State, federal incentives mitigate credit risk for solar

Every day the earth receives enough energy from the sun to power everything on the planet for a whole year. If we could use sunlight for our energy needs, there would be no need to burn fossil fuels or to build nuclear power plants to produce electricity. Yet only a fraction of the energy we use actually comes from sunlight. One major hurdle is cost. While the fuel itself is free, there is often a large capital investment required to get the power into the grid.

“The solar industry in the United States is experiencing strong growth,” said Russell Cramer, vice president of solar financing at 1st Source Bank in South Bend, Ind. 1st Source has carved a niche in solar financing. What’s driving growth in solar includes declining material costs, solar-friendly state programs, and the federal investment tax credit benefits, Cramer said.

Though the U.S. market share of the worldwide solar industry declined in the early 2000s, the solar market is shining once again. According to the Solar Energy Industries Association, there was a 50 percent annual growth in the solar market in 2015 alone, and analysts are projecting growth to continue, thanks to the Federal Solar Investment Tax Credit being extended through 2023.

Another driver is renewable standards across 29 states that require utilities to purchase a percentage of their electricity from qualifying renewable sources.

1st Source Bank began investigating the solar market a few years ago in an effort to diversify its portfolio, Cramer said. “After researching solar, we became interested in providing construction loans and permanent loans to commercial solar projects with strong energy buyers; we determined to focus on projects in the 5 to 20 megawatt range,” Cramer said.

A 5 megawatt solar farm can produce enough electricity to power roughly 650 homes for one year.

“We feel that this area of the market is underserved,” Cramer said. From a business perspective, Cramer said, 1st Source likes to work with experienced solar project developers who have long-term power purchase agreements. In June 2018, 1st Source financed a large, two-system solar project developed by Nautilus Solar. The projects, located in Dundas and Waterville, Minn., were on track to be completed this year. The fixed-tilt, ground-mount structures required a $30 million construction loan, a $17 million term loan and a $10 million tax equity investment. “From an environmental perspective, we like to be involved in the renewable energy space and we appreciate the positive benefits solar has on local communities,” Cramer said.

For several years now, Cincinnati-based Fifth Third Bank has played a significant role in solar construction throughout the southeastern United States. Eric Cohen, head of the bank’s North Carolina-based Renewable Energy Finance division, said North Carolina ranks second, behind California, for the total amount of utility-scale solar on the grid. As the industry grew in North Carolina so did Fifth Third’s involvement in solar lending. “In 2012, Fifth Third informally developed a group of commercial bankers dedicated to working with new solar organizations,” Cohen said. They positioned the solar group in the center of activity. “Today, there is a dedicated effort to work with solar organizations throughout the country.”


Industry response

The affordability of renewable energy and sustainability goals coupled with local, federal, and state incentives have attracted wide interest in installing solar across the residential, commercial, and utility sectors.

According to the Minnesota Commerce Department, in 2017, Minnesota experienced significant growth in solar-generated electricity, with an increase in capacity of nearly three times over the capacity generated in 2016. In addition, during the first half of 2017, Minnesota added more capacity than all of the cumulative capacity added in the previous decade.

While solar companies are turning to banks for funding, banks are turning to the USDA’s Rural Electric for America Program, or REAP, which provides loan guarantees to offset risk. The REAP program provides loan guarantees up to a $25 million per loan cap, most of which is used for solar. REAP fees are low, 1 percent versus 2 percent for USDA Business and Industry loan guarantees. What’s more, yearly fees are 25 basis points per year for REAP versus 50 basis points per year for B&I.

Ron Omann, energy/environmental coordinator for rural development at the USDA’s Minnesota office, said bank use of REAP guarantees has grown significantly. In fact, while Minnesota’s USDA office closed two REAP loans in 2016 and two in 2017, it’s closed seven loans by the third quarter 2018, with 11 more in the works.

The surge in solar in Minnesota can be attributed to a legislative mandate that requires Xcel Energy to pay solar farm developers retail electric rates for the next 25 years. This payment stipulation means banks can extend loans to 25 years instead of 15, Omann explained.

“Guarantees are also important if the lender is pushing against loan limits. It’s a huge benefit to sell on the secondary market,” Omann said. The REAP guarantee kicks in once the solar project is up and running, he explained. “And the owner of the solar farm must be a for-profit business, meaning a municipality that wants to build a solar farm must start an LLC,” he added.

“We have seen that growth areas are influenced by the programs and incentives offered in specific states,” Cramer said. “The community solar garden program in Minnesota is a good example of this type of growth and we are pleased to finance projects that are a part of this program. Based on the new state programs that are in place or will soon be starting, we expect to see solar growth in states like Massachusetts, Illinois, and Michigan in 2019.”

Minnesota’s Community Solar Garden program is a state-mandated program with 58 projects online, up from about 10 one year ago; it creates enough electricity to power about 32,000 homes.

While the solar garden serves commercial customers too, as of March 2018 one-third of the program served other entities such as schools. Community Solar Gardens are centrally-located solar photovoltaic systems that provide electricity to participating subscribers. The Minnesota Solar Garden is considered to be one of the most successful in the nation.

1st Source financed its first solar project at the end of 2016 but its niche has expanded quickly. It currently funds projects in seven states.

Fifth Third’s Cohen said the industry is experiencing tremendous growth. Costs of the panels themselves have dropped. While there is a tariff imposed on solar panels, there are domestic manufacturers that are keeping the industry supplied. “There is more of an uptick in farms than manufacturers,” Cohen said. “We are seeing growth throughout the nation. Many cities in the country are evaluating solar and have projects underway.”

Some of the developments are being driven by state programs, but others are motivated by the cost of construction declining and making solar development more economical,” Cohen said.

In March, Fifth Third announced it would become the first publicly-traded company worldwide and the first bank to commit to buying 100 percent solar power.

One of the major challenges facing the solar industry is financing. Omann said he was surprised there weren’t more banks offering solar lending, though he admitted the REAP process was complex. “We try to streamline [things] and make it all electronic, but, for this purpose, a newly established LLC doesn’t have any financial information, doesn’t have employees, and requires a developer to put skin in the game,” Omann said.

In the commercial sector, there is a high demand for large scale projects, particularly those that will attract ongoing financing, and many companies have not yet established the appropriate bandwidth or financial wherewithal to take these on with success.

“Solar lending has some elements that make it unique, given the federal investment tax credit benefits and the interplay between tax equity financiers and debt providers in most projects,” Cramer said. “Ultimately though, we have found that solar assets generally produce within expected ranges. Third-party validation reports are obtained by the bank in the areas of engineering, environmental impact, design, and construction. Asset life is generally considered to be in the 30 to 35 year range.

“There is certainly a learning curve for new solar lenders, given all the moving pieces, but we have found that working with experienced solar development companies and strong third-party vendors helps a great deal,” Cramer said.

Cohen said solar lending is largely project finance. “Some banks have groups that handle this type of lending and are very comfortable with it,” he said. “Others find this niche a challenge to enter if they are not familiar with terms, agreements and structures. There is not a lot of red tape involved in the process, but there is a thorough analysis of all documents and a certain level of diligence that is required by the industry.”

As the market continues to mature, the comfort level with accuracy of forecasted energy production levels will continue to increase, thereby lowering the relative perception of risk. “We have already seen new financiers enter the solar space and we think this will continue given the overall opportunities in solar,” Cramer said.