Note 19 - Lease Pass-Through Financing Obligation

Through December 31, 2016, SolarCity had entered into eight transactions referred to as “lease pass-through fund arrangements.” Under these arrangements, our wholly owned subsidiaries finance the cost of solar energy systems with investors through arrangements contractually structured as master leases for an initial term ranging between 10 and 25 years. These solar energy systems are subject to lease or power purchase agreements with customers with an initial term not exceeding 20 years. These solar energy systems are included under solar energy systems, leased and to be leased – net in our Consolidated Balance Sheets.

The cost of the solar energy systems under the lease pass-through fund arrangements as of December 31, 2016 was $785.3 million. The accumulated depreciation related to these assets as of December 31, 2016 was $2.1 million. The total lease pass-through financing obligation as of December 31, 2016 was $122.3 million, of which $51.5 million was classified as current liabilities.

Under lease pass-through fund arrangements, the investors make a large upfront payment to the lessor, which is one of our subsidiaries, and in some cases, subsequent periodic payments. We allocate a portion of the aggregate payments received from the investors to the estimated fair value of the assigned ITCs, and the balance to the future customer lease payments that are also assigned to the investors. The estimated fair value of the ITCs are determined by discounting the estimated cash flows impact of the ITCs using an appropriate discount rate that reflects a market interest rate. We have an obligation to ensure the solar energy system is in service and operational for a term of five years to avoid any recapture of the ITCs. The amounts allocated to ITCs are initially recorded as deferred revenue on our Consolidated Balance Sheets, and subsequently, one-fifth of the amounts allocated to ITCs is recognized as revenue from operating leases and solar energy systems incentives on our Consolidated Statements of Operations on each anniversary of the solar energy system’s placed in service date over the next five years.

We account for the residual of the payments received from the investors as a borrowing by recording the proceeds received as a lease pass-through financing obligation, which is repaid from customer payments and incentive rebates that are expected to be received by the investors. Under this approach, we continue to account for the arrangement with the customers in its consolidated financial statements, whether the cash generated from the customer arrangements is received by us or paid directly to the investors. A portion of the amounts received by the investors from customer payments and incentive rebates is applied to reduce the lease pass-through financing obligation, and the balance is allocated to interest expense. The incentive rebates and customer payments are recognized into revenue consistent with our revenue recognition accounting policy. Interest is calculated on the lease pass-through financing obligation using the effective interest rate method. The effective interest rate is the interest rate that equates the present value of the cash amounts to be received by an investor over the master lease term with the present value of the cash amounts paid by the investor to us, adjusted for any payments made by us. The lease pass-through financing obligation is non-recourse once the associated assets have been placed in service and all the customer arrangements have been assigned to the investors.

As of December 31, 2016, the future minimum lease payments to be received from the investors based on the solar energy systems currently under the lease pass-through fund arrangements, for each of the next five years and thereafter, were as follows (in thousands):

2017	$	37,208
2018		37,653
2019		36,371
2020		35,622
2021		35,413
Thereafter		381,289
Total	$	563,556

For two of the lease pass-through fund arrangements, our subsidiaries have pledged its assets to the investors as security for their obligations under the contractual agreements.

For each of the lease pass-through fund arrangements, we are required to comply with certain financial covenants specified in the contractual agreements, which we had met as of December 31, 2016.

Under the lease pass-through fund arrangements, we are responsible for any warranties, performance guarantees, accounting and performance reporting.

Under the lease pass-through fund arrangements, there is a one-time future lease payment reset mechanism that is set to occur after all of the solar energy systems are delivered and placed in service in a fund. This reset date occurs when the installed capacity of the solar energy systems and placed in-service dates are known or on an agreed upon date. As part of this reset process, the lease prepayment is updated to reflect certain specified conditions as they exist at such date, including the final installed capacity, cost and in-service dates of the solar energy systems. As a result of this reset process, we may be obligated to refund a portion of an investor’s master lease prepayments or may be entitled to receive an additional master lease prepayment from an investor. Any additional master lease prepayments by an investor would be recorded as an additional lease pass-through financing obligation, while any refunds of master lease prepayments would reduce the lease pass-through financing obligation.