Assessing Regulatory Risk in the Residential Solar Asset-Backed Securities Market

Megan Hirsh

With the solar investment tax credit (“ITC”) beginning to phase out at the end of 2019, now is a good time to think about how current regulatory risk will affect the value proposition of residential solar. Given the anticipated utility bill savings that residential solar offers, wealthier households may choose to independently invest in residential panels. But liquidity is a problem for most American households. As a result, solar providers created third-party-owned financing models, making solar a more accessible investment.[1]

With “no money down” contracts and low initial rates, households face fewer barriers to accessing solar. Some households sign leases or power purchase agreements with solar providers for rooftop systems. Solar providers own the systems and create value by managing cash flows from contracted household payments and regulatory incentives. Other households take advantage of Property Assessed Clean Energy (“PACE”) financing. PACE programs allow a property owner to finance the up-front cost of energy or other eligible improvements on a property and then pay the costs back over time through a voluntary assessment on the owner’s property tax bill.[2] The funds for financing PACE can come from the local government or a third-party financier.[3] 

In addition, in 2013, the U.S. Department of Energy advocated for solar securitization—pooling solar asset-backed cash flows into financial instruments that can be traded in primary and secondary markets—in order to bring more capital into the market.[4] Since then, securitization deals have raised $4.7 billion.[5] The value proposition of solar, however, is partially dependent on state and federal regulations that currently incentivize investment. This post explores the existing regulatory risk in the growing market for solar asset-backed securities (“ABS”), including disputes over state net-metering policies, the potential application of ability to repay (“ATR”) requirements to PACE financing agreements, and the expiring solar ITC.  

Disputes Over State Net-Metering Policies

For households, the primary value proposition of residential solar is the lower rate paid to local utilities.[6] Net-metering policies, which most states require, mandate that utilities credit solar households for excess electricity produced.[7] Thus, net metering allows households to take advantage of third-party financing by assuring future cash flows in the form of mandatory credits for excess power production.

Net metering is a key regulatory incentive, so disputes over net-metering policies will impact the value of residential solar. As concerns about free-riding and cross-subsidization have grown, net-metering disputes have cropped up in many states.[8] Public utilities and consumer groups are lobbying against net-metering policies, leaving these incentive programs in a state of flux.[9] Last month, for example, the Louisiana Public Service Commission voted to replace net metering with a “compensation at avoided cost” model, which will greatly undermine the economics of rooftop solar for many customers.[10] But interest groups are powerful on both sides. After the Public Utilities Commission of Nevada (“PUCN”) abandoned net metering, solar companies pulled their operations out of the state, resulting in a loss of over 2,500 solar-related jobs. The PUCN ultimately reversed its prior decision and re-adopted net metering.[11]

As of the second quarter of 2019, a growing number of states are taking a “study first, act second” approach to net metering. By allowing for longer transition periods, states provide greater market certainty, and sufficient time to conduct cost-benefit analyses of alternative policies.[12]

Application of “Ability-to-Repay” Laws to PACE Financing

PACE financing requires enabling legislation.[13] Such legislation is currently active in 36 states.[14] Federal challenges to PACE-enabling schemes, however, are generating risk in the solar ABS market. Last year, President Trump signed a federal law directing the Consumer Financial Protection Bureau (“CFPB”) to write new rules for PACE financing.[15] The new rules must carry out the purposes of Truth in Lending Act’s (“TILA”) ATR requirements and apply TILA’s general civil liability provision for violations of ATR requirements.[16] But the law also requires that regulations “account for the unique nature” of PACE financing.[17]

The Dodd-Frank Act amended TILA and imposed a requirement that lenders “make a reasonable and good faith determination based on verified and documented information . . . that the consumer has a reasonable ability to repay the loan.”[18] In January 2019, the Director of the CFPB said that the amendment was “designed to assure that consumers are offered and receive residential mortgage loans on terms that reasonably reflect their ability to repay the loans.”[19]

In March 2019, the CFPB issued an Advance Notice of Proposed Rulemaking to solicit information relating to PACE financing.[20] PACE advocates are opposed by consumer groups, who claim that PACE loans are “fraught with consumer abuses.”[21] In addition, the real estate industry is advocating for more oversight due to the difficulties caused by the “super-lien” status of PACE.[22]

