Bond Spread over 7 Year Interest Rate Swaps
7 Year Interest Rate Swap
2.2% 2.1% 2.1% 1.9% 1.3%
2.2% 3.3% 3.0%
4.8% 4.8%
1.0% 0.3% 0.7%
3.2% 3.9%
0%
2%
4%
6%
8%
10%
12%
LMC III
Jul. 2014
LMC IV
Aug. 2015
Callisto
Aug. 2015
FTE 1
Jan. 2016
LMC V
Mar. 2016
Yie
ld
Solar Securitization Tranche B Spread over U.S. Corporate BB Bonds
U.S. Corporate BB Bond Spread over 7 Year Interest Rate Swaps
7 Year Interest Rate Swap
Tranche B spread over U.S. Corporate BB bonds has
increased by over 3x since Nevada PUC Net Metering
Ruling in Dec. 2015
Tranche A spread over U.S. Corporate BBB bonds has rebounded slightly since
Nevada PUC Net Metering Ruling in Dec. 2015
1 1
Section V
Process Considerations
Collateral Aggregation
Originators must have proven ability to underwrite and aggregate a large
portfolio of homogenous collateral
– Securitization collateral can be either leases & PPAs or loans
The universe of distributed solar financiers who can steadily deploy a large
volume of solar systems is growing but still relatively small
– Securitization first movers SolarCity and Sunrun both have proven
ability to deploy over 35 MW - the approximate minimum securitization
issuance size - every quarter
– Competitors such as Vivint Solar, SunPower, Sunnova, Sungevity and
Spruce Finance have also demonstrated ability to deploy MW at scale
but have not yet formally announced a securitization
Key areas of potential concern for ABS investors as distributed solar
financiers scale are underwriting offtakers with weaker credit profiles and
sustainability of originator’s competitive position
25
Relatively large minimum issuance size required by both investors and Originator
– To attract ABS investors, collateral pool must have sufficient scale to diversify credit and other concentration risks
– Amount raised for Originator must justify relatively high transaction costs compared to alternative forms of financing
Completed securitizations have all been collateralized with over 35 MW of installed capacity and have raised at least $50 million
– Declining installed costs expected to reduce amount raised per MW, potentially leading to larger minimum issuance size
Originators typically warehouse assets for eventual securitization in aggregation facilities until sufficient scale achieved
– Lenders now provide secured credit facilities with favorable terms in expectation of near-term securitization exit, allowing Originators to realize some benefits of securitization strategy upfront
Origination Capability Minimum Issuance Size
Source: Company Filings
Origination Capability of Leading Residential Solar Financiers Size of Completed Issuances
44 47
118 108
56 64
36
0
50
100
150
200
250
300
0
50
100
150
200
250
300
LMC I LMC II LMC III LMC IV Callisto FTE 1 LMC V
Am
ou
nt
Rai
sed
($M
M)
Inst
alle
d C
apac
ity
(M
W)
Installed Capacity Amount Raised
0
50
100
150
200
250
300
1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15
MW
Dep
loy
ed
SCTY RUN
Minimum Issuance Size:
~35 MW
Minimum Issuance Size:
~35 MW
~60-70% of cash 49% of MACRS
1% of ITC 99% of ITC
ABS Proceeds
Asset Backed Securities
~30-40% of cash1 >90% of tax1
~60-70% of cash1
0
5
10
15
20
25
LMC II LMC III LMC IV Callisto LMC V
Yea
rs
Weighted Average Customer Agreement Remaining Initial Term
Securitization Expected Maturity
Tax Equity Considerations (Cont’d)
Primary risks for tax equity investors are ITC recapture risk and basis risk
– ITC Recapture Risk: ITC vests over a 5 year period so if the project is disposed for any reason, a pro-rata portion of the ITC is recaptured
– Basis Risk: Threat that Internal Revenue Service (“IRS”) successfully challenges fair market value (“FMV”) for which ITC is claimed, reducing ITC value
