Graham Smith, CEO of Open Energy
By Graham Smith, CEO of Open Energy
The cost of solar has declined rapidly in recent years. The United States Department of Energy’s SunShot Program, which set out to achieve a utility-scale solar cost of under $1 per watt, has realized its objective three years ahead of schedule, signaling a victory for the industry. With U.S. solar installations having surpassed 14,626 MW in 2016, industry growth seems unstoppable. Yet a lack of access to tailored financing solutions has persisted as a major barrier to solar.
Both U.S. residential and utility-scale solar have experienced major gains in the efficiency of financing, but the commercial sector has yet to see a reliable financing infrastructure. Significant heterogeneity among commercial solar projects results in drawn out and complicated legal and engineering due diligence. In turn, developers face high transaction costs relative to deal sizes, which many commercial projects cannot afford.
There is a clear need for better understanding between commercial developers and financing parties. One place to start is by elucidating the way in which financiers evaluate and rate projects to guide developers as they source new project opportunities. By understanding financiers’ priorities, developers can come to the table prepared to address common questions and move toward optimal efficiency in project execution.
So, what key factors does a financier take into consideration when evaluating a commercial solar project?
Does your offtaker have strong credit?
When it comes to debt, offtaker credit is often the most important factor influencing a developer’s interest rate. If the entity buying the power has an investment-grade rating, either publicly or via a shadow rating tool, developers are more likely to be offered a favorable lending rate. For outside tax equity investors as well, it is important to have confidence in the credit of the party that is obligated to purchase power. To get ahead of the game, developers should consider creditworthiness when sourcing new clients and conduct research using credit rating services such as Moody’s, to determine a company or municipality’s credit rating. If the off-taker is not publicly rated, which is often the case for smaller corporations, schools and nonprofits, developers should be prepared to provide at least three years of most recent audited financial statements.
If you are seeking debt, have you estimated debt service coverage ratios (DSCR)?
Debt service coverage ratio, or DSCR, refers to the amount of project cash flow available to service debt payments on a loan in any given quarter or year. For example, a developer might be planning to develop, own and operate a solar array that in its first year will generate revenue, after operating costs, equal to 1.20 of their required payments on interest and principal. To a lender, however, a DSCR of 1.40 might be necessary because there is a greater implied level of security in the project’s ability to repay as required. If a loan’s average DSCR is very high, then the borrower may be in a good position to request a larger debt amount.
Do you have a reputable operations and maintenance services plan in place?
Operations and maintenance services are like a solar system’s health insurance, so financiers need to have confidence in the provider. If a developer is self-performing operations and maintenance, it should be prepared to present information about its track record.
If the projects will utilize solar renewable energy credits (SRECs), have they been contracted with an investment-grade counterparty?
Financiers prefer contracted SRECs over uncontracted SRECs because they provide cash flow security. When an investment-grade counterparty like a utility or large investment bank is contracted to purchase SRECs, financiers can underwrite these revenues with certainty. While some developers understandably are reluctant to be locked into a fixed price when there is the potential for higher prices in the future, this risk profile is often incompatible with institutional standards. Developers seeking debt project finance should be willing to contract SREC for at least three years forward.
With a better understanding of how financiers evaluate projects and the combination of factors that influence financing terms, developers can close the information gap and improve the probability of deal execution. As a $67.5 billion market in the Northeast United States alone, the commercial solar sector has the potential to propel the entire market. Financing acumen can empower developers to increase transparency and standardization in the sector, raising investor confidence and ultimately contributing to the growth of the broader solar industry.