Solar panels are physical units attached to the roof of a structure (often residential) that convert the sun's energy into electricity, which, to some extent, should offset the cost of conventional electricity used to power the home. In this Credit FAQ, S&P Global Ratings provides a recent snapshot of the sector by addressing frequently asked questions related to the way solar panels are funded, how transactions are structured, the solar panel market outside the U.S., and more.

Frequently Asked Questions

How is the use of solar panels changing?

The use of solar panels on residential homes has increased over the past decade. According to U.S. Energy Information Administration data, residential solar production capacity has grown more than 10-fold between July 2014 and July 2024, to 34.750 gigawatts (GW) from 3.346 GW. While this growth is most likely attributable to consumers' desire to control the cost of electricity, it may also be part of consumers' efforts to reduce carbon emissions.

How are global solar panel markets funded?

Most solar panels are funded by loans, which in turn are often funded through securitization. Typical loan sizes in the U.S. vary, but the average cost is roughly $30,000. Securitizations backed by distributed-generation solar systems have been around since at least 2013. Early securitizations were more concentrated in lease-backed transactions, while later transactions are more tilted toward loan pools.

S&P Global Ratings rated its first solar asset-backed securities (ABS) transaction in 2013 and currently maintains public ratings on seven solar ABS transactions. We published our criteria and methodology for the solar ABS sector in 2019, with the latest revision in 2024 (see "Global Methodology For Solar ABS Transactions," July 26, 2024).

How are the loans structured?

Solar panel loans typically have fixed interest rates over a term ranging from five to 20 years, and, in many cases, no down payment is required. Individuals who install solar panels in the U.S. are eligible for a federal tax credit of 30% of the cost of the panels.

Most solar loan contracts offer the obligor the ability to pay off the remaining value before the end of the contract term. Reasons for prepayment could include a sale of the property on which the solar system is located, a refinancing of the mortgage on the property, or the availability of other liquidity for the borrower to pay off the contract.

In the case of some loans, the structure assumes that individuals will use the tax savings to prepay a large portion of the loan. That is, the monthly payment amount during the initial period is keyed off a reduced balance that assumes an eventual partial prepayment, normally before the 18th month after origination. Should the borrower's balance not be reduced accordingly by the 18th month after origination, the loan is re-amortized to the total remaining balance, which can result in a substantial payment shock. Because relevant statistics are not readily available, it is not clear how many borrowers claim the tax credit and how many of those who do use their tax refund to pay down their solar loan.

The loans are typically structured as direct, full-recourse obligations of the borrower to the lender. In addition, a U.S. lender will typically secure its loan with a fixture lien on the solar equipment. It is possible that such a lien could appear in a title search on the property where the equipment is installed; however, it is not clear from available data whether a prospective buyer or mortgage lender for the property would require satisfaction and release of the lien before closing on the purchase or loan. It is also unclear to what extent borrowers would be able to place--or have in fact been placing--other senior liens (e.g., Property Assessed Clean Energy loans) on homes with solar fixture liens.

The way the value proposition is presented and marketed to customers at origination could affect the characteristics of the loans. For example, solar loan contracts marketed as cost-saving products that will reduce a customer's overall electric bill would tend to have lower coupons, longer repayment terms, and more deferred fees and expenses incorporated into the financed amount, as this would lead to lower required downpayments and monthly payments.

What could happen if a borrower defaults on a solar panel loan?

In the event of a borrower default, U.S. lenders' most immediate recourse is that the solar panels can be remotely deactivated; this could lead to higher utility bills for the homeowner. Another disincentive to default is that the payment status of the loans is reportable to credit bureaus, and nonpayment could lead to adverse changes in a borrower's credit score.

While more direct remedies are available, we do not believe they would be the preferred course of action for a lender. The cost and timeframes associated with either obtaining a default judgement on the borrower or repossessing the physical equipment would likely render those options impractical. Given the uncertainty in both the timing and value of recoveries, we generally assume there would be no recoveries on defaulted loan balances.

How are the transactions structured?

