Leasing the Sun - SolarCity's Recipe for Success

As the credit crunch was starting to loosen earlier this year, one of the first glimmers of hope came from the solar energy space. In June, SolarCity and U.S. Bancorp Community Development Corporation (USBCDC) formed a partnership to finance small and medium-scale solar projects for homeowners and businesses across the U.S. The two companies created a new US $50 million tax-equity based fund to finance projects under SolarCity's SolarLease program.

The program allows homeowners and businesses to purchase power from solar energy systems owned and installed by SolarCity through a power purchase agreement (PPA). SolarCity, the system owner, takes advantage of commercial tax credits that it then applies to customer financing. The homeowner or commercial building owner benefits from a reduced monthly energy bill, and the lease payment is fixed, providing the homeowner or business a hedge against future utility rate increases.

The USBDC fund was one of only two tax-equity funds closed in the U.S. during the first half of 2009 that applied to residential solar projects — and both of the funds were created with SolarCity to finance solar installations.

Tax equity financing has been one of the primary constraints on the growth of the solar industry. The fund will allow SolarCity to increase installation throughput and hire more installers to keep pace with the strengthening demand from businesses and homeowners for affordable solar power.

According to sources on both sides of the fund, SolarCity's business model was the foremost driver in the process of getting the deal with USBCDC closed. Despite the fact that virtually every solar company in the country was looking to U.S. Bank for financing, SolarCity was chosen for three key reasons: it top quality products, its commitment to customer service and the equity that solar adds to residential and commercial real estate. For SolarCity, ensuring these areas of the company's business remain strong is the best strategy to be on the radar of financiers in the still difficult economy and credit environment.

Since the expansion, SolarCity has announced the availability of its SolarLease program to customers of Los Angeles Department of Water and Power (LADWP), the nation’s largest municipal utility. The company has also announced a new residential solar service in Oregon. SolarCity’s PurePower program allows homeowners to pay the same rate they were previously paying for electricity from the utility company. PurePower pricing for a 3.5-kilowatt solar system in Oregon starts at $30 per month.

The expansion of the U.S. Bank (NYSE: USB) fund has allowed the company to grow operations substantially to meet increasing demand. SolarCity has hired 140 people in the last 5 months and passed the 4,500-customer mark. SolarCity's growth is part of a wider trend in the PPA market that is taking place because of the retail electricity market it serves. With a large percentage of the nation's rooftops having potential for solar, and the massive and growing electricity industry, many analysts believe the industry won't come close to market saturation for at least the next 20 or 30 years.

USBCDC, one of the nation's largest tax-credit investors, solely makes investments in tax-credit equity and the Investment Tax Credit (ITC) is an extension of the group’s long-time experience in the New Markets and Historic tax credit programs, according to Tina Lin of USDCDC's Historic, New Markets & Solar Tax Credit Investments group.

The structures of USBCDC's tax equity fund deals run the gamut from direct investment, partnership flip models, lease pass-through to sale lease-back structures. USBCDC's return on investment comes primarily from the tax credits themselves so most funds they create with solar companies have short investment horizons, generally just 5 years. However, most transactions are entered into with the goal of doing more business in the future.

Since the closing of this deal, major changes have taken place in the solar finance space. Of these changes, none has been larger than the cash grant in lieu of the ITC provision of the American Recovery and Reinvestment Act becoming an option for developers. As these funds continue to be released and as the economy in general recovers more players will be back in the solar financial picture, but the possibility exists that trend may not last unless the provision is extended.

The conversion of the ITC to a cash grant has improved the tax-equity market, and we are starting to see many new investors enter this space because of that. Important to the industry is an extension of those grants through 2012. This will give new investors time to understand solar investments.

Disclosure: No positions.