Financing Energy Efficiency & Renewable Energy Projects Program Concepts & Finance Models for State Governments NGA Center for Best Practices Draft January 4, 2009 Matthew H. Brown - ConoverBrown John MacLean - Energy Efficiency Finance Corp.
ConoverBrown LLC & EEFC Consultants specializing in clean energy finance & environmental strategy Strong commercial transaction ti & policy experience; published numerous papers on clean energy finance. Domestic and international government, non-profit & private clients, including financial institutions, utilities, ESCOs, associations, State & local governments Working with clients to set up new financing programs using a range of structures Work with NGA: workshops, consultations ti with States, Issue Brief
Outline Goals of Clean Energy Finance Programs EE/RE Market Overview Key Elements of Successful Programs Clean Energy Finance Program Examples Program Design Strategy Wrap-up & Questions
GOALS OF EE/RE FINANCING PROGRAMS
Goals of EE/RE Financing Programs: Energy Users Perspectives Financing overcomes first-cost barriers Simplify the EE/RE project investment process for energy users Work with commercial parties who can deliver EE/RE projects and services Create financial products & delivery mechanisms adapted d to each distinct i target sector
Goals of EE/RE Financing Programs: State Public Policy Goals Energy savings Energy & economic security in the face of volatile energy prices Enterprise competitiveness Emissions reduction; achieve climate goals; address negative externalities of fossil fuel use Job creation & economic development Huge potential for EE & RE not being developed by market forces alone Public facilities are major energy users & EE/RE market deserving special attention
EE/RE Development Finance : State Perspectives & Strategies Development finance: use public funds to mobilize private investment, working with market actors Leverage private with public capital Recruit financial institutions to offer EE/RE financial products Identify & build on existing commercial capacities Create scalable and sustainable programs Build State capacities to play programmatic & catalytic roles
EE/RE FINANCE MARKET OVERVIEW
Target Markets, Definition of EE/RE Energy efficiency (EE) investments in facilities in all sectors Distributed & customer-sited renewables (RE) not including large grid-connected RE or bio-fuels Sectors include: single & multi-family residential, commercial, industrial, institutional & public, agriculture
EE Market Characteristics: What are we investing in? Energy efficiency investments consist of: Market Measures Typical Per- Installation Cost Residential HVAC systems, insulation, duct sealing, appliances, water heaters, windows, doors $7,500 Commercial Lighting, HVAC, Motors $10,000 and up Industrial Motors, Customized Improvements $100,000 and up
Residential Loan Product Structures Product Unsecured Characteristics High volume, low value loans. Consumer credit model. Underwriting typically based on credit score, debt-income ratios. Fast-response loan evaluation. Conforming product draft in development. Limited 2ndary market. Secured Higher value (>$12,500-$30,000) $30 000) loans. Tax or other lien typical. Often for whole house renovations or solar. PACE model is getting attention. Limited 2ndary market.
Other Markets Institutional (501c3, Health Care Facilities, etc.) Public Sector (Local Governments, Ports, School Districts, States, etc.) Agricultural
Remember the Alternatives to Energy Efficiency-Specific Finance Home equity line of credit Typically variable rate product. Assumes that one has equity in the home. More difficult to access now than 2+ years ago. Consumer credit Typical of a Home Depot/Loews credit card. Often with a discounted teaser rate that increases dramatically. SBA 7(a) loans: M ft b f l t th t i l b i t fit May often be for larger amounts than typical business retrofits. Personal guarantee required of the business owner.
Sources of Loan Capital for EE/RE Finance Programs Loans from financial institutions -- banks, credit unions Federal funds EECBG, SEP State Treasury or Pension funds Bonds & capital markets -- Utility Public Benefit Funds Private investor capital Fannie Mae
KEY ELEMENTS OF SUCCESSFUL CLEAN ENERGY FINANCE PROGRAMS
Key Elements Simplicity appropriate to the need of energy-user Longer loan tenors increase ability to meet monthly payments Interest rates vary y( (0%-8.99%) %) and a highly subsidized rate may not be critical for success Risk management and (perhaps) credit enhancement are critical
Key Elements A robust contractor and vendor network is key to marketing the program Tailored project delivery and finance mechanisms needed for each market Market aggregation strategies & marketing partners needed due to large numbers of small, dispersed projects Recognize trade-off between complexity and up-take of the program
Simplicity Appropriate to the Need Different market and submarkets need different levels l of complexity. For example: Mortgage loans require much greater due diligence than a small $5,000 $, loan or credit card. Small business needs for energy retrofits differ greatly from residential energy retrofits or emergency appliance replacements.