In 2017, new ATR laws went into effect in California to increase industry oversight. After California’s ATR laws took effect, applications and approvals for PACE financing dropped sharply with the unexpected increase in required documentation.[23] But consumer protection groups contend that California’s ATR laws are still not doing enough to protect consumers. Therefore, these groups are advocating for the CFPB to put in place stronger federal ATR rules.[24]

Expiring Solar Investment Tax Credit

The solar ITC is one of the most important federal policies supporting the growth of solar power. The solar ITC was originally established by the Energy Policy Act of 2005.[25] In 2015, Congress passed a multi-year extension that extends the residential solar ITC through 2022. Until the end of 2019, the ITC is a 30 percent tax credit for solar systems on residential property. The tax credit drops to 26 percent in 2020, then 22 percent in 2021, and finally 0 percent in 2022.

It is no surprise that solar investment is surging in 2019 before the tax credit goes down at the end of 2019.[26] But over time, the gradual ramp down of the solar ITC will reduce incentives to invest in residential solar. When the solar ITC was originally set to expire in 2016, the U.S. Energy Information Administration projected that 2017’s rooftop solar photovoltaic installations would have plunged by 94 percent.[27]

On February 9, 2018, Congress modified the ITC by replacing the requirement to place energy property in service by a certain date with a requirement to begin construction by a certain later date.[28] To determine which ITC applies to a residential solar investment, market actors can consult Internal Revenue Service Notice 2018–59.[29]

Conclusion

Disputes over state net-metering policies, the new federal ATR law, and the expiring solar ITC are just three sources of regulatory risk in the residential solar ABS market. But third-party financing and the securitization of solar asset-backed cash flows remain viable tools for bringing more capital into the market and increasing access to solar. Market actors must stay vigilant and monitor changing regulations in order to determine the accurate value of solar assets.

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[1] Dr. Francis M. O’Sullivan & Charles H. Warren, Solar Securitization: An Innovation in Renewable Energy Finance 6 (2016) (Working Paper No. 2016-05, MIT Energy Initiative), http://energy.mit.edu/wp-content/uploads/2016/07/MITEI-WP-2016-05.pdf.

[2] Office of Energy Efficiency & Renewable Energy, Property-Assessed Clean Energy Programs, U.S. Dep’t of Energy (2019), https://www.energy.gov/eere/slsc/property-assessed-clean-energy-programs.

[3] Property Assessed Clean Energy (PACE), Am. Council for an Energy-Efficient Econ. (last visited Oct. 13, 2019), https://aceee.org/sector/state-policy/toolkit/pace.

[4] See generally Travis Lowder et al., Continuing Developments in PV Risk Management: Strategies, Solutions, and Implications, U.S. Dep’t of Energy, https://www.nrel.gov/docs/fy13osti/57143.pdf.

[5] Total Corporate Funding in Solar Sector Up 34% with $9 Billion in 9M 2019, Reports Mercom Capital Group, Bus. Wire (Oct. 9, 2019, 1:58 PM), https://www.businesswire.com/news/home/20191008005830/en/.

[6] O’Sullivan & Warren, supra note 1, at 9.

[7] N.C. Clean Energy Technology Center, Net Metering, Database of St. Incentives for Renewables & Efficiency (October 2019), https://s3.amazonaws.com/ncsolarcen-prod/wp-content/uploads/2019/10/DSIRE_Net_Metering_Oct2019.pdf.

[8] Lincoln L. Davies et al., Energy Law & Policy 166 (2d ed. 2018).  

[9] Utilities Lobbying to Eliminate Solar Net Metering, Yahoo Fin. (July 10, 2019), https://finance.yahoo.com/news/utilities-lobbying-eliminate-solar-net-120000882.html.

[10] Christina Roselund, Louisiana Guts Net Metering, PV Mag. (Sept. 12, 2019), https://pv-magazine-usa.com/2019/09/12/louisiana-guts-net-metering/.

[11] Davies et al., supra note 8, at 166.