• Distributed solar developers typically sell assets to distributed solar financiers at FMV, which is materially higher than total project costs
Cashflow to cash equity investor increases significantly after the “flip” period, creating a clear incentive to structure solar securitizations that mature around expected flip date so unencumbered assets can be refinanced, which limits initial maturity and resulting advance rate
– Tax equity investments are typically structured with a scheduled flip around years 6-8 after the recapture period has expired
• At the flip, shares of cash and taxable income to the tax equity and cash equity investors are reallocated, with the cash equity investor’s share of asset cashflows increasing from ~65-70% to ~90-95%
• Cash equity investor typically also has a buyout option of the tax equity investor’s position at fair market value (“FMV”)
Basis risk friction between tax equity investor and securitization investors also restricts maturity and advance rate, particularly for partnership flips
– Tax equity investor typically requires indemnification from distributed solar developers if IRS successfully challenges the FMV
• Indemnification mechanism includes cash sweep, ensuring investor receives target yield without relying on developer’s corporate credit
– If cash sweep is activated, securitization investor’s share of cash declines significantly, leading to possible default
• Securitization investor cashflows are subordinate to tax equity investor because solar securitizations are typically structured as backleverage on the cash equity investor’s position
– Rating agencies currently require either an inverted lease structure or insurance to cover basis risk cash sweep challenge with funded cash reserve accounts also helping to mitigate risk
• Inverted Lease: ITC transferred to tax equity investor under pass-through election in IRS code and less exposed to FMV contestation
• Partnership Flip: Insurance is available but currently expensive. As insurance costs decline leading to more developers selecting this option, securitization advance rates may also increase
27
Marathon Observations Distributed Solar Cashflow Profile
Sources: S&P, Kroll Bond Rating Agency
Tax Equity Financing Restricts Maturity & Advance Rate
Typical Tax Equity Flip Period
Source: SolarCity February 2016 Investor Presentation
0%
20%
40%
60%
80%
100%
1 2 3 4 5 6 7 8 9 10
Sh
are
of
Cas
hfl
ow
Operating Year
Tax Equity Investor Cash Equity Investor
Cash Equity Investor’s cashflow increases significantly after flip
Originator typically has a buyout option at FMV after the ITC has fully vested
Materials Preparation Rating Process Marketing
Solar Securitization Process Overview
Process Timeframe: Initial solar securitization takes 6-9 months
– Originators should have high quality historical operating data
– Novel asset features, such as dependence on merchant power or
SRECs, would likely increase timeframe
Rating Agencies: Securitizations require investment-grade rating on
the A Tranche and high non-investment grade rating on the B
tranche to be marketed to investors with lowest cost of capital
– Stress tests to ensure principal returned to ABS investors must be
passed to achieve desired rating (See Page 29
Transaction Costs: Securitizations have relatively high transaction
costs compared to alternative financing mechanisms
– Fees for SCTY’s first securitization were 5.7% of gross proceeds
28
Source: Kroll Bond Rating Agency
Marathon Observations
Process Summary
Security Form
Includes preparation of all normal
marketing materials (ex. Confidential
Information Memorandum, etc.)
