Mid-scale solar projects offer shiny new lending prospects
By Michael McGuire
Community banks continue to scramble in this low-interest rate environment to find new opportunities for credit demand that both maintains spread margins as rates rise and provides assurance for long-term credit quality.
But there is one overlooked solution for community banks, an asset class many know little about. Distributed generation commercial solar projects, with sizes ranging from 50 kilowatts to 2 megawatts, currently comprise a market significantly underserved by financial institutions. These projects represent a potential sweet spot for community banks, with individual funding requirements between $250,000 and $5 million.
Distributed generation is about getting power from many small energy sources. It is independent—its power is not sold into the grid under transactions with the major utility companies—and can provide emergency power for a wide range of public services, such as fire and police departments, in local communities. The U.S. Department of Energy has long been aware of the promise of distributed generation, examining its potential benefits in the areas of improved power quality and reduced vulnerability to terrorism through infrastructure resilience. As an additional benefit, some of its technologies, such as solar photovoltaic panels, don’t rely on fossil fuel.
For community banks, there is vast potential with distributed generation solar systems installed on third-party rooftops. Commercial distributed generation rooftop solar projects, the biggest single segment of the solar market, have the largest potential, but it has had the least amount of capital directed to it. The bottom line? Community banks are sitting atop a gold mine of untapped construction and permanent financing needs.
Community banks have the opportunity to provide interim financing to the engineering, procurement and construction teams building the systems. There are also opportunities for permanent financing, or a combination of construction and permanent financing from the same bank in one package.
The solar contractors need lines of credit and project construction financing. Typically, a special-purpose entity is created for each project that seeks long-term, variable-rate financing. The special-purpose entity would own the solar equipment and sell the power from the project to the host premises under a power-purchase agreement.
Members investing in a solar project typically include corporations and other entities uniquely positioned to achieve the maximum economic benefit from the tax credits and depreciation incentives associated with renewable energy projects. The power-purchase agreements, and the long-term dependable cash flow they generate, make excellent collateral for a community bank funded asset-based credit facility. Payments in connect with these agreements are typically sent directly to a bank checking account creating significant compensating balances.
Community banks will find a new credit market to serve, and an opportunity to use some of their excess liquidity—investing in transactions that produce better yields than they often obtain from traditional commercial and industrial loans. These transactions are highly secure and require less servicing than commercial and industrial loans. Banks will experience better overall economic returns, higher levels of credit performance and less credit administration challenges with a loan facility secured by a power-purchase agreement than they would with typical commercial and industrial credits.
For those community banks weary about stepping into new territory, there are analytical tools, credit risk scoring models and other resources to help with the transition and give them confidence to succeed in this space. Banks should start by evaluating the economic feasibility of the solar space, creating a loss-reserve methodology and conducting a risk assessment. They will need to develop risk management expertise in this area and they should look for ways to align with solutions that address stakeholder needs and automate the management of their transactions.
The sustainable energy industry can be complex and fragmented, but once community banks understand it, evaluate it and access it, they could find the new world of credit demand they’ve been seeking.
Michael R. McGuire (firstname.lastname@example.org) is chairman of Wiser Capital, a company in Santa Barbara, Calif., that evaluates the solar analytics and economic value of third-party financed mid-scale commercial solar development.