Solar loans are on the rise as the industry undergoes a transition and credit investors consider whether these asset-backed securities are worth the risk. In some ways, they’re similar to other types of collateral, and credit investors are already used to dealing with the types of risk they pose. However, analysts at Moody’s warn that they’re one of the riskiest securitization asset classes.
The credit positives and negatives of solar loans
U.S. residential solar loans are a fairly new way for consumers to secure credit for improvements on their homes, so they make up only a small percentage of asset-backed securities thus far. As a result, investors may be hesitant to put their money in because they don’t understand this asset class, but Moody’s VP and Senior Analyst Daniela Jayesuria and team explain that the risks associated with these loans aren’t anything new to credit investors.
The reason solar loans are so new is because until now, the residential solar market has been dominated by third-party ownership of solar panel systems via power-purchase agreements and leases. GTM Research projected late last year that 2017 will be the year direct ownership of residential solar panels retakes its position as the top solar financing model.
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The firm projected that 55% of the U.S. residential solar capacity that’s installed this year will be bought by customers who either pay in cash or take out a loan to finance their systems. It added that solar leases and power-purchase agreements peaked at 72% of installed systems in 2014, but this year, it expects third-party ownership to remain flat in terms of megawatts as directly-owned megawattage grows.
One reason direct ownership of solar panels is on the rise is because prices have been falling, and numerous small installers are now offering loans, according to GTM. Additionally, solar panels are spreading into new states where third-party financing isn’t available, for one reason or another.
The credit positives and negatives of solar loans
Because of this growth, credit investors are likely to start hearing more and more about solar loans as an asset class that may be worth their investment dollars.
Residential solar loans are backed by solar panel systems that are installed on homes. As such, Moody’s explains that the main factors which mitigate the risk of extending this type of credit are “relatively strong” credit quality in the borrowers and “the ongoing utility of rooftop solar panels.” Homeowners want to install solar panel systems to save money on their electric bills, so the idea is that instead of paying more for electricity, they’re paying for a permanent improvement to their home that should eventually pay for itself.
According to Moody’s contractor fraud, net metering regulations, and future technological changes are the main credit negatives for solar loans. They also note that other types of ABS collateral have some of these same credit drivers, although to different extents.
Solar loans fall on the riskier end of the spectrum
Jayesuria and team compared solar loans to other types of asset-backed securities that are driven by similar credit positives and negatives. On the spectrum of the ABS they looked at, they found solar loans to be less risky than unsecured marketplace lending consumer loans but riskier than closed-end second lien mortgages. Other less-risky ABS they looked at for this study include private student loans via refinancing lenders and mid-ticket equipment loans.
The Moody’s team explained that often, borrowers for solar loans are of prime credit quality because they’re homeowners and because so far, companies that finance these loans have simply focused their attention on prime borrowers. This is what makes them similar to closed-end second lien mortgages. The main reason solar loans are less risky than unsecured consumer loans taken out via marketplace lending platforms is because these platforms often target near-prime borrowers in addition to prime borrowers. Thus marketplace lenders often accept borrowers with lower credit quality.
Solar loans are issued with 10- or 20-year terms, and if the borrow sells their home, the loan has to be prepaid. It’s also common for the company that financed the solar loan to place a lien on the solar panel fixtures. Because the term length can be up to 20 years, solar loans have greater term risk than other ABS collateral types. Marketplace lenders, on the other hand, often limit their loan terms to between three and five years, thus reducing the term risk associated with their loans.
Incentive to repay versus risk of contractor fraud
Jayesuria and team note that borrowers have a strong incentive to pay back solar loans because of how much they usually save on their electric bills. This is similar to the second-lien mortgage because homeowners fear foreclosure if they don’t repay the loan. However, there is no such incentive with marketplace loans.
On balance, however, there are risks associated with the sponsor and/ or servicer. If the contractor’s workmanship is poor, borrowers could be less willing to repay the loan because the solar panels don’t work properly. Changes to net metering are also unique to solar loans, as states that currently have net metering in place make the cost of installing solar panels competitive versus electricity rates. If this should change, some or all of the incentive to repay could be removed, making this a riskier ABS class.
Other risks that are unique to solar loans include the fact that they haven’t been around for very long and haven’t been through an economic downturn yet, which means that it’s unclear how they would fare during a stressed economic environment. Exposure to technology changes also presents a risk because great improvements in technology may be made during the long terms of these loans.
Further, recovering the collateral on this type of loan is much more difficult, costly and inefficient because the solar panels must be taken off of the home they were installed on.