Solar ABS in the U.S. are collateralized by a pool of solar panel loans (typically about 10,000) made to issuers with credit scores in prime range with heavy concentration in Texas, California, and Florida. Recent transaction sizes have been around (or above) $400 million. More recent transactions have included a larger portion of borrowers with lower credit scores.

Credit enhancement can be achieved through a combination of senior-subordinate structuring and reserve accounts, as well as a yield supplement overcollateralization (YSOC), often included in transactions with negative excess spread. YSOC provisions are notional amounts (not additional cash reserves) used to adjust the reported collateral balance downward, which therefore lowers the reported overcollateralization (OC) amounts and ratios. These are then compared to OC requirements that govern how proceeds are distributed to the various debt classes and residuals.

How can structural features affect how collateral performance impacts the debt?

Structures with average debt coupons that exceed the average collateral interest rate will typically use a portion of principal proceeds to pay interest. On the other hand, structures with positive excess spread may be set up with the expectation of using a portion of interest proceeds to pay principal on the notes and build up OC. Loan transactions rated by S&P Global Ratings have featured negative excess spread, while lease transactions have exhibited positive excess spread.

For structures with negative excess spread, slower prepayment scenarios would generally lead to lower current interest coverage, an increase in the overall amounts of principal proceeds that would be needed to pay debt interest, and a slower increase--or even a decrease--in OC levels. Structures with positive excess spread may benefit from slower prepayments, as more proceeds would be available over the lifetime of the transaction to pay down debt. However, slower prepayments would increase the average amount of time that the transaction is exposed to borrower credit risk, which may contribute to higher overall defaults.

Subordination floors, OC targets, and performance-related triggers can benefit rated debt by diverting excess cashflows from residual payments to debt repayment. However, such mechanisms can also adversely affect the junior debt, because principal or interest they would otherwise receive might get diverted to the senior debtholders. For instance, in most of our rated solar loan transactions, junior classes are not currently receiving any principal payments because the transactions are below their OC targets for the senior classes.

What is driving solar loan performance?

Default rates have accelerated for solar loans, especially for the most-recently originated. Part of the reason for the performance decline lies in the weakening of U.S. consumers, who have reduced pandemic-era savings and struggled with years of inflationary pressure. As unemployment starts to rise (we expect it to hit 4.4% next year), default rates will likely remain elevated, at least in the near term.

While macroeconomic factors cause some borrowers to become delinquent, not all poor performance derives from consumer financial strain. Indeed, some obligors may voluntarily default if they believe that the value of their solar panel system and the expected cost savings have not materialized. This is a factor we consider in our criteria, especially in the context of lease pools; however, it's difficult to know what portion of defaults are voluntary. Moreover, should the aforementioned payment shock (that may arise once a loan is re-amortized) be too great a financial burden, the borrower may be incentivized to "walk away" from the loan.

While prepayment experience has varied across transactions, prepayments for our most-recently rated transactions have trended below the 3% conditional prepayment rate used as a "slow prepayment" case in our 'A' rating scenarios. Older transactions initially experienced higher rates of prepayments, especially during the pandemic-period mortgage refinancing wave, although rates for those transactions have also slowed since in response to the Federal Reserve's last tightening cycle. Based on available data, we have observed some increases of prepayments around the re-amortization points of the loans (i.e., the end of interest-only or other initial periods).

An increase in prepayments around the 18-month re-amortization point is common for standard solar loans without interest-only or deferred payment periods. In our rated pools, all standard loans have passed their re-amortization points, while certain loans with interest-only periods may have not yet re-amortized.

The Fed recently cut the benchmark rate by 50 basis points, and we expect more cuts this year and next (see "Economic Outlook U.S. Q4 2024: Growth And Rates Start Shifting To Neutral," published Sept. 24, 2024). Nevertheless, it takes time for such monetary policy actions to work their way into other parts of the yield curve, and for now mortgage rates remain stubbornly high and we expect prepayments to remain depressed in the near term. Even a substantial reduction in mortgage rates might not be enough to spur prepayments for borrowers who are not selling their homes. In our rated loan transactions, average collateral coupons are between 2% and 3%, while current mortgage rates are well in excess of 6%.

