Month: July 2014

SolarCity Quietly Moving to Loans and Customer-Owned Solar

Officially, SolarCity, Sunrun and Vivint do not offer loans for the residential photovoltaic (PV) systems that they help finance and install.

Unofficially, its another story.

These market-leading firms make their money with residential solar leases and power-purchase agreements (PPAs). And business is pretty good (see SolarCitys recent securitization).

Third-party ownership (TPO) remains the dominant model for financing a residential solar installation in the US, but thats changing. Direct ownership via loans and other mechanisms like PACE are gaining traction, because PV systems continue to get cheaper while financing options continue to improve.

If customers are moving toward loans, surely SolarCity, Sunrun and Vivint will as well.

Recently we reported that SolarCity, the leading residential solar installer and financier, would soon unveil a loan product, according to sources close to the firm. The program was to be open to applicants with FICO scores of 650 and higher with a 30-year option. The loan program was to be tested in a limited market to begin with, in order to better understand and codify the sales process.

And now SolarCitys 30-year loan product has been spotted in the wild by one of our sources. (They are everywhere.) It looks like a hybrid PPA-loan, according to our contact, who called it confusing and expensive.

GTM has also learned that SolarCity has started a pilot loan program in TPO-unfriendly Colorado and is financing the loans off its balance sheet.

Additionally, our contacts note that SunEdisons 20-year loan includes equipment but has an expensive dealer fee. Both the SolarCity and SunEdison loans are unsecured and have a relatively low rate of 4.5 percent to 6.5 percent, according to our sources.

Neither SolarCity nor Vivint offered an official comment in response to GTMs request.

Some detail about Sunruns loan hopes can be found online, including a listing for a product manager position that will develop and manage product financing offerings which will include secured and unsecured loans. Sunruns Andrew Pontti notes, We currently dont offer a loans, but we follow the consumer financing landscape closely and appreciate financial innovation that helps more homeowners go solar. Our view is that there will likely be a robust market for other financing methods over time, and their success will be determined by consumer interest.

A financial industry contact says that there are two products that are doing well in the market, both unsecured:

  • A loan with an interest rate buy-down program where the consumer gets a low interest rate (1 percent to 3 percent) and the dealer (contractor or sales organization) pays a fee of anywhere from 12 percent to 20 percent.
  • A no-interest, no-payments loan (ie, a same-as-cash loan) for some period of time (12 to 24 months) which includes a dealer fee of 10 percent to 20 percent

Our contact notes that unsecured loans are the dominant choice in the market.

In June, SunPower partnered with Admirals Bank on a $200 million loan program for residential solar installations over the next two years. Clean Power Finance and Sungevity are also in the loan business, and Kilowatt Financial, Sungage and Mosaic are moving into the solar loan transaction business. Look for NRG to enter the fray as well.

Nicole Litvak, a solar analyst at GTM Research, just authored a report on this topic, US Residential Solar Financing 2014-2018. (For more information on the report, click here or contact Matt Casey at GTM Research is forecasting third-party ownership to peak at 68 percent of the residential PV market this year.

Litvak notes that a few banks, such as Admirals Bank and EnerBank, provide solar-specific bank loans with interest rates typically between 5 percent and 10 percent depending on term (five to twenty years) and FICO score.

GTMs Matthias Krause reports that Mosaic will allow homeowners to take out a 20-year solar loan with no down payment and a 4.99 percent interest rate. The loan is bundled with residential operations and maintenance services provided by Enphase along with its microinverters, according to the article. Mosaics Billy Parish hopes that higher-quality loans will help the securitization process. In Mosaics experience, lenders and investors have historically viewed solar loans as riskier than leases because there is no assurance that the system will continue to produce energy after installation.

According to an online survey of 1,031 California homeowners that was conducted by Mosaic in April, around 60 percent of respondents would prefer to own a residential rooftop system rather than lease it, assuming that savings and performance are similar. And, more importantly, among the 26 percent who still favor leases, more than half would choose a loan instead if a warranty was included, writes Krause.

GTM Research expects the US residential PV market to exceed 1 gigawatt for the first time in 2014.

Last month, GTM Research published its latest report on residential solar along with an update on the leaders and trends in the industry landscape:

Market data is from the recently released report US Residential Solar Financing 2014-2018. For more information on the report, see this page or contact Matt Casey at

Tags: admirals bank, clean power finance, cpf, gtm research, loans, mosaic, pv, residential solar, solarcity, sunrun, third-party ownership, vivint

A Rough Road For Financial-Services ETFs

By Robert Goldsborough

In the first half of 2014, the market performance of the US financial-services sector trailed the broader US equity market by several hundred basis points.

