The U.S. residential solar market is once again re-inventing itself, even as its growth skyrockets.

The third party ownership (TPO) financing structure that revolutionized the business has peaked. From 2010-11, it changed residential solar by bringing billions in institutional money into the sector to drive out the high-upfront-cost adoption barrier.

"Loans and direct ownership are playing a bigger role in the market. That is the big story of 2015," explained GTM Research Sr. Solar Analyst Nicole Litvak, author of U.S. Residential Solar Financing 2015-2020. "The market reached 72% third party ownership in 2014 and we think that is the peak."

Most of the top TPO financier-installers, led by SolarCity, have introduced a loan product, Litvak said.

Though loans have not yet reached 20% of SolarCity’s 2015 sales, they are increasing, according to the sector leader's Q2 earnings report. SolarCity expects 25% to 30% of its total 2015 installations to be through loans, according to Litvak.

Since SolarCity sells a third of U.S. residential solar, "that alone is a big part of the market," Litvak said.

Sunrun, third in market share, also has a loan product. Number two Vivint Solar was working on one before it was acquired by SunEdison. Clean Power Finance, in partnership with Elevate, will soon add loans for solar and energy efficiency. Sungevity and NRG Home Solar offer loans through Mosaic.  American Solar Direct and Petersen Dean are also now emphasizing direct ownership through cash sales and loans.

This profound business model shift has not slowed solar growth. The residential sector has grown in 15 of the last 16 quarters. In Q1 2015, one of the Northeast's snowiest winters, residential solar added 437 new MW, a 76% increase over Q1 2014 and its biggest-ever single quarter growth.

For the first time, residential solar grew more than non-residential solar in 2014. GTM Research forecasts it to be the biggest of solar's three sectors after 2017, when the sunset of the 30% federal investment tax credit (ITC) is expected to cause a sharp drop-off in utility-scale solar.

TPO Trends

"The [solar] market is still in its infancy, and it is yet to be decided which business models, financial products, or sales strategies will beat out the competition," the research explains.

Just as TPO eased into the market after 2010, it will not abruptly disappear. Total capacity installed through TPO financing will increase with the market even though its share will give way to direct ownership after 2017. A referral base will remain and installers will offer the option because "there will always be consumers who prefer to not own," the research reports.

The Solar Energy Industries Association is fighting to preserve the 30% ITC beyond 2016 but most industry watchers expect its built-in phase out to begin with a drop to 10% for commercial forms of solar, including TPO, and to zero for residential solar.

"In 2016, the TPO share goes down because there will be demand from customers who want to buy their own systems before the residential ITC expires," Litvak explained. "In 2017, it will shift back toward TPO because it will still have the 10% tax credit for the fund and the customer may not be able to get a loan with zero down."

After that, the market is expected to trend steadily back toward direct ownership as loan designs become more appealing, system costs continue to fall, and more people see the benefit in a purchase.

Both leases and power-purchase agreement (PPAs) will remain viable products, according to the forecast.

Consumers and installers tend to prefer PPAs, in which customers pay for system production with a cost per kilowatt-hour and, usually, an annual escalator to raise the price but keep it below expected electricity rate increases.

The tax equity investors that fund TPO prefer the fixed customer payments a lease offers but have accepted PPAs as performance data has validated them.

In California and Hawaii, prepaid leases and PPAs are popular to reduce risk or to expand coverage to energy efficiency with a property assessed clean energy (PACE) loan.

The loan market

Of the 742 MW installed by the top ten residential installers in 2014, 94% was TPO and installers will continue to push TPO sales where they can, the research suggests. "But they will also be working for cash sales and preparing consumers to turn to direct ownership through loans after the end of 2016, when the ITC is no longer available."

Residential solar loans are either secured or unsecured.

A secured solar loan is typically secured by the home. There are three types: (1) Home Equity Loan/Home Equity Line of Credit, (2) Federal Housing Administration (FHA) Title I or PowerSaverLoan, (3) Property-Assessed Clean Energy (PACE) Loan.

Much of the market has moved away from secured loans but PACE remains popular in California.

Most of the new wave of loans are unsecured, though some are actually secured to the solar hardware.

Installers prefer working with companies that offer unsecured loans for several reasons. First, they tend to have the lowest and therefore most marketable interest rates, often below 3%. Second, because they tend to be marketing-savvy, unsecured loan providers often also offer a sales-friendly software platform that makes installers' pitches easier. Finally, the research finds, installers prefer being able to offer financing to waiting for the buyer to get a home loan.

One drawback to providing an unsecured loan is that the installer pays a "dealer fee" of between 5% and 20% of the total cost, with higher fees attached to the lower interest products.

Most installers avoid this obstacle "by passing the fee along to the customer, hidden in the cost of the system," Litvak said. "But it often inflates the cost to the customer."

The other important drawback is that unsecured loans, while providing the marketability of a no-down-payment product, often require a balloon payment at the end of the first year that matches the 30% ITC return the customer, as owner, gets. This does not cost the installer anything but can lead to a loss of good will and vital referrals if the customer isn't informed.

As solar financiers become familiar with unsecured loans, they are structuring them with longer terms, of 10-12 years or 20-30 years. This allows for a low-to-no-down payment plan.