Financial Model will be significantly more
complex to allow Rating Agency to run
required scenario analysis
Regulation 17G-5 requires Issuers to post all
information to a data site that all rating
agencies can access
Rating Agency runs a series of scenario analyses, known as Stresses, to determine rating over an ~8 week period
For each Stress, Rating Agency adjusts key financial parameters to determine if cashflow supports debt obligations for each tranche
– Key financial parameters include the default rate, retail power price, inverter replacement cost, etc. (See Page 29)
As rating increases a level, Stress gets more difficult to achieve
Rating Agency issues an ABS Presale Report
containing rating for issue
Structuring Agent formally initiates marketing
to potential investors based on tranche
– Tranche A is marketed primarily to
investors such as pension funds that must
hold investment-grade debt
– Tranche B is significantly more difficult to
place and is usually marketed to finance
companies, hedge funds and other investors
not requiring liquidity who can hold to
maturity
Current Status: All completed securitizations have been issued as
private placements under Rule 144A
– Advantages: Minimize issuance expenses because extensive public
disclosure, such as a prospectus, not required by SEC
– Disadvantages:
• Restricts investment universe to qualified institutional buyers
• Limits secondary market activity, which increases upfront cost
of capital due to illiquidity premium
– Minimum holding period of 6-12 months
– Issuer financial information must be publicly available for
securities to be sold in secondary market
Indicative Residential Solar Credit Rating Criteria
29
Source: Kroll Bond Rating Agency
Category Criteria Base Case B rating BB Rating BBB Rating A Rating
Offtaker
Default • None
• 4% default and never pay
• Spread evenly over 10 years
• 6-7% default and never pay
• Spread evenly over 10 years
• 8-11% default and never pay
• Spread evenly over 10 years
• 13-16% default and never pay
• Spread evenly over 10 years
Renegotiation • None
• 20% of offtakers renegotiate with no payment for 1 month
• Renegotiated rate 10% below contract with 1% annual escalator
• 27.5% of offtakers renegotiate with no payment for 8 months
• Renegotiated rate 12.5% below contract w/ 1% annual escalator
• 37.5% of offtakers renegotiate with no payment for 9 months
• Renegotiated rate 15% below contract with 1% annual escalator
• 50% of offtakers renegotiate with no payment for 12 months
• Renegotiated rate 20% below contract with 1% annual escalator
Generation
Availability • 98-99% • Post-Year 25: 94%
• 98-99% • Post-Year 25: N/A
• 97.5% • Post-Year 25: 92%
• 97% • Post-Year 25: 90%
• 95% • Post-Year 25: N/A
Production • One Year P50 • One Year P50 • One Year P75 • One Year P90 • One Year P90
Degradation Rate • 0.75% annually • Post-Year 25: 1.5%
• 0.75% annually • Post-Year 25: N/A
• 0.9% annually • Post-Year 25: 1.8%
• 1.2% annually • Post-Year 25: 2.4%
• 1.2% annually • Post-Year 25: N/A
Revenues Cashflow Eligibility • All cashflows
• No uncontracted cashflows
• N/A
• No uncontracted cashflows
• Investment-grade counterparties only
• No uncontracted cashflows
• Investment-grade counterparties only
Expected Useful Life • 30 years • N/A • 30 years • 25 years • N/A
Operating Costs
Management Fee • $23-25/kWdc • 2% annual escalator
• N/A • $25/kWdc • 2% annual escalator
• $26/kWdc • 2% annual escalator
• $27.5/kWdc • 2% annual escalator
Inverter Replacement Cost • $1,100 in years 10-12 • N/A • $1,400 in years 10-12 • $1,500 in years 10-12 • $1,600 in years 10-12
Tax Equity
Buyout Price • As scheduled • N/A • N/A • Increases 1% • Increases 8%
Flip Date • As scheduled • N/A • N/A • Extended 6 months • Extended 12 months
A Rating Agency will issue a credit rating based on stress tests of the underlying asset pool
Higher rated securities can withstand larger levels of potential adverse events, such as default, reduced energy production or higher operating costs, and still meet debt obligations
Solar Securitization Transaction Fees
30
Notes
First solar securitization ever
issued
Only included 1603 projects to test
investor appetite for solar
securitizations without having a
senior tax equity claim
Notes
First solar securitization issued
subordinate to tax equity
investment using partnership flip
structure
Notes
Second solar securitization using
1603 projects
LMC Series I
Source: Company Filings
LMC Series IV LMC Series II
Notes