Thus far this year, there have been some small bumps in the road for a sector that has enjoyed a robust comeback during the past five years, but where volatility remains meaningfully high and uncertainty even higher. While no one doubts that large banks, which dominate the financial sector, are far better capitalized than they were heading into the financial crisis, the final results in March of the Federal Reserves annual stress test on the United States 30 largest banks demonstrate both a lack of robustness on the part of some large lending institutions–including Citigroup (C)–as well as the clear presence of a prominent headwind in the form of elevated compliance, regulatory, and legal costs across the industry.

Another headwind is the US economy. While it unquestionably has shown some bright spots during the past several years, concerns about a less-than-strong economy generally has weighed on banks, which feel less inclined to lend in such an environment. Less lending means less growth for banks.

The Opportunity in US Financial Services
Morningstars equity analysts view the financial-services sector as largely fairly valued, with pockets of opportunity in individual stocks. A future rally in the sector likely would be driven by several factors, including continued improvement in the US economy (and likely, overseas economies as well), which would in turn prompt central banks to continue pulling back on their easy money policies and instead allow for interest rates to rise. That likely would mean greater lending from banks, as well as lower global unemployment. At the same time, global markets would need to continue their march upward (Morningstars equity analysts hold the view that the financial-services industrys asset managers performance more or less will follow the market). And, in theory, continued strong markets would bring more deal activity for investment banks. On top of all this, banks likely would continue their ongoing cost-cutting efforts (we view many physical bank branches as endangered species).

Unpacking Specific Subsectors Performance
Broadly, the financial-services sector breaks down into a handful of subsectors, which include banks, insurance firms, REITs, and asset managers/capital markets. Banks have underperformed the overall US equity market thus far this year, amid stress-test results and a general sector rotation away from financial services. Insurance firms also have lagged amid strong debt and equity markets, which tend to force down insurers prices and thus returns on invested capital. Meanwhile, REITs have done very well after a not-so-great 2013, during which investors panicked. Although one might think that the specter of rising rates would hurt REITs, rising rates also usually mean a strong economy, and for REITs, a boom means higher occupancy and steadily increasing rents on tenants.

A Closer Look at an Array of Financial-Services ETFs
Some of Morningstars own proprietary data points can help investors make sense of the many exchange-traded funds out there that are devoted to the financial-services sector. First, we will apply some of these data points to a group of broad-based, market-capitalization-weighted financial-services ETFs. Next, we will take a closer look at strategic-beta financial-services ETFs, global and foreign financial-services ETFs, and the narrowly constructed ETFs devoted to several financial subsectors. Finally, well examine recent trends in fund flows in the financial-services sector.

An Overview of Market-Cap-Weighted Financial-Services ETFs
There are three large and liquid cap-weighted financial-services ETFs: Financial Select Sector SPDR (XLF), Vanguard Financials (VFH), and iShares US Financials (IYF). All seek to replicate broad indexes of the largest US financial stocks, including diversified financial-services companies, banks, REITs, insurers, and capital markets firms. All have relatively similar portfolios, although there are small differences in composition.

The table below provides more details on the three funds:

Fidelity recently launched a broad-based, cap-weighted financial-services ETF, Fidelity MSCI Financials Index (FNCL), with a rock-bottom expense ratio of 0.12%. Although the fund has had some success gathering assets ($121 million as of this writing), the three larger broad financials ETFs dwarf FNCL in terms of assets and liquidity.

PowerShares Samp;P SmallCap Financials (PSCF) is another market-cap-weighted ETF devoted to the financial sector. As its name suggests, PSCF tracks an index of small-cap US financial-services companies. It takes its holdings from the Samp;P SmallCap 600 Index. In the Morningstar Style Box, PSCF falls within the core-value segment, between micro-cap and small cap. Morningstar does not compute a price/fair value ratio or an Economic Moat Rating for PSCF. The ETF has lagged cap-weighted financial ETFs during the past year, although its performance has been in line with those funds over the trailing three-year period. PSCFs expense ratio is 0.50%.

