TODAY’S STUDY: ALL ABOUT SOLAR LOANS, SOLAR LEASING, AND SOLAR PURCHASE CONTRACTS
Banking on Solar: An Analysis of Banking Opportunities in the U.S. Distributed Photovoltaic
David Feldman and Travis Lowder, November 2014 (National Renewable Energy Laboratory)
This report provides a high-level overview of the developing U.S. solar loan product landscape, from both a market and economic perspective. It covers current and potential U.S. solar lending institutions; currently available loan products; loan program structures and post-loan origination options; risks and uncertainties of the solar asset class as it pertains to lenders; and an economic analysis comparing loan products to third party-financed systems in California.
Solar-specific loan financing is growing in the United States—2014 in particular saw several new loan product announcements and program launches (See Footnote 2 in the Introduction). A solar loan financing arrangement differs from third-party ownership (TPO) in several key aspects, including: the retention of ownership rights by the system host and its associated tax benefits and other incentives; the fixed nature of its monthly payment (similar to a lease but not a power purchase agreement [PPA]); and the variability in the size of payments based on the interest rate and tenor of the loan (i.e., individual payments spread over a longer period will be smaller in size).
Several analysts and industry stakeholders have indicated that solar loans will increasingly capture market share relative to the TPO model in the coming years. While the actual competitiveness of the loan option in solar finance will be determined by the offerings in the market, this report attempts to provide a framework for understanding how loan structures could affect the ultimate cost to distributed PV consumers. Solar loans have the potential to provide an economical option (from an LCOE perspective) for homeowners and businesses to finance the purchase of a solar system, retaining the benefits of ownership that TPO systems cannot provide while avoiding the large upfront cost of a PV system.
Section 4 of this report presents the results of an economic analysis comparing the economics of residential and commercial customers using solar loans to those using TPO to finance on-site PV generation. As demonstrated in Figure ES-1 below, the levelized cost of energy (LCOE) for residential systems with solar loans was lower than the LCOE for residential systems with PPAs by 19% to 29% (varying by the term of the loan), due to the higher cost of capital necessary for the sponsor and tax equity in a PPA transaction.
There are, however, several economic factors which influence the value of loans to consumers that go beyond the pro forma financial models. These include the higher annual payments to service these shorter-term loans during the beginning of the lifetime of the solar asset – as demonstrated in Figure ES-2 below. In fact, in the first year of a five-year loan, the debt service payments were calculated to be almost double what a customer would pay to a utility, and over twice as much as a PPA or 20-year loan. At the end of the loan term, a customer’s annual payments would drop to the cost of operations and maintenance (O&M), including an inverter replacement in year 10, and, if desired, monitoring by a third party; however, some customers may not want to pay more for their electricity for the first five or ten years of the PV system’s operation.
Other factors that may impact the economics of a solar loan or TPO include whether or not the host has sufficient tax liability to take advantage of the federal and/or state tax incentives; the additional liability and maintenance costs associated with ownership; the complications of adding assets and liabilities onto one’s balance sheet (as opposed to a TPO transaction, which is off-balance sheet); and the economic time horizon of individual decision makers. Moreover, any specific market offerings in either solar loans or TPO products will differ from the assumptions in this report, which provides only a general framework for interpreting the comparison and relative competitiveness of both forms of finance. System costs, monthly payments, amortization schedules, the ultimate cost of energy, and other factors will differ by each product and each individual deal with the consumer.
The growth in distributed (and particularly residential) solar photovoltaics (PV) deployment in the U.S. has been facilitated in large part through the third-party ownership (TPO) model. In 2013, TPO represented some 66% of the U.S. residential solar market, and a considerable portion of the commercial market (Litvak 2014). The success of the TPO model is attributable in part to its economic proposition: TPO can provide consumers access to PV-generated electricity at a price that is competitive with those consumers’ utility (i.e., retail) rates. However, in the last two years, another solar financing option is becoming commensurately competitive and has begun to capture market share: loans.
Until recently, loan financing for distributed solar installations was largely done through home equity loans or home equity lines of credit (HELOCs), commercial loans, and other standardized loan products available to homeowners and businesses for general expenditures. Historically, solar-specific loans—i.e., products for which the underwriting, loan terms, lender security interest, and other programmatic aspects are all designed for financing solar installations exclusively1 —have not had much market presence. Prior to the fall of 2013, there were few widely available (i.e., not jurisdictionally limited, such as property assessed clean energy programs or on-bill financing in a utility’s service territory) solar loan options in the United States. However, from the period between approximately October 2013 and October 2014, at least nine new solar-specific loan programs were announced, and several more have begun operations without a formal announcement.2
A solar loan financing arrangement differs from TPO in several key aspects, including:
• Ownership: When financing through a loan, the system host retains ownership of the PV assets. Third-party ownership, as the name implies, entails ownership and maintenance by the solar company and its investor partners.
• Tax benefits and other incentives: Owners of loan-financed systems receive all applicable tax benefits and incentives available to the solar assets (this follows from ownership). As of October 2014, these benefits and incentives could include: the 30% federal investment tax credit (ITC) for individuals (see Section 3), production-based incentives (PBIs), renewable energy credits (RECs), and others. When leasing a system through a TPO arrangement, these benefits typically go to the third party. Additionally, third-party owners can make use of the accelerated depreciation schedule to increase the system cost savings—homeowners cannot.
• Monthly payments: A solar loan is typically amortized through monthly payments of both principal and interest (P&I). In contrast, TPO systems are paid for via either a monthly fixed rate in a lease arrangement, or a charge per unit of electricity produced by the system (on a $/kWh basis) in a PPA arrangement. It is common for both leases and PPAs to contain annual escalators that step up the charges by a specified percentage (typically around 3%) each year.