Longer Tenors Reduce Monthly Payments Shortest term loans are often for personal or business loans. Mid-length term loans often occur with on-bill tariff programs. Longest terms occur with efficiency/solar loans that are tied to mortgages and tax assessment programs.
Longer Tenors Lower Monthly Payments Hypothetical Project Annual Energy Savings: 42,301 kwh Annual Energy Cost Savings: $6,927 Monthly Energy Cost Savings: $577 16 Month Term 24 month Term 36 Month Term Project Cost (net of $7,800 $8,835 $, $8,835 $, $8,835 $, rebate) Monthly 0% Loan Payment $552 $368 $245 Net Savings (Between Energy $25 $209 $332 Cost Savings and Monthly Principal & Interest) Source: United Illuminating Company, 2008.
Interest Rates Interest rates range from 0-8.99% for most programs. 0% rates are rarely necessary, with possible exception of small commercial sector. Rates should be set with the target market and transaction point in mind. Target rates in residential sector are typically around 7% with incentives for whole-house approaches.
Risk Sharing & Credit Enhancement Risk sharing facilities can be instrumental to support commercial Financial Institution EE/RE lending Goals: pioneer new finance products, expand risk horizons, broaden access to finance, extend tenors, reduce rates Credit enhancements can support a range of lending and finance models: PACE, utility on-bill financing, commercial loan facilities, bond issues, etc. Credit enhancement structures include: Loan Loss Reserve Funds Subordinated d Debt Structures t Guarantees
Robust Contractor & Vendor Market Contractor networks are key to successful programs. The actual energy savings as opposed to projected savings can differ substantially as a result of poor installation. (Socially Responsible Investors will want strong performance guarantees) Unethical contractor practices can kill a program. Many financial institutions feel nervous about letting contractors promote and close loans.
Tailored Finance Mechanisms for Each Market The first step in designing any program is to identify the market and then build the finance program around that market. Ask: When and why will people invest in efficiency (transaction points)? Where and how does the program capture that transaction point? Does it need to be fast-closing? Is it based on an audit or prescribed measures? How important is the interest rate? How important is it for energy savings to exceed loan payments?
Market Aggregation & Marketing Partners Residential and small commercial programs involve large numbers of small loans. The cost of underwriting, marketing and servicing these loans can be substantial relative to loan value. Mechanisms to streamline and use existing networks to conduct these tasks can be critical. Contractors can market programs. 3 rd parties can service loans and do some underwriting. Much of application process can be completed on line or over a 1-800 number.
Market Aggregation & Marketing Partners (con t) Aggregation may need to happen at the investor level as well many small loans are not of great interest to investors, but securities made up of a bundle of many loans may be of interest.
Trade-off Between Complexity & Uptake Some programs (PA) are highly streamlined and have achieved high volumes. But much of that volume is from the simplest loans for non-audit based EE measures. Greater complexity = smaller loan volume. Yet the more complex projects may yield larger energy savings.
Finance Program Examples First Session Utility On-bill Collections Loan Loss Reserves supporting 3 rd Party Lenders Bellingham/Whatcom, WA PA Keystone HELP Mobilizing i State-Chartered t t Bond Authorities
Finance Program Examples Second Session Property Assessed Clean Energy (PACE) Programs State t Revolving Loan Funds State Treasurer Linked-Deposit Programs Pooled Financing & Energy Savings Performance Contracting for Public Sector Facilities
Secondary Business & Transaction Models Power Purchase Agreements for Residential Solar PV ESCO Financing Vendor Financing i Other Credit Enhancements: Interest-rate Buy-downs, Loan Guarantees a Energy Star Mortgages Energy Savings Certificates Net Metering Feed-in Tariffs
Connecticut: On-bill loan United Illuminating (UI) program is one of the most successful on bill loan programs in the small commercial sector. Has reached nearly 1/3 of eligible customer base. UI offers a 0% loan that is paired with rebates. UI-certified contractors conduct an audit and provide results to the utility. Customer/borrowers apply for loans and are screened for credit worthiness. Default rates on loans have been less than 1%.
Connecticut: On-bill loan UI is now bumping up against its $4.5 million program maximum and has asked the utility commission to increase loan maximum to $7 million. Lighting upgrades and refrigeration make up the majority of the installations. Typical loans are $8-12,000. The combination of rebates and on bill loan always give the customer a net positive cash flow from day one. Relationship with contractors has been absolutely critical to program success.