Data Points
Valuation-wise, investors could benefit from looking first at price/fair value ratios. One of the most useful data points for ETF investors is Morningstars fair value estimate, which leverages the bottom-up fundamental analysis produced by our global team of equity research analysts. Our equity analysts evaluate the value of a business using our discounted cash flow model, which calculates the present value of a companys future discretionary cash flows based on its cost of capital, as determined by our analysts. Our per-share fair value estimate represents the aggregate, asset-weighted fair value estimate of the stocks in an ETFs portfolio that are covered by Morningstar equity analysts, divided by the ETFs number of shares outstanding. Our equity analysts may not cover each of the stocks in an ETFs portfolio, so we assume the stocks that arent under coverage trade at fair value.

Looking at the three market-cap-weighted financial-services ETFs, we see that they all trade at ratios greater than one, which indicates that the portfolio may be overvalued. XLF trades at 101% of fair value, VFH trades at 102% of fair value, and IYF trades at 101% of fair value. So the three big cap-weighted financial-services ETFs do not trade at any kind of discounts to their fair values.

When evaluating ETFs, another useful data point is the economic moat rating, which helps establish the quality of a funds underlying portfolio. Morningstars equity analysts evaluate firms competitive advantages, or the barriers that a company builds around itself, as well as how long we believe the company can sustain that edge over its competitors. Our equity analysts spend a great deal of time evaluating and debating the strength and sustainability of a firms competitive advantage and examining its returns on invested capital before assigning it to one of three moat sizes: wide, narrow, or none. Wide-moat companies all tend to have at least one strong sustainable competitive advantage (many have several) and earn ROICs well in excess of their cost of capital. Narrow-moat firms, by contrast, are ones that may not be able to continue generating hefty ROICs as competition heats up over the long haul.

In any sector, theres a broad mix with all kinds of moat sizes. However, a portfolio with a large percentage of companies with narrow and wide moats is one that we would categorize as high-quality. The bulk of the assets in large, market-cap-weighted financial-services ETFs are invested in narrow-moat companies. For example, 19% of XLFs assets are devoted to wide-moat companies and 61% are invested in narrow-moat firms. The ratios are similar for VFH, which invests 13% of its assets in wide-moat companies and 50% in narrow-moat firms, and for IYF, where the breakdown is 20% and 49%. Clearly, the large market-cap-weighted financial services ETFs are fairly high-quality portfolios, although anywhere from 10% to 15% of assets are invested in companies with no competitive advantages whatsoever.

Strategic-Beta Financial-Services ETFs
There are several good-sized ETFs devoted to the financial-services sector that seek to improve their return profile relative to traditional market benchmarks. Morningstar terms this category of funds strategic beta. Here are three strategic-beta ETFs devoted to the financial-services sector that we believe are worth discussing.

The first, Guggenheim Samp;P 500 Equal Weight Financial (RYF), tracks an equal-weighted index of 84 stocks. As is the case with other equally weighted funds, RYF offers more of a small- and mid-cap tilt than its market-cap-weighted peers. For example, 35% of RYFs portfolio consists of mid-cap names, compared with just 9% of XLF and 21% of VFH. RYF is only slightly more volatile than its cap-weighted counterparts. RYF has meaningfully outperformed its cap-weighted brethren over the trailing one-, three-, and five-year periods. RYFs position in the style box is almost identical to that of VFH; both funds fall between medium and large and near the boundary of core value and core. RYF also invests in a significant number of high-quality financials firms. In fact, just 18% of RYF is devoted to companies with no economic moat. RYF charges 0.40% and trades at 103% of fair value.

First Trust Financials AlphaDEX (FXO) tracks a fundamental index that uses a proprietary stock-selection methodology to rank financials firms on both growth and value factors. As a result, FXOs portfolio differs meaningfully from many of its sector-ETF peers. The index rebalances quarterly and takes valuation into account when rebalancing. As a result, FXO sits squarely in the center of the core-value band in the style box, while the cap-weighted financials ETFs–and RYF–all sit at or near the border between core value and core. FXOs portfolio also has more of a small- and mid-cap tilt than its competitors, with fully 57.5% of assets invested in mid-cap firms and another 15.0% devoted to small-cap companies. FXO has meaningfully outperformed the cap-weighted US financials ETFs over one-, three-, and five-year periods, and it has done so with slightly less volatility than the cap-weighted funds. FXO charges 0.70%.

