Credit Rating Agency ‘Gatekeepers’ open the Gates for Solar Asset-backed Securities Market, but at what cost?

Whilst the concept of an ‘asset backed security’ was certainly not part of the common parlance before the Financial Crisis, now the concept (if not the technical detail) is perhaps more understand in the current climate. It is important to note that the concept and process of securitisation and asset-backed securitisation certainly is not an absolute negative, we know full well that it is open to abuse and that certain elements need to be witnessed for that abuse to occur. For this reason, this blog post reacts to the news that the credit rating agencies are in the process of opening the gates for solar-backed issuances to feed the hunger in the market for anything related to sustainability, ESG, and non-traditional sources of investment.

 

It was reported in GlobalCapital yesterday that ‘ratings coverage gives investor boost to solar ABS market’. It was noted that the solar ABS sector as a whole is set to hit new records for issuance volumes in 2021, and this was mainly due to the forthcoming addition to the market of industry leaders Sunrun and Solar Mosaic. Whilst both have similar webpages containing modern houses and Tesla cars being charged in the garage, the reality is that these companies exist to provide solar options to consumers by way of a variety of financing options. Sunrun, for example, offers either a lease for the solar equipment over a number of years, or a ‘power purchase agreement’ whereby consumers pay for their energy usage over a certain period but do not have to foot the bill for the initial outlay of installation etc. Mosaic is more of a traditional financier, using crowdfunded capital to lend to homeowners to install solar. The two companies have grown rapidly given the intensified focus on cleaner energy and more sustainably-focused investment. Mosaic has, in recent years, attempted to move to a more public space for its financing needs and has been very successful. So much so, it has recently introduced a new model, whereby consumers can agree a loan with an 18-month deferral on interest and payments, all within a 25-year package. Sunrun, in its journey, demonstrates a more traditional pathway of an early-adopter who has grown organically and now seeks to devour the market. As an example, in 2020 it purchased Vivint Solar for $3.2 billion, creating a $22 billion-valued company in the process. The article in GlobalCapital is indeed correct that the entry of these companies into the solar-based ABS market could be a gamechanger.

 

However, there are warning signs a plenty. Sunrun has been no stranger to transgressive behaviour. In 2017, the SEC investigated the company because the suggestion was that they (and others in the market) were masking how many consumers were cancelling their contracts for their services, with the aim being to present a rosier picture to outsiders, including investors. The company was also the focus of an undisclosed investigation from the FBI and the Justice Department for the same transgressions. The reason for this attention was that the data manipulation, according to former managers, took place right around the company’s IPO. The company rejected these accusations, and since then the trail has gone cold – there is no further mention of the investigations anywhere (and tellingly nowhere from the SEC’s communications). In truth, since that period the company has gone from strength to strength. For Mosaic, its turn towards interest/payment deferral-based loans signals its strength and its push to entice consumers with tempter angles for its products. One wonders whether this may also signal an aim to entice consumers who may not necessarily have the funds to hand, hence the changed model of financing.

 

It is on that basis that there are warning signals. Securitisation is much more complicated than the following explanation, but essentially a pool of ‘assets’, which are in reality the financial stream emanating from loan payments from a pool of consumers, are then sold in different ‘tranches’ (or slices) so that investors can invest in the slice that suits their risk profile etc. One of the major issues in the Financial Crisis was that the act of securitisation in the residential home-based ABS market became a major market in itself, and to keep the engine running, more and more loans had to be fed into the machine. When quality consumers were all used up, the practice of transgressive action took hold as loan originators manufactured loans and aimed for consumers they knew could not afford it (these were referred to as NINJA loans, standing for No Income, No Job, No Assets, as well as the fact that those consumers would often disappear off the radar after starting the loan, if they ever existed at all). It is not my suggestion that similar practices are occurring in the solar ABS market. My point, however, is that the credit rating agencies were so far removed – either by design or otherwise – from this underlying reality, that they simply did not price this reality in; if they did, the market would have seized immediately and the flow of rating payments from that lucrative market would have dried up immediately. It is therefore particular worrying that the GC article states that both ‘Deutsche Bank is acting as the structuring lead for both transactions’ – which in itself is worrying given the Bank’s track record with misdemeanours – and that ‘recent activity from the likes of S&P is driving up issuance volume’. Another solar competitor – GoodLeap – recently had one of its issuances rated by S&P for the first time and stated that ‘the institutionalisation of ESG assets will, in turn, help lower borrowing costs and ultimately drive growth in sustainable home improvement products by providing consumers with access to more affordable payments options’.

 

There are two points to raise here in conclusion. The solar ABS market is so new that it is almost impossible that the rating agencies have performed their full due diligence on the practices of the market that develops the loans that they then rate. The rating agencies argued, in the wake of the Crisis, that the amalgamation of loans in such pools in difficult to understand and therefore rate, which is at odds with them all prescribing their top ratings. Yes, it is now the case that there rating addendums added to ratings for structured finance that are supposed to, since Dodd-Frank, show investors that the ratings are not necessarily the same as the corporate rating scales, but will that be enough? In the Crisis, the rating agencies were actively using methodologies to obtain the required results for major issuances, and this is what the Rating Agencies were pursued for by the Justice Department before the record settlements. Is there enough supervision and oversight to prevent this happening again? Second, what we are seeing is the financialisation of ESG and sustainability, which is obvious and expected, but no less dangerous. Let us consider the statement from GoodLeap, that there will now be more options to reduce costs for consumers. That makes sense from a traditionalistic capitalist viewpoint, but that is not what sustainability, as a concept, should be pandering to – it is those very same traditionalistic understandings that led to the issues we face today anyway. The constant focus on profitability must be countered, because the threat of a bubble in this marketplace alone is now very real. Now the gatekeepers have opened the gate, things cannot be reversed. We have lived through the consequences before, and as I and others have predicted for years, the ‘system’ has moved parasitically onto a new host; last time it was sold as allowing more people to participate in the American Dream, and this time it will be sold on the basis of sustainability and planetary concerns. If one believes that the parasite will act differently this time, then there is no need to intervene. However, regulators should not take this approach in theory, but if one considers an alternative understanding of what a regulator is then it is very unlikely they will intervene to prevent the bubble – if one considers that regulators exist to allow the system to keep moving irrespective of the damage, then the next few years in this particular market will be very predictable indeed, unfortunately.

Keywords – ESG, sustainability, solar, ABS, finance, @C_R_R_I