MidWest Energy: On-Bill Tariff One of the more successful on-bill tariff programs, designed for the residential sector, primarily. A PAYS-like program; many elements are modeled d after the Pay As You Save Model. Customers agree to make a payment on their energy bill that covers efficiency measures identified in an energy audit. Customers pay 4% for this financing. This is a subsidized rate that would otherwise be 8% absent a buy-down from the KHRC.
MidWest Energy: On-Bill Tariff This energy charge is not considered a loan. Any unamortized portion of the remaining balance is passed on to the next building occupant. This allows for an extended repayment period. Repayment term is capped a 180 months for residential and 120 months for the commercial sectors. Program requires that energy $ savings must exceed financing charge, and financing charge be no larger than 90% of the energy savings. In some cases, this means that the customer must make a financial contribution to bring down the size of the loan. Typical projects have resulted in financing i = to 82% of the energy savings.
MidWest Energy: On-Bill Tariff After 20 months of operation, the program had ~450 projects completed or in the queue. Substantial interest in the program existed. It may be taken state-wide as well. 1/2 of projects were thermal shell improvements in addition to HVAC measures. Typical projects cost is $4,500. 14% of the projects are on rental locations. Almost all are in the residential sector.
Challenges and Lessons Learned Utilities have some concerns about on bill programs (default risk, billing systems that don t accommodate) Lenders have concerns (turning over collections to another entity, definition of default) Regulators may have concerns about default risk and how it could affect non-participating ratepayers.
Loan Loss Reserve Funds Supporting 3 rd Party Lenders Public funds, e.g., ARRA $, can be used as Loan Loss Reserve Funds ( LRF ) LRF provides partial risk coverage to motivate commercial financial institutions to pioneer new products, broaden access to finance, extend loan tenors, lower interest rates LRFs cover first losses on a portfolio of EE/RE loans LRFs as a % of total loan portfolio principal = 2-10% LRFs achieve significant leverage of public funds LRFs can support a range of EE/RE finance program types: PACE, bond issues, commercial loan facilities, OBF LRFs are encouraged by USDOE as a use of ARRA funds; no guarantor required
Bellingham/Whatcom Co., WA: Loan Loss Reserves, with 3 rd Party Lender Sustainable Connections (SC) non profit and Opportunity Council (CAP agency) provide a onestop shop that includes: Audits & Energy savings plans for a range of EE measures Rebates, incentives & access to financing Qualified contractors Project performance measurement and evaluation Consumer education & social marketing Partnering with community institutions & utilities Using City & County EECBGs and WA State SEP Credit Enhancement Grant for LRF and interest rate buydowns RFP process conducted for FI Partner Implementing Agreements with FI Partner: LRF Agreement: risk sharing formula, Event of Loss, recoveries, Program Agreement: marketing, loan origination
Loan Loss Reserve Structure City of Bellingham $250K Financial Institution(s) Whatcom County $250K Deposit Account Loss Reserve Fund Loans Loss Reserve Fund : Loan Facility $500,000 : $5 million Residential & Commercial Borrowers
Pennsylvania: 3rd Party Lender w/ Loan Loss Reserves Among most successful EE finance programs: simple and effective with an innovative capital source. Keystone HELP offers unsecured personal loans at rates ranging from 4.99%-6.99%. 4.99% for whole-house, audited measures. 599% 5.99% for advanced d measures. 6.99% for straight-up ENERGY STAR measures Administered by a 3rd party lender that specializes in energy lending. Delivered through a certified contractor network & 1-800 number. Loan Loss Reserve funded by utility sustainability fee
Pennsylvania: 3 rd Party Lender w/loan Loss Reserves Typical loans are from $5,000-$7,000 over a 4-5 year term, but offer a 10 year fixed rate unsecured loan. Capitalized with $20 million from State Treasurer; 5% LRF from PA Energy Development Authority and utilities. Distribution of ~4,500 installations: Whole House 10% Windows / Insulation 30% HVAC 60%
LRFs: Challenges and Lessons Learned Best applied to portfolios of large # s of loans Need source of concessional funds for the LRF Leverage ratios: can start low and increase with experience Make LRF assignable supports secondary Make LRF assignable, supports secondary market
State-Chartered Bond Authorities Bond authorities exist in every state; these capacities can be used for EE finance Tax-exempt bonds, typically long tenors Eligible borrowers Industry & Manufacturing Health care & Higher education Low-Income & Multi-Family housing Eligible use of proceeds includes EE/RE retrofits in facilities of eligible borrowers How to mobilize these capacities?