First solar securitization issued
subordinate to tax equity
investment using inverted lease
structure
LMC Series III
Transaction Fees for SolarCity Securitizations
Total
Principal ($MM) 54.4
Issuance Discount 0.05%
Gross Proceeds ($MM) 54.4
Net Proceeds ($MM) 51.3
Fees 3.1
Fee Share of Gross Proceeds 5.7%
Total
Principal ($MM) 70.2
Issuance Discount 0.01%
Gross Proceeds ($MM) 70.2
Net Proceeds ($MM) 67.4
Fees 2.8
Fee Share of Gross Proceeds 4.0%
Tranche A
Principal ($MM) 160.0
Issuance Discount 0.01%
Gross Proceeds ($MM) 160.0
Tranche B
Principal ($MM) 41.5
Issuance Discount 0.01%
Gross Proceeds ($MM) 41.5
Total
Gross Proceeds ($MM) 201.5
Net Proceeds ($MM) 195.9
Fees 5.6
Fee Share of Gross Proceeds 2.8%
Tranche A
Principal ($MM) 103.5
Issuance Discount 0.05%
Gross Proceeds ($MM) 103.5
Tranche B
Principal ($MM) 20
Issuance Discount 1.46%
Gross Proceeds ($MM) 19.7
Total
Gross Proceeds ($MM) 123.2
Net Proceeds ($MM) 119.9
Fees 3.3
Fee Share of Gross Proceeds 2.7%
Securitization Accounting Impacts
31
Source: SolarCity 2015 10-K, p.49
Source: SolarCity 2015 10-K, p.41
Case Study: SolarCity’s Financial Statements
Marathon Observations
Balance Sheet Consolidation: As ultimate equity holder in the Issuer, asset backed securities are typically consolidated on Originator’s balance sheet
– Leverage Ratios Impact: Securitization will increase leverage ratios for the Originator
– Interest Tax Shield: Securitization will generate net operating losses for the Originator
– Sale Treatment: Securitization typically treated as debt and does not require a true sale at FMV
Subordinated Tranches: As the number of subordinated tranches increases, there is a tension between whether subordinated tranches should be treated as
debt or equity for accounting purposes
– If classified as equity, a true sale would occur and a gain or loss on sale could need to be reported No balance sheet consolidation
Section VI
The Future of Solar Securitization
Residential Solar Securitization Outlook
Term Callisto Securitization Investec Credit Facility
Structure • Tranche A • Tranche B
• Senior Tranche • Subordinate Tranche
Advance Rate • Tranche A: 68% • Tranche B: 76%
• Senior Tranche: 65% • Sub Tranche: 75%
Interest Rate • Tranche A: 4.4% • Tranche B: 5.4%
• Senior Tranche: L+250 • Sub Tranche: L+500
33
Transaction Overview: On January 19, 2016 Sunrun closed a $250 million senior
secured credit facility with Investec, which will be used to aggregate residential
solar assets until sufficient scale is achieved for a securitization
Lender Terms Comparable to Securitization: Structure and pricing terms for
Investec Credit Facility comparable to Sunrun’s Callisto securitization
Sources: Company Filings
Marathon Capital Observations
Sunrun Aggregation Facility Case Study
Solar Securitization Growth
Leases & PPAs Losing Market Share to Loans
Residential solar securitization is rapidly gaining investor acceptance
– Advance rates have increased from ~60% to ~75%
– However, pricing trends for lease & PPA securitizations are negative
• After declining from 4.8% to 6% primarily due to weakening macro credit conditions
– More than $200 million of residential solar assets were securitized in 2014 & 2015 with 2016 likely to set a new record; however, solar securitization market share by MW installed is just 7%
Residential solar developers can now extract comparable terms from banks on secured credit facilities that aggregate projects to facilitate securitization, significantly reducing upfront Originator C corp equity requirement
– Reduces exposure to volatility in asset-backed security markets
Future loans securitizations with different investment characteristics are likely as loans gain market share vs. leases & PPAs
0%
10%
20%
30%
40%
50%
60%
70%
80%
2014 2015f 2016f 2017f 2018f 2019f 2020f
Res
iden
tial
Th
ird
-Par
ty O
wn
ersh
ip
Mar
ket
Sh
are
Source: GTM Research, U.S. Residential Solar Financing 2015-2020
54
272 234 235
100
0%
2%
4%
6%
8%
0
100
200
300
400
2013 2014 2015 2016 YTD
Sec
uri
tiza
tio
n S
har
e o
f
Dis
trib
ute
d S
ola
r M
W I
nst
alle
d
Am
ou
nt
Rai
sed
($M
M)
Closed Announced Solar Securitization Market Share
Commercial Solar Securitization Outlook
Securitizing C&I solar assets is feasible as long as certain minimum criteria are established
– Investment Grade Offtakers*: Issuances should mainly include PPAs with investment grade offtakers
– Counterparty Diversification: Issuances should aim to have ~50 distinct offtakers with no single offtaker accounting for >10% of ADSAB
