Securitisation of a portfolio of solar installations – technical due diligence considerations

At the Solar expo and conference held in May, I attended a very interesting talk by Jackson Moore, from DNV-GL.  This looked at the securitisation of a portfolio of solar energy projects, and some of the key items to consider when conducting the technical due diligence on bundles of hundreds, if not thousands, of small scale projects.

Now my experience of technical DD work has been on large scale projects (>5MW) where a lot of focus and energy has been given to reviewing the individual project’s merits and risks, to advise interested parties (often the lenders) on the associated risks and opportunities.  The project details and aspects are interrogated and weighed up individually.  It takes time, and thus has a consulting cost associated with it.  For smaller projects, where the budget or project financial model may not allow for extensive transaction or consulting fees, it doesn’t make sense to drill down into each project’s finer details, and the bundling of projects into a larger portfolio of similar projects makes sense.

Risk profile

For me, and possibly for anyone else who has followed, to any extent, the mortgage-based crash in the US that led to the implosion of the financial system in 2008, the securitisation of debt products triggers a warning bell.  Bundling of small debt packages without conducting adequate inspection of the individual projects increases the risk to the lender, as there is not as much scrutiny on the risk profile of each project.

The aim though is to mitigate this risk through having a broad portfolio of projects.  This portfolio will have projects with varying technologies, geographies, installers, owners and other project make-up that help to prevent an overexposure to any one type of project risk.

The lack of inspections worsens the overall risk profile, but the broad range of projects, and the size of the portfolio, aims to address this.

Mitigating against technical risks

While it isn’t possible, or rather feasible, to inspect all individual projects, there are due diligence tools and techniques that can be used to further improve the portfolio’s risk profile.  The main action to be taken is to scrutinise the individual processes used by project developers in the design, installation, commissioning and operation of these smaller facilities.  Processes to be reviewed include:

• energy modelling;
• performance guarantee methodology;
• supplier selection criteria and qualification processes;
• testing procedures;
• vendor list management;
• design and construction quality assurance procedures; and
• contract development and review.

Let’s look at some of these in more detail.

Energy Modelling

The methodology used in modelling facilities’ performance and anticipated energy output should be a well thought out process.  The methodology should clearly outline how, for example, shading losses will be calculated (using satellite imaging/visual assessment/onsite monitoring etc).  The methodology for determining other technical inputs and assumptions (such as uncertainty values) will also need to be defined and, importantly, the developer should also indicate how they will ensure that their employees are adhering to these processes.  Do they have an internal quality assurance procedure and is this being implemented.

The technical due diligence team would review the procedures and methodologies to comment on their appropriateness, but it is also recommended that a statistically sample of projects is audit and analysed to determine if the methodologies are being followed correctly and if the internal QA procedures are being implemented.

Technical review

Each project will have aspects of it that are unique, and designed according to the relevant local conditions.  However, it is recommended that factors that are likely to be consistent across projects are reviewed for their suitability.  For instance, it would be possible to agree on a short list of Tier 1 module suppliers that may be appointed.  Or an approved list of competent installers, each with an appropriate and demonstrable track record.

This allows for a single review of technical project issues to be applied to a wide range of projects.

Design and construction quality considerations

The main word here is documentation.  As with the energy modelling procedures used, all design, installation, commissioning and operating procedures should have rigorous quality assurance processes in place, to ensure that project activities are carried out according to a suitable standard.  The procedures themselves should be reviewed, but it is very important that the developer is able to provide evidence that the implementation of the procedures has been checked thoroughly.  Documentation such as inspection notes, sign off sheets, certificates or punch lists should be available on each project, and it should be clear that the developer has interrogated these, and is in control of the overall project quality, for each individual project.

This allows the technical DD team to review a sample of the projects, identifying if there appears to be any issue with the developer’s internal quality assurance procedures and processes, or the implementation thereof.

Off-take contracts

There are any number of potential pitfalls when it comes to contracts in energy facilities.  Off-take contracts outline the rights and responsibilities of both the solar facility provider and the customer.  What is most important if projects are to be bundled together, is that these contracts are standardised.  This could either be through standardised Power Purchase Agreements (PPAs) or leasing agreements.  Either way, the terms should be the same across all the projects.  Contracts can therefore be reviewed once, and all projects should have the same type of contract risk associated with them.

In addition, the performance guarantee outlined in the off-take agreements should be relatively low (based, for instance, on a P90 yield assessment or better).  This makes it easier to assess the risk of underperformance, and mitigate against payouts across the project portfolio.

Recommendations for the various parties

In summary, below are some of the recommendations for key stakeholders to improve the overall feasibility and risk profile of their portfolio of projects:

Project developers

• energy modelling procedures are incredibly important and should be followed carefully
• all processes and activities are to be documented accurately and thoroughly
• only projects which are known to have followed the approved processes and procedures should be submitted as part of a portfolio
• only approved suppliers and vendors should be used

Installers

• quality of installation is of paramount importance and should be put above anything else
• the project documentation should be in place and captured accurately
• if the quality is found to be sub-standard it is likely that the installer will not be included as an approved contractor in subsequent funding rounds

Financier

• the emphasis should be on process based review, as opposed to individual project reviews
• a statistical sample of projects should be reviewed to ensure that the processes are being followed and implemented appropriately
• the increase in risk associated with not carrying out a review of each project should be tempered by the overall portfolio of projects

Note:  I have referred to project developers in this post, but this is interchangeable with project owner or **sponsor.  **Jackson referred to project sponsors in his talk, but I lean towards the term developers.