[12] Autumn Proudlove et al., Fifty States of Solar: Q2 2019 Quarterly Report Executive Summary, N.C. Clean Energy Tech. Ctr., July 2019, at 8, https://nccleantech.ncsu.edu/wp-content/uploads/2019/07/Q2_19_SolarExecSummary_Final-1.pdf.

[13] PACE programs are typically enabled through state legislation and authorized at the local government level. Municipalities may directly administer residential PACE programs, or through public-private partnerships with one or more PACE providers. Office of Energy Efficiency & Renewable Energy, supra note 2.

[14] California, Florida, and Missouri are currently the only states offering residential PACE. Other states only offer commercial PACE (“C-PACE”), which is a tool that can finance energy efficiency and renewable energy improvements on commercial property. See PACE Programs, PACENation (last visited Oct. 13, 2019), https://pacenation.org/pace-programs/.

[15] Economic Growth, Regulatory Relief, and Consumer Protection Act, Pub. L. No. 115–174, § 307, 132 Stat. 1347 (2018).

[16] Id.

[17] Id.

[18]  Dodd Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111–203, § 1411, 124 Stat. 2142 (2010) (codified at 15 U.S.C. § 1639(c)(a) (2012)).

[19] Consumer Financial Protection Bureau, Ability-to-Repay and Qualified Mortgage Rule Assessment Report 1 (2019).

[20] Residential Property Assessed Clean Energy Financing, 12 Fed. Reg. 1026 (proposed Mar. 8, 2019).

[21] Compare California Low-Income Consumer Coalition, Comment Letter on the Consumer Financial Protection Bureau’s Advanced Notice of Proposed Rulemaking to Solicit Information Relating to Resident Property Assessed Clean Energy Financing (May 7, 2019), https://www.regulations.gov/document?D=CFPB-2019-0011-0117 with U.S. Green Building Council, Comment Letter on the Consumer Financial Protection Bureau’s Advanced Notice of Proposed Rulemaking to Solicit Information Relating to Resident Property Assessed Clean Energy Financing (May 7, 2019), https://www.regulations.gov/document?D=CFPB-2019-0011-0111.  

[22] PACE loans act as super-liens, bypassing existing liens, including the first mortgage. This super-lien status causes difficulty in California’s real estate market. Lenders refuse to subordinate their first mortgage to existing PACE liens. And homeowners who obtain PACE loans are often in violation of their mortgage terms. See, e.g., California Association of Realtors, Comment Letter on the Consumer Financial Protection Bureau’s Advanced Notice of Proposed Rulemaking to Solicit Information Relating to Resident Property Assessed Clean Energy Financing (May 7, 2019), https://www.regulations.gov/document?D=CFPB-2019-0011-0076.

[23] Ron Hurtibise, Will New Federal Rules Slow PACE of Energy-Efficiency Storm-Hardening Home Upgrade Program?, S. Fla. Sun-Sentinel (June 13, 2018, 6:30 PM), https://www.sun-sentinel.com/business/fl-bz-trump-signs-bill-giving-feds-new-pace-financing-oversight-20180612-story.html.

[24] California Low-Income Consumer Coalition, Comment Letter on the Consumer Financial Protection Bureau’s Advanced Notice of Proposed Rulemaking to Solicit Information Relating to Resident Property Assessed Clean Energy Financing (May 7, 2019), https://www.regulations.gov/document?D=CFPB-2019-0011-0117.

[25] Energy Policy Act of 2005, Pub. L. No. 109–58, § 1335, 119 Stat. 1033 (codified at 26 U.S.C. § 25D).

[26] In 2015, there was a solar building frenzy driven by developers attempting to capture the ITC before it was due to drop in value at the end of 2016. Sustainable Energy in America, Bloomberg New Energy Fin. 21 (2016), https://big.assets.huffingtonpost.com/BCSE2016.pdf.

[27] Will Solar Energy Plummet if the Investment Tax Credit Fades Away?, Wall St. J. (Nov. 15, 2015, 10:11 PM), https://www.wsj.com/articles/will-solar-energy-plummet-if-the-investment-tax-credit-fades-away-1447643512.

[28] Bipartisan Budget Act of 2018, Pub. L. 115-123, § 40411, 132 Stat. 150.

[29] I.R.S. Notice 2018-59, 2018-28 I.R.B. 196 (2018).