To further maximize probability of success, C&I Originators should consider selecting assets which meet following criteria
– Standardized Contracts: Offtaker-specific contracts significantly increase due diligence time and cost for investors
– Limited Merchant Exposure: Uncontracted cashflows, such as merchant power or SREC revenue, heavily discounted by investors and rating agencies
Similar to commercial mortgage backed securities, commercial solar will likely be evaluated as a separate asset class from residential solar deals
– Until a C&I securitization is successfully issued, Originators should be conservative with proposed pricing and advance rates
34
In September 2015, AES Distributed Energy announced a securitization of
C&I and residential solar assets ( “Aurora securitization”)
– 71% of ADSAB derived from C&I offtakers
Aurora securitization has yet to close
Marathon Observations
AES Aurora Securitization Case Study
Strategic Considerations for Potential C&I Issuers
Source: Kroll Bond Rating Agency
Closing Tranche B is Challenging
– Kroll rated B tranche at B, unlike first five SolarCity and Sunrun
securitizations, for which B tranches were rated BBB (investment grade)
– B rating due to increased leverage and counterparty concentration risk
• Proposed advance rate of 78% greater than all other securitizations
that have successfully closed
• Single offtaker accounts for 33% of the ADSAB, ensuring portfolio
does not fully benefit from counterparty diversification
Transaction Overview Lessons Learned
Term Aurora Securitization SCTY LMC Average
Installed Capacity • 43 MW • 71 MW
Principal Amount • $100 Million • $100 Million
Proposed Pricing • Tranche A: 5% • Tranche B: 10%
• Tranche A: 4.6% • Tranche B: 6.2%
Advance Rate • Tranche A: 72% • Tranche B: 78%
• Tranche A: 62% • Tranche B: 69%
Expected Maturity • 10 Years • 7 Years
Largest Offtaker • 33% of ADSAB •
Long-Term Outlook
Despite strong counterparty credit and diversification, solar securitizations today have higher cost of capital and lower advance rate than traditional securitized assets due to limited operating history, concentration risks, greater expected loss on defaults, tax equity subordination, higher illiquidity premium and enhanced sponsor default risk
– Uncertainty premium for solar securitizations will be eliminated over time as additional performance data is collected
– Primary driver of loss given default is whether the contract’s value to offtaker remains intact (e.g. solar system continues to generate offtaker electricity bill savings)
Long-term, solar securitizations will likely have higher cost of capital and lower advance rate than traditional securitized assets because even though several factors, such as geographic concentration and policy risk, will likely be reduced over time, other factors, such as value recovery through foreclosure, operating risk and contract term, will endure
35
Marathon Observations
Comparison of Factors Influencing Cost of Capital for Securitized Assets
Category Influencing Factor Residential Solar Leases & PPAs Commercial Solar Mortgages Auto Loans & Leases Credit Card Loans
Probability of Default
Counterparty Credit Prime FICO Score Investment-Grade Rating Prime
FICO Score Subprime
FICO Score Prime FICO
Score Subprime
FICO Score Prime FICO
Score Subprime
FICO Score
Counterparty Diversification ~15,000 Offtakers 80% National National National
Systemic Risk Non-Diversifiable Non-Diversifiable Non-Diversifiable Non-Diversifiable Non-Diversifiable
Contract Term 20-30 Years 15-30 Years
Monetizing Retained Value
Advance rate for solar securitizations can theoretically be significantly increased over time
– Issued solar securitizations have only been structured with A & B Tranches, which increase advance rate to ~75%
– Securitizations of most asset classes have at least 3 tranches, leading to advance rates >80%
• Increasing the number of tranches creates tension over whether the subordinated tranches should be treated as equity instead of debt, impacting both the
Originator’s taxable income and the investor’s return
Significant challenges need to be addressed to increase advance rate for solar securitizations
– Reduce Uncertainty Premium: As time passes additional data will be reported, allowing investors to better assess operating risk and expected loss given default
– Geographic Diversification: Expanding customer base to new markets diversifies location specific risks, such as recessions, natural disasters, etc.