Example: Washington State Housing Finance Commission Financing for EE projects in the 501c3 and multi-family housing sectors, eligible for tax-exempt bond financing In partnership with a local ESCO that will offer full project development and energy efficiency solutions $1 million funded d by ARRA SEP grant (WA Energy Efficiency i Credit Enhancement Grant) used as 0% interest subordinated loan and loan loss reserve Creates $10 million finance facility; bonds will be privately placed; bond proceeds to be lent directly to eligible borrowers Marketing will be done through h existing i portfolio, as well as through association partners
Challenges and Lessons Learned EE/RE retrofit projects are smaller; need to streamline issuance procedures & manage transaction costs Pi Private placement vs. public capital markets bond sales Blind pools, composite pools, credit challenges with pools Tax-exempt vs. taxable bonds, both possible Bonding authority can be both finance conduit and marketing partner
Program Design Strategy: Where to Begin Identify Target & Priority Markets with Effective Demand: Where are EE/RE project economics most compelling? Potential Marketing & Project Delivery Partners Identify Potential Financial Institution (FI) Partners Banks, credit unions, bond authorities, etc. Financial Products What financing structures do the priority target markets need? What financial products can prospective FI partners offer? What types of financing & services can the State offer to support FI partners to deliver the needed d financial i products?
Summary of Key Points Development finance: appropriate roles of State government to support EE/RE finance Leverage Multiple business & finance models; adapt finance products to target markets Combine finance with marketing, project development services & delivery mechanisms Use RFP processes to choose partners & refine programs Everyone is an energy-user: choose target markets where there is effective demand
2 nd Session Presentation
Finance Program Examples Second Session Property Assessed Clean Energy (PACE) Programs State t Revolving Loan Funds State Treasurer Linked-Deposit Programs Pooled Bond Financing & Energy Savings Performance Contracting for Public Sector
PACE Programs Property owners take out a loan to pay for energy efficiency ce cy or renewable e abe energy. e Local government places an assessment on the owner s tax bill a tax lien. That assessment is paid back by whomever owns the property over a long term, typically up to 20 years at a rate of about 7%.
PACE Programs Still very new with experience only in three local governments (CO, CA, NY). Multiple new programs beginning soon. P h i d i 16 ih li l Programs now authorized in 16 states with multiple new states now considering such programs.
Challenges and Lessons Learned Attractive to investors because they offer security in the form of a senior tax lien. A source of concern to some mortgage bankers for the same reason. May be particularly well suited to larger investments that require an energy audit the thinker. Not so well suited to emergency appliance replacements where speed is critical.
PACE: The Generic Model Local Gov t Establishes Special District i t based on state leg. Local Gov t secures authorization to issue bonds Local Gov t. Issues Bonds, either PAB or Taxable* Local Gov t establishes loan program Homeowners opt in to special district Homeowners sign up a contractor Homeowner agrees to property lien; check issued Homeowner pays P&I on loan through property tax bill *Note that use of PABs is not required for this program. CA programs are not raising capital in this way.
Turnkey PV Installation Property Owners: Households & Businesses Loan Terms 20 years 7.75% Solar PV Payments Project Assistance Bond Turnkey Suppliers Purchaser RFQ process on Property Tax Bill Property Lien & Loan $ 20 million City of Berkeley Renewable Energy Issues Taxable Bonds
State Revolving Loan Funds Capitalized by ARRA funds, utility funds, or general obligation funds Lower interest rates and longer terms than those available commercially Can be administered by the State or selected financial institution and target desired sectors Interest and reflows can recapitalize and sustain the program Colorado Clean Energy Revolving Loan Fund being designed WA Energy Efficiency & Renewable Energy Loan & Grant Program Clean Water State t Revolving Funds
Example: Delaware Sustainable Energy Utility State-wide fund (501c3) for financing EE/RE SEU will provide market and project development services Funding sources Industrial development bond issue planned for $30 million; tax-exemption anticipated; System benefit charge funding mechanism in place with revenues deposited to a Green Energy Fund No State credit; no new taxes (except SBC increase) Considering State appropriation for credit enhancement Consider using RGGI auction allowances Outsourced contract administration; procurement conducted
Challenges and Lessons Learned All these programs are relatively new and untried outside of isolated markets yet have substantial theoretical potential. To the extent that they rely on governments as lenders, they may quickly face a capacity barrier a lack of staff to administer programs. Secondary markets for these loan products are still young and undeveloped.
State Treasurer Linked Deposit Programs Linked Deposit Programs place small portion of State Treasurer cash balances (e.g., $20-50 million) with approved FIs for on-lending to priority economