Distributed energy service companies (DESCOs) deploying off-grid solar solutions in Sub-Saharan Africa have had limited success in raising debt from local financial institutions such as commercial banks. The high collateral requirements, high interest rates, and short tenors offered by local financial institutions are incompatible with the business models of off-grid solar companies, who need to ensure that the pricing of their products remain affordable to a customer base with extremely limited purchasing power.
While some DESCOs have been able to raise financing from other sources such as development finance institutions (DFIs) and international impact investors, these facilities and investments are often denominated in a hard currency such as the U.S. dollar or the Euro, which add a layer of currency risk given that the revenues of off-grid solar companies are in local currency. Intermediaries sponsored and/or funded by DFIs and impact investors such as the Off-Grid Window of the Facility for Energy Inclusion and SunFunder have made available a limited source of local currency financing. However, crowding local financial institutions into the sector is the only long-term solution to ensuring that DESCOs have access to the scale of capital they require.
Collateralizing receivables and isolating operator risk
In order for DESCOs to tap into local financial markets, they will need to offer mechanisms that provide local banks with the level of comfort needed to unlock financing on terms that are mutually agreeable to both parties while remaining aligned with domestic and/or international credit standards and requirements. In particular, this will require satisfying lender collateral requirements and reducing lender exposure to the operational risks associated with the off-grid solar industry.
One way to address both of the aforementioned issues is by collateralizing receivables and isolating operator risk through off-balance sheet financing structures.
DESCOs have limited access to physical collateral to which lenders have recourse in the case of a default. However, physical assets do not have to be the only type of collateral that can be leveraged to obtain financing. With the widespread adoption of pay-as-you-go (PAYGO) and mobile banking solutions in Sub-Saharan Africa, DESCOs have increasingly been selling larger solar home systems on credit, with customers paying an upfront fee followed by monthly payments for 6-36 months.
These systems are generally equipped with remote shut-down devices that allow DESCOs to de-activate them when a customer fails to pay for a certain period of time. Individually, these consumer credit contracts entered into with customers carry a high risk of default. However, grouped as a portfolio of hundreds or thousands of contracts, they provide DESCOs with a predictable and steady stream of income that can be collateralized to leverage debt. In the case of a DESCO’s default, lenders can seek recourse to the continued income generated from a portfolio of customer contracts.
While collateralizing receivables can help DESCOs meet lender collateral requirements, DESCOs still need to address underlying concerns lenders hold regarding the sustainability of their business models, which involve selling products on credit to a customer base comprising people from unconnected/under-connected rural and peri-urban communities with limited and mostly intermittent and irregular income.
DESCOs can address this by bifurcating their business lines into two separate legal entities: (i) an operating company (the “OpCo”), the legacy DESCO, that sells, distributes, and maintains the solar home systems, and (ii) a bankruptcy-remote special purpose vehicle – ‘asset company’ (the “AssetCo”) – that exists for the sole purpose of buying the future receivables from the OpCo. In this structure, the OpCo sells solar home systems to customers (i.e. enters into contracts with them), bundles the contracts of future receivables from these sales, and then sells them to the AssetCo, which buys this portfolio of contracts with a blend of debt raised from local commercial banks (collateralized by the very receivables it is purchasing) and equity from investors.
In this case, the lender – i.e. the lender to the AssetCo – is not exposed to the operational and market risks facing the OpCo, which, in any event, does not hold the debt of the AssetCo on its balance sheet. Should the OpCo experience financial difficulties or go bankrupt for any reason, the lender will continue receiving regular payments from the steady and regular income generated by the portfolio of future receivables held by the AssetCo (i.e. the Borrower).
The DESCOs Financing Program
The African Development Bank (AfDB) and the European Union (EU) are coming together under the auspices of the DESCOs Financing Programme to work with local financial institutions and DESCOs to structure and execute receivables-backed, off-balance sheet financing transactions.
In order to provide the level of de-risking necessary to better crowd in local financial institutions and improve the pricing and tenor of debt, the AfDB, with the support of the EU, will provide partial credit guarantees (PCGs) on up to a third of the debt raised by an AssetCo in a transaction structured as described above. In situations of default, lenders would not start experiencing losses until the equity/retained earnings layer of the AssetCo and amount covered by the PCG are exhausted.
In the next blog, we will go into technical depth on how the Bank envisages structuring and de-risking receivables-backed, off-balance sheet transactions in the off-grid solar sector.
This blog post is the second in a series covering the Distributed Energy Service Companies (DESCOs) Financing Programme.
By: Fatma Ben Abda, Principal Distributed Energy Specialist, Renewable Energy and Energy Efficiency Department, and Nicolas Miyares, Consultant, Energy Financial Solutions, Policy and Regulation Department.