• Effect on home valuation: Some studies suggest that homeowners could increase the value of their home when they install and own a solar system on their rooftop (Hoen et al. 2013; Desmarais 2013). While no comparable study has yet been performed on TPO systems, the National Renewable Energy Laboratory’s (NREL’s) communications with appraisers and homeowners in California, as well as speculations made in recent news articles (Wade 2014) suggest that systems financed through a PPA or a lease may not be rolled toward the value of the home (appraisers may, in fact, count them a deduction against the home value), and could complicate the sales process. It is important to note, however, that the effect that each financing option has on home value is still not well understood. Additional data, regulatory decision making, and the development of industry best practices will be necessary before the market arrives at a standard method for appraising solar assets.
• Cost: The cost to finance a system through a loan is largely determined by the interaction between the loan amount, the applicable interest rate, and the tenor or term of the loan. For example, a $20,000 loan with a 6% annual percentage rate (APR) of interest and a 15-year maturity will add an extra $18,000 in costs to the principal amount, or about an extra $100 a month in interest payments. TPO systems are typically financed on a portfolio basis through complex financial structures that bring in tax equity investors to monetize the 30% ITC and depreciation expense. The weighted average cost of capital (WACC) of these structures reflects, principally, the tax equity’s yield on their investment, the cost of any associated debt, and the sponsor’s (i.e., the solar company’s) cost of equity. The resulting cost of the system will be influenced by this WACC, which is typically higher than the cost of capital on the loan.
This report provides a high-level overview of the developing U.S. solar loan product landscape, from both a market and economic perspective. It covers current and potential U.S. solar lending institutions; currently available loan products; loan program structures and post-loan origination options; risks and uncertainties of the solar asset class as it pertains to lenders; and an economic analysis comparing loan products to third party-financed systems in California. The report begins (Section 2) with an overview of the U.S. distributed solar market to contextualize the discussions to follow. For readers already familiar with this information, the authors recommend beginning at Section 3 on page 18.
The penultimate section of the report (Section 4) provides an economic analysis of solar loans versus TPO. The authors built three pro forma financial models to calculate the levelized cost of energy (LCOE) for a residential loan, a commercial loan, and a TPO PPA in the state of California. These LCOE figures are used to compare the system costs associated with each financing arrangement, and—for the residential loan and TPO PPA—to compare with the retail rates of one of California’s three investor-owned utilities. This report finds that the single largest differentiating factor influencing LCOE in the models was the cost to finance the solar assets— namely the interest rate on the loan, and the WACC in the TPO PPA. Accordingly, the modeled LCOE for solar loans was lower than the TPO LCOE in this analysis. The U.S. Solar Market…Solar Loans: Lenders, Processes, Products, and Risks…The Solar Loan Product Landscape…
In June of 2014, GTM Research released its second update on the residential solar financing landscape. The report predicted that the TPO market, which has been a large driver of residential PV deployment for the last several years, would peak in 2014 and gradually cede share to loans and alternative forms of financing (such as PACE) thereafter (Litvak 2014).
While the actual competitiveness of the loan option in solar finance will be determined by the offerings in the market, this report attempts to provide a framework for understanding how loan structures could affect the ultimate cost to distributed PV consumers. Solar loans have the potential to provide an economical option (from an LCOE perspective) for homeowners and businesses to finance the purchase of a solar system, retaining the benefits of ownership that TPO systems cannot provide while avoiding the large upfront cost of a PV system. According to the analysis, solar loans at 5-, 10-, and 20-year maturities delivered a lower LCOE than a 20-year TPO PPA, representing a reduction of 19% to 47%. Both loans and TPO were found to generate electricity at a rate lower than the blended rate for SDG&E’s second and third tiers of residential rates.
It is important to emphasize that while solar loans may result in a lower cost of generation to the consumer, thus reducing the lifetime costs associated with the system, the monthly payments on a loan may not necessarily reflect these favorable economics. Depending on the interest rate, the principal and the tenor of the loan, monthly P&I could be higher than the system owner would pay under both a TPO arrangement and the utility rate. However, the faster the loan is paid down, the more “free” electricity the host will enjoy post-financing, offsetting utility bills at no additional cost for the remaining useful life of the system. This becomes something of an optimization exercise for consumers deciding on a financing option, who may weigh their ability to make possibly higher monthly payments against the ultimate savings a loan could provide over the system lifetime. From a qualitative survey of the solar-specific loan options available in the market or in the planning phase as of this writing, NREL has determined that most products fall into the range of 5 to 20 year maturities. Of note, SolarCity has recently announced that it intends to roll out a 30-year product (Wesoff 2014), which would match typical mortgage maturities and could reduce monthly payments to a level highly competitive with or lower than utility rates in markets with lower power prices.
There are other factors, beyond loan tenor, that may impact the economics of a solar loan and TPO: the hosts’ requirement for a tax liability to take advantage of the federal tax incentives; the additional liability and maintenance costs associated with ownership; the complications of adding assets and liabilities onto one’s balance sheet (as opposed to a TPO transaction which is an off-balance sheet); and the economic time horizon of individual decision makers. Individual decision makers will have to determine how these risks and benefits compare with their own economic profile.
A broader range of loan financing options with flexible interest rates and maturities, coupled with deeper market penetration, could help reduce the financing costs associated with installing solar, and thus provide another trajectory for the achievement of the U.S. Department of Energy’s SunShot goals. Distributed solar continues to perform robustly in terms of both growth and its ability to attract investment; the wider availability of financing, the diversity of financing options, and the competitive rates at which to finance in this space, will all prove influential to the ultimate success of this market, both in the near term and post-ITC.