Finally, PowerShares KBW High Dividend Yield Financial (KBWD) is a concentrated, higher-risk but higher-yielding financial industry ETF that tracks a dividend-yield-weighted index containing small- and mid-cap financials firms like banks, insurers, and equity and mortgage REITs. In the style box, KBWD is squarely in the deep-value region, between micro-cap and small cap. It has no direct peer. Morningstars equity analysts dont cover enough of its holdings for us to have an estimate of fair value for the fund or a moat rating. And the fund only has traded for about three and a half years, so it has less performance history than some other financials ETFs. However, KBWD has meaningfully lagged its traditional cap-weighted peers over the trailing one- and three-year periods. The ETF yields about 8% but charges a pricey 1.55%.

Global and Foreign Financial-Sector ETFs
Investors looking for exposure to financial-sector firms outside of the US have several options. One is to consider an ETF holding global financial-services names. iShares Global Financials (IXG) is one such option. IXG devotes about 41% of its assets to US companies, with most of the remaining assets invested in companies based in developed foreign markets, such as Banco Santander, Commonwealth Bank of Australia, and Royal Bank of Canada.

IXG has posted meaningfully higher volatility during the past five years (19.9%) relative to its US-only financial-sector ETF peers. At the same time, IXG charges 0.48%. IXGs performance is highly correlated with the three large US-only financial-services ETFs (92% to 93% during the past five years). As a result, cost-conscious investors looking for financial-services sector exposure might prefer XLF or VFH, which carry expense ratios of 0.16% and 0.19%, respectively.

Other ETF options for investors seeking access to financial-services companies from outside the US include iShares MSCI Europe Financials (EUFN), the very small SPDR Samp;P International Financial Sector (IPF) (0.50%), and even First Trust STOXX European Select Dividend Index Fund (FDD) (0.60%). However, its important to note that while FDD has a large tilt toward financials companies (40.5% of assets), it also holds European dividend-paying companies from other sectors as well.

Sub-Sector-Level Financial-Services ETFs
Investors with a strong conviction about an individual subsector within US financial services can consider ETFs devoted to banks, REITs, or insurers. Banking firms have lagged the US financials sector thus far this year in the wake of the mixed results from the stress tests. The largest and most liquid broad-based banking ETF is SPDR Samp;P Bank (KBE), which charges 0.35%. Investors interested solely in regional banks can consider SPDR Samp;P Regional Banking (KRE) (0.35%), iShares US Regional Banks (IAT) (0.46%), or PowerShares KBW Regional Banking (KBWR) (0.35%).

REITs have performed very well thus far in 2014, enjoying a recovery after investors panicked in 2013. The market for REITs came back after investors acclimated to the notion of the Fed potentially winding down quantitative easing. And investors bullishness comes from the signaling effect that would be inherent in higher interest rates–namely, that rates tend to rise when an economy is strong. REITs are cyclical by nature, and with a boom would come higher occupancies and the ability for REITs to steadily increase building rents. Investors interested in REIT ETFs should consider Vanguard REIT (VNQ) (0.10% expense ratio), Schwab US REIT (SCHH) (0.07%), iShares US Real Estate (IYR) (0.44%), and iShares Cohen amp; Steers REIT (ICF) (0.35%).

Insurance companies have lagged the broader market in 2014. The reason is that as the capital markets have done well–both stock and bond markets have rallied–insurance companies book values have gone up. That has resulted in declining customer prices and as a result, lower ROICs for insurers. Several suitable insurance-sector ETFs are SPDR Samp;P Insurance (KIE) (0.35% expense ratio) and iShares US Insurance (IAK) (0.46%).

Flow Trends
A look at where fund flows have been going often can help give investors some insight into what other investors are thinking. Recent fund-flow data for financial services show several noteworthy dynamics. First, strategic-beta ETFs devoted to the financials industry have enjoyed strong inflows during the past year, owing to their track records of outperformance and a generally increased focus from investors and advisors on strategic-beta funds. Next, most regional-bank ETFs have had significant inflows during the past year but outflows year to date. Also, there have been meaningful flows into financial-services industry ETFs devoted to European financial companies.

Disclosure: Morningstar, Inc. licenses its indexes to institutions for a variety of reasons, including the creation of investment products and the benchmarking of existing products. When licensing indexes for the creation or benchmarking of investment products, Morningstar receives fees that are mainly based on fund assets under management. As of Sept. 30, 2012, AlphaPro Management, BlackRock Asset Management, First Asset, First Trust, Invesco, Merrill Lynch, Northern Trust, Nuveen, and Van Eck license one or more Morningstar indexes for this purpose. These investment products are not sponsored, issued, marketed, or sold by Morningstar. Morningstar does not make any representation regarding the advisability of investing in any investment product based on or benchmarked against a Morningstar index.