– Resolve Policy Risk: Tariff structure and net metering changes can eliminate solar value proposition, leading to default or renegotiation
– Increase Secondary Market Liquidity: Small issuance sizes reduce trading post issuance, forcing investors to demand larger first-loss equity piece upfront
– Mitigate Sponsor Default: Without a proven backup servicer, investors must rely on sponsor for operating assets
However, several factors unlikely to be addressed resulting in permanent cap on advance rates below traditional securitized asset classes
– Tax Equity Senior Claim: Securitizations structured for ~7 year maturities to allow refinancing after tax equity buyout when additional cashflow is available
– Limited Value Recovery in Foreclosure: Depreciating asset, rapid technological progress and costly removal ensure large losses if foreclosure is necessary
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Increasing Solar Securitization Leverage
Sources: Moodys, S&P, Fitch, Kroll Bond Rating Agency
Securitization Leverage by Collateral Type
75% 81% 84%
89% 92% 93%
99%
0%
20%
40%
60%
80%
100%
Solar Aircraft Leases Student Loans Equipment Loans Automobile Loans Credit Card Loans Home Mortgages
Ad
van
ce R
ate
Tranche A Tranche B Tranche C Tranche D
Critical Obstacles to Overcome
37
12
1,699
0
50
100
150
200
250
300
350
400
1
10
100
1,000
10,000
Solar Securitization
History
Asset Backed Securities
Feb. 17, 2016
Tra
de
Co
un
t
Tra
de
Val
ue
($ M
illi
on
s)
Trade Value Trade Count
Source: FINRA Market Data Center
Geographic Diversification
Increase Secondary Market Liquidity
Resolve Policy Risk
Source: Capital IQ
Mitigate Sponsor Default Impact
0%
20%
40%
60%
80%
100%
LMC I LMC II LMC III LMC IV Callisto FTE 1
Sh
are
of
AD
SA
B
California Top 3 States Top 3 Average: 87% Share
Source: Source: NC Clean Energy Technology Center and Meister Consultants Group, The 50 States of Solar Q3 2015 Source: S&P, Kroll Bond Rating Agency
Excess Generation Compensation Reduction Solar Fixed Charge Minimum Bill
Over 100x more asset backed securities are traded in a
single day than in history of solar securitization trading
0
20
40
60
80
100
120
140
160
180
200
Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16
Sto
ck P
erfo
rman
ce
(Jan
. 2, 2
015
= 10
0)
SCTY RUN VSLR
Backup Servicer Necessary: Residential solar stocks are volatile, leading to ABS investor uncertainty about an Originator’s ability to
service assets for long-term
Conclusions
1. While securitization offers a compelling value proposition, it is not always the optimal cash equity
monetization strategy for all distributed solar financiers
2. Reliance on third party tax equity financing restricts the maturity and advance rate of solar
securitizations, affecting virtually all current participants
3. The increase in solar securitization yields in early 2016 was primarily due to weak macro credit
conditions but the Nevada PUC net metering decision may have increased perceived policy risk for
distributed solar securitizations
4. In the long-term, solar securitizations will generally have a higher cost of capital and lower
advance rate than traditional securitized asset classes due to greater expected loss given default
even after the asset class develops a proven track record
5. However, achievable actions over time should both reduce the current cost of capital and increase
advance rates, making securitizations of distributed solar assets increasingly efficient
38