Assessing Risk for a Vast Commercial Solar Market

Rocky Mountain Institute (RMI) and the truSolar working group have developed a risk-screening tool targeted toward middle-market commercial solar projects.

According to Jamie Mandel, manager at RMI, commercial rooftop and ground-mount systems, which can range from 10 kW to 1 MW, are not financed as often as they should be.

The small- and medium-sized companies and developers that provide these systems do not have FICO scores to attract sufficient debt financing. They are also too small for project finance. The middle-market customers seeking to install these systems may include family companies and small chain stores.

Many of these projects lack a standardized risk assessment profile, a common language, and a shared industry standard to reduce obstacles. These missing pieces contribute to a lack of information which makes lenders skeptical about the risks involved.

Distributed Sun’s chief executive officer, Chase Weir, said standards are lacking for projects downstream in the value chain where buyers and sellers transact. “NABCEP is a good example of a widely accepted standard further up the value chain that provides a nationally recognized procedure to certify engineers who design these systems. Further down the value chain, there is not currently a standard approach to evaluating investment risk.”

RMI and the truSolar working group have created a framework which, if adopted by all counterparties in deals, will lead to substantial benefits, Weir said. “When counterparties to deals you’re doing – and counterparties to deals you’re not doing – all implement the same truSolar framework, the whole industry can enjoy economies of scale.”

Expanded Scale

The truSolar score is similar to Carfax, a commercial service that provides vehicle history reports to individuals and businesses.

Another similar example comes from the telecom industry. Not too long ago, major telecom companies convened a working group and realized that each company conducted business differently. This was preventing them from scaling up. This realization resulted in the creation of Code Division Multiple Access (CDMA), which has now become a standard technology for 3G high-speed mobile use.

The introduction of CDMA brought mobile smartphones to the global market, which was not yet a trillion-dollar market at that time. CDMA helped to scale the mobile phone industry up to reach a hundred-billion-dollar market.

TruSolar will serve a very similar function. A universally accepted standard would potentially open up the solar market to reach more customers in the next 10 years.

“Solar is a billion-dollar market that wants to become a trillion-dollar asset class,” Weir said. “Markets don’t accomplish this scale without transaction standards. There is an inevitability to it, but it takes time. Until everyone agrees on the rules and protocols, we’re holding back growth.”

truSolar will provide these rules of the road and create formulas to quantify risk.

Benefits of truSolar

One big question is: What effect will this tool have on the cost of capital?

Weir said he expects the tool to produce direct benefits such as increased conversion rates, reduced professional service fees, lower soft costs and transaction costs, and ultimately, a healthier market with more mature businesses and sustainable margins.

Wide-scale adoption of the tool may also impact other drivers of soft costs. For instance, this may lead to better understanding of the solar asset class in the lender and securitization markets and subsequently reduce the cost of capital.

By increasing adoption of solar power through more efficient primary markets, truSolar enables securitization and competition. This may reduce the weighted average cost of capital by several hundred basis points, Weir said.

The unlevered after-tax cost of capital today is 8-10 percent, Weir said. Securitization and the emerging yieldco structure is driving the cost of capital to 4-6 percent.

Some companies are already achieving these low costs of capital, but these are the billion-dollar scale companies, which are limited in number. According to Weir, truSolar’s vision of democratizing an institutional best practice, not just among large companies but for mom-and-pop businesses and new market entrants as well, may be achieved by 2018.

Although this statement paints a positive vision of solar’s future, Weir noted that the truSolar group did not view the tool as a direct means of lowering the cost of capital.

RMI wants to reduce the cost of solar, Mandel said. RMI is interested in the accurate pricing of risk and the reduction of transaction costs rather than the lowering of risk.

Mandel said reduced transaction costs could lower the cost of solar by 40 cents per watt.

Currently, most projects proposed in the solar industry do not get financed. The truSolar team is hoping to reduce deal dropout rate, which was built into this 40-cent reduction in cost.

It is possible that banks may not trust a self-scoring tool like truSolar; this may create opportunities for private companies to offer third-party verification and auditing services.

The truSolar working group has not determined who the third-party verifier will be.

According to Mandel, Distributed Sun has created an affiliate company, called beEdison, that will be providing commercial products based on the truSolar score. RMI feels that having an initial commercial partner is critical to long-term success, and ultimately hopes that others will seek licenses as well.

Working Group and Peer Review

The truSolar working group was formed in late 2012. It kick-started efforts by identifying leading companies along the industry value chain. These companies include materials, racking, panel and inverter companies; financiers; insurance companies; and rating agencies.

In the past 18 months, 1000 professionals and eight firms in the industry have provided feedback on the tool’s functionality and accuracy.

According to Weir and Mandel, it is critical that the working group transition to an independent industry body, called the “accreditation body,” which will manage a living standard and act as the final arbiter on risk scoring and algorithm management.

RMI, the chair of the organizing committee, is currently drafting bylaws and structuring a sustainable revenue model to establish truSolar as an independent 501(c)6 entity.

Trust and transparency are a priority and are paramount for widespread adoption, according to Weir. It has not been determined yet whether truSolar will partner with an industry body or remain independent.

Looking forward, Weir said he anticipates the tool will have a positive effect on the market and open channels for improved information, understanding and communication. These direct benefits will indirectly reduce soft costs and a lower cost of capital.

Weir and Mandel said that as the truSolar tool moves through the peer review process and is launched into the market, they will be prepared for challenges.

Mandel said he expects adoption will be one of these challenges. “Adoption means the tool is relevant, trusted and accurate.”

Technical accuracy could also be a concern, as well as business model structure.

“A business model that focuses too heavily on preserving revenue streams will not build trust,” Mandel said. “At the same time, if the business model is too open, you run the risk of destroying incentives or introducing competition.”

The working group completed the alpha phase this spring. This resulted in a list of over 800 attributes to evaluate risk.

These attributes included construction, operation and maintenance provider, location, sunlight, component products, contract structure, and financing approach.

The recently completed “beta phase” focused on quantifying attributes, designing algorithms, and narrowing in on which attributes quantify risk best.

At this stage, the tool combines over 400 attributes. truSolar is taking this a step further to create a score so that this information can be easily interpreted by industry stakeholders, especially lenders.

Ultimately, lenders must understand risk factors so that they can accurately assess project viability, Weir said.

One essential function of the tool is a pre-screening test to determine if and when a project is worth full due diligence. The test will include about 150 questions.

The tool will identify problems and generate a prescriptive recommendation based on the user’s inputs, while stressing profitability.

Weir said that this profitability assessment is not just based on formulaic measures like internal rate of return – or pre-tax or after-tax, levered or unlevered financing.

“The tool evaluates risks to generating kilowatt-hours and cash flow and helps investors understand how to reduce, eliminate and transfer risk, or accept risks,” Weir said.

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