How does the type of contract affect the risks a transaction is exposed to?

In lease transactions, the issuer/lessor is responsible for system maintenance and the associated costs. In a loan transaction, these costs are borne by the borrower but could potentially contribute to the borrower defaulting.

In addition, the lender may partner with third-party installers to provide system design, installation, and ongoing services to customers (though some lenders also maintain in-house installation teams). Technically. the third-party installations do not involve the lender; however, some borrowers might still view them as related and withhold payment (at least temporarily) if they are not satisfied with the performance of the installer or the system. Pools that are concentrated in terms of individual installers could be more exposed to this risk. The tenor of the contract can also affect the level of exposure to the risk of changes in the regulatory environment and other longer-term risks, such as the need for inverter replacements and other major maintenance.

How do policy trends affect the risk of solar ABS?

Electric power production and transmission is a highly regulated industry. Regulatory decisions affect the available price of electric power for consumers, as well as the rates available for distributed-generation systems selling power back to the grid.

Recent regulatory trends have been generally positive for the value proposition of solar systems in our rated transactions. Rates have increased in many jurisdictions in the last few years, making the power produced by the systems more valuable in terms of the consumption they are replacing. In addition, net metering arrangements for existing systems have been largely left in place, which contributes to the value of excess power sold to the grid.

We expect these policy trends to continue in the near term. The outlook for policy in the longer term is less clear. Transactions with longer expected repayment terms will generally be more exposed to long-term regulatory risk. This would also be the case for transactions that are concentrated in terms of relevant statutory and regulatory frameworks.

What is the landscape outside the U.S.?

There is an active market for solar panels in Europe, with a recent shift from a leased-based market to a loan-based one. There are several warehouse facilities being funded by a broad array of investors, and volumes are rising to point that capital markets will likely become a source of funding. The most active market is in Germany, with several lenders and an ABS transaction on the horizon, but there is also interest in Spain and Italy.

European borrowers tend to be homeowners with high credit scores. We therefore expect the performance to be better than that of typical unsecured debtors. However, the historical performance data available from the originators is typically very limited, as they only recently started to originate these loans. This makes it particularly difficult to predict how solar loans will perform over their lifetimes, especially considering their long tenor, which can be as much as 25 years.

In Latin America, markets for solar panels continue to expand. Brazil has been a particularly active market, with securitizations of solar panel receivables becoming a familiar asset class in the country. Most financing is achieved through loans for the acquisition of equipment, and the typical loan term is shorter than those in the U.S. and European markets. Loan maturities are typically between five and 12 years with monthly amortizations. As with the European market, historical data is limited. Therefore, there is an inherent degree of uncertainty regarding performance through economic downturns.

What are the key features of our criteria?

Our published solar ABS criteria are global in scope and do not preclude us from rating transactions backed by assets in any jurisdiction. Assumptions such as default levels are assigned based on credit considerations relevant to each jurisdiction.

Our criteria specify the framework for analyzing pools of various obligor types (including residential, corporate/industrial, and government obligors) and contract types (loans, leases/power purchase agreements, and hybrid solar contracts). Ratings on certain transactions may be limited due to factors such as country risk.

Also, a particular transaction may be capped if its performance is materially affected by risk factors specified in our criteria, including the limited operating history of the asset class, the pace of technological innovation, the potential impact of the regulatory environment surrounding the solar industry, and (for residential lease-backed transactions) the potential for voluntary defaults. In cases where transaction performance is materially affected by these risk factors, we generally cap residential lease backed transactions to the 'BBB' category and other solar ABS to the 'A' category.

In Europe, for example, we believe the 'A' cap is justified by the limited historical performance data in the region. However, as that market matures and more information and data become available, we may be able to assign a higher credit rating. Similarly, we may consider assigning higher ratings in the case of short-tenor transactions (defined in the criteria as seven years or less) if we believe the risks addressed in our criteria are mitigated by a shorter duration structure.

Related Research

• Economic Outlook U.S. Q4 2024: Growth And Rates Start Shifting To Neutral, Sept. 24, 2024
• Global Methodology For Solar ABS Transactions, July 26, 2024