A solar energy financing provider, such as a lender or equity provider, may require a solar credit enhancement to increase the chances that they will be repaid by a solar developer.
Solar credit enhancement may unlock solar project financing for non “investment-grade” solar projects by reducing (or eliminating) risk of non-payment by energy offtakers.
Credit enhancement strategies not only reduce risk, but may also provide additional benefits, such as increased loan to value (LTV) and other improvements in a developer’s cost of capital.
Types Of Solar Credit Enhancement
Credit enhancement strategies that solar developers use to unlock project financing and make solar projects more bankable include, but are not limited to:
- Guaranty: A guaranty may come from the solar developer or the offtaker. In the former situation, a guaranty is a written document that requires the solar developer to step in and assume payments to the lender or tax equity if the offtaker fails to pay what is owed. A guaranty is also referred to as “recourse”, which means that the solar developer is liable at the corporate level – or even personally – for any outstanding balance on the loan. This is obviously risky because solar offtaker obligations can stretch out for decades.
- Reserves: Loan loss reserves (LLR) or debt services reserves (DSR) may be held in the form of cash or a letter of credit or a bond. Cash and letters of credit are the least preferable because they tie up capital and show up as a liability on balance sheet. A solar surety bond provides the same function as a letter of credit (LOC) but does not negatively impact the solar developer’s balance sheet or borrowing capacity.
- Insurance: Credit enhancement with offtaker insurance is a cause for optimism in solar development. This is because it transforms non-credit rated offtakers into Google or Apple (i.e. investment grade) in the view of the lender or tax equity. You can transfer the risk of offtaker non-performance to an insurance company for up to 10 years for a one-time, up front premium.
While other forms of credit enhancement exist, such as commercial property assessed clean energy (CPACE) programs and credit tranching1, the credit enhancement methods described above are simpler to implement.
These strategies can transform otherwise illiquid assets into investment grade securities that can provide broader liquidity and reduced risk for sponsors, lenders and tax equity.
Offtaker insurance can also increase loan to value (LTV) ratios and/or reduce interest rates or provide longer loan terms.
Cause For Credit Enhancement Optimism
There is no playbook for how solar developers should manage COVID-19 and potential impact to the solar industry…
However, the most effective strategy may be to buy insurance to offset challenges to offtaker creditworthiness.
A recent report by Euler Hermes predicts a potential time bomb of insolvencies is hidden in the U.S. economy with a surge of bankruptcies or downgraded credit ratings to occur in 2021.
A non-investment grade rating by Standard & Poors or Moody’s can make deals more difficult, increase cost of capital, reduce liquidity, lower loan-to-value or all of the above.
Offtaker credit enhancement insurance solves this problem and transforms non-credit rated or low rated offtakers into investment grade for up to 10 years.
This is an example of ongoing innovation in solar project risk-transfer. Compared to letters of credit, cash reserves or guarantees, such insurance helps solar developers increase liquidity, and address lenders’ underwriting requirements by reducing exposure to non-credit rated risk.
Opportunities abound in government sectors, small businesses, non-profit organizations and schools that are eager to invest in commercial solar, but have lower than investment-grade credit profiles and offtaker insurance can be used as a negotiating tool with solar tax equity investors to guarantee the stream of future cash flows.2
- Credit tranching carves up cash flows from a pool of solar assets into multiple classes of senior and subordinated debt. Lower classes of debt (eg. BBB, Baa, etc.) have higher exposure to default, and thus receive a higher rate of return than more protected layers of senior debt (AAA, Aaa, etc.). Losses, if any, hit the lower graded tranches first.
- Photo by Renovus Solar.