Is Detroit’s financial oversight board too big to succeed?

Since Mike Duggan became mayor of Detroit more than six months ago, hes methodically kept a list of his accomplishments, including his friendly working relationship with City Council. Given the toxic relations of past mayors with council, Duggans detente with its members is akin to finding bigfoot on the second floor of City Hall.

It could come in handy when Emergency Manager Kevyn Orr leaves this fall and the mayor and city council are allowed to have a hand in city finances.

But a third party soon will be introduced into this budding relationship: After Detroit exits bankruptcy, a state Financial Review Commission will have authority to approve the mayor and councils four-year budgets, approve sizeable contracts, approve collective bargaining agreements and report to the governor twice a year for the next 13 years.

This powerful, nine-member commission, created as part of a grand bargain with state leaders, is intended to protect nearly $200 million in state funding to Detroit by ensuring that city leaders budget money responsibly. But experts say the commissions credibility and effectiveness could be blunted if its perceived as blocking the ability of Detroits democratically elected officials to run the city. If not handled delicately, these experts say, the commission could face the same old political fighting that has scared away residents, businesses and progress.

To avoid this, the state must ensure a meaningful number of local experts and officials are on the commission, said James Spiotto, a municipal bankruptcy expert and co-author of Municipalities in Distress?: How States and Investors Deal with Local Government Financial Emergencies.

Duggan and Council President Brenda Jones pushed for local representation on the commission and lawmakers added a city council appointee. Theres also a counter-balance a gubernatorial non-Detroit resident appointee.

Nobody likes being told what to do, Spiotto said. No mayor or city council wants a mandate from on high. It should be the citys recovery plan. If you dont have buy in, itll never get done.
You need the right people on the board who are professional and experienced and have power and dedication to help the municipality turn itself around.

The commission and its duties

As part of the so-called Grand Bargain, the state legislature approved a package of bills to help Detroit get out of bankruptcy, that included $195 million in state funding to Detroit and creation of the Michigan Financial Review Commission, run out of the state Department of Treasury.

If all goes well, and the citys financial targets are met, the commission will dissolve in 13 years.

The size of Detroits commission nine people could slow progress to that finish line, said Lawrence Miller, a researcher at the University of Washington, who has studied the relationship between financial control boards and governmental financial conditions in distressed cities nationwide.

The creation of state-controlled boards to oversee troubled cities is nothing new, with Philadelphia, New York City and Pittsburgh serving as predecessors to Detroit. But Miller said that smaller boards of five to seven people help maximize cooperation and minimize political logjams.

I think theres a tradeoff between representativeness and expediency, Miller said. Washington DC and Springfield, Mass. had five-member boards. In New York, Yonkers and New York City had seven members. Eight (members) is certainly too many because it will slow the decision-making process without adding new information, and because bigger cities had success with financial control boards with fewer members.

While the Detroit commission may be too large, its budget will help reduce political games, according to Miller. The commission is to receive $900,000 from this years state treasury budget for operations. Financial control boards in New York and Washington, DC worked better than those in cities such as Yonkers because the big-city boards had the money to hire their own staffs to conduct financial research instead of relying on city officials to turn over information, Miller said.

The lesson, then, is that financial control boards with their own staffs have the capacity to implement new information systems to obtain reliable numbers they can trust and use to make important decisions that will affect the citys future including replacing agency leaders when necessary, according to Miller.

Avoiding do-overs

Lou Schimmel knows a little something about overseeing a city or three. Schimmel served as emergency financial manager or emergency manager in Ecorse, Hamtramck and Pontiac. In each city, after he balanced the budgets and left, the city back slid into deficit. Each was then placed in the hands of yet another state-appointed emergency manager.

Schimmel is now on the transition advisory board for Pontiac, a body permitted under the current Michigan emergency manager law. The Pontiac transition advisory board is less powerful than the commission that will oversee Detroits finances. However, the role is the same to make sure a distressed city does not fall back into the hole after an appointee reins in the budget.

In all three places, as emergency manager Schimmel sidelined elected officials while he cut the budget. The route to recovery, Schimmel said, is the mindset of the people involved both elected officials and those on the oversight board.

The question is, when do you get rid of the board? I guess when you get a mayor and council that buy into doing things that dont create problems, Schimmel said.