With a 20-30 year term, a loan resembles leases and PPAs but offers the benefits of direct ownership like tax credits and increased savings when the loan is paid off. With a 10-12 year term, customers get many of the same benefits but have a shorter payback period and therefore even more savings.

Loan providers have also begun to realize they need to provide the same system monitoring and operations and maintenance services customers get with TPO solar.

SolarCity has developed its own loan construct. “It is the newest loan model but not necessarily a better loan model, just maybe better for SolarCity,” Litvak explained.

With most loans, like leases, the customer makes a monthly payment. With SolarCity's 30-year term MyPower loan, the customer pays for the system's production as in a PPA. The numbers are structured so that the customer theoretically has paid the price of the system at the end of the contract term. But there is risk for SolarCity because output can vary.

"If the customer's payments are lower than the total cost of the system, SolarCity takes the loss," Litvak said. "But they will be pretty conservative in their estimates."

SolarCity uses a "retained value" metric that is based on "the net present value of all future cash flows the company will receive from solar assets currently under contract," the research reports.

The industry is watching because SolarCity is usually ahead of the curve but "it is a complicated model and no one has made a good case against it yet," Litvak said.

A group of companies are "pure play loan providers." GreenSky Credit, which partners with financial institutions, and EnerBank, which works from its banking services, have been offering unsecured solar loans since before most others came into the market. Both are known for 2.99%, 12 year offerings that earn high dealer fees from installers.

Admirals Bank, a full service bank, has been trying various ways to work in solar for some time. It recently introduced an unsecured loan. Mosaic was originally a crowdfunding platform for commercial-scale solar but now offers a range of loan products and is working with major installers, including NRG Home Solar, Sungevity, and American Solar Direct.

Sungage Financial has a $100 million loan fund with Digital Federal Credit Union. It offers 5, 10, 15, and 20 year term loans. Dividend Solar, Sunlight Financial, and Blue Raven Solar are also active.

As with TPO players, there will be consolidation, the research forecasts. During 2017, they will have to survive without the ITC. The unlikely case would be a TPO provider acquiring a loan company, because most TPO providers have or are developing their own loans. The more likely case would be a loan provider acquiring an installer.

Utilities in solar financing

Utilities have tried or are in the process of trying most of the ways to get into the solar market, as the research documents. Pacific Gas and Electric, an investor owned utility, provided funds to both SolarCity and Sunrun in return for the tax benefits. Integrys Energy Services, an unregulated subsidiary of Integrys Energy Group, funded Clean Power Finance (CPF). And Edison International, Duke Energy, and other undisclosed utilities invested in CPF.

In Arizona, Arizona Public Service (APS) and Tucson Electric Power (TEP) have initiated commission-approved pilot programs to own solar installations on the roofs of their customers' homes. Arizona installers say it is anti-competitive for regulated utilities to compete in the private sector but the Arizona Corporation Commission has sanctioned the programs.

Customers with APS-owned solar on their roofs get a $30 monthly electricity bill credit for 20 years. TEP customers participating in its commission-approved 10 MW or more program will pay an upfront fee of $250 to lock in a 25-year fixed monthly rate based on their historical electricity consumption. It is more expensive than the APS plan but is expected to provide more savings over the agreement term if Arizona electricity rates rise as predicted.

More recently, both Georgia Power and New York's Consolidated Edison have taken advantage of new legislation to enter the solar market with unregulated branches of their companies. It is not yet clear the extent of their involvements.

There are, the research notes, clear winners and losers when utilities go into solar.

• Because regulated utilities are prevented from discriminating against their customers, some may get access to solar despite credit worthiness that might otherwise disqualify them.
• Financiers that fund programs put their money to work with the secure backing of the utilities' strong balance sheets. (This means financiers that do not work with utilities would be losers.)
• Because the utilities will be constrained to rely entirely on local installers, they will get work that might otherwise go to national installers. (This makes national installers losers.)

Looking beyond 2016

GTM Research compared the costs and benefits of a 20-year PPA in leading TPO states and a 12-year, 2.99% loan or a cash purchase in the leading solar markets. Even in 2017, when the ITC falls to 10% for PPAs and leases and is not available to purchasers of residential solar, TPO's market edge "is not as great as is generally perceived," the researchers find. "All three financing options experience a slight but not drastic downturn."

In the long term, the research concludes, it will not be savings but marketing and the services offered by installers that will determine the kind of financing customers choose.

Assuming electricity prices rise and policies don't significantly change the equations, year one savings with a PPA in 2020 will be 30% instead of the present 25%; year one savings on a 12-year loan will be 26%; and a cash sale will take 6.5 years to pay off instead of 6.1 years.

As a result, preferences for PPA, loan, and cash purchase in 2020 are expected to be about the same as they are now.

Multiple state level trends will buoy the growth of loans but both approaches will grow in volume, even as the rapidly falling solar installed cost lowers the markets' dollar value. The $100 million fund that supports 30.8 MW this year will support 45 MW in 2020.

But even residential solar's 32% cost drop by 2020 will not prevent it from being a $10 billion market, the research foresees. After 2017, direct ownership will grow by 166% to 2020 while TPO grows by 33%.

This means the billions that have gone into tax equity financing will be looking for an opportunity. That opportunity, GTM suggests, will be in the loan market. It was, at 10% of the 2014 market, about $130 million. If it is half of the 2020 market, $3 billion will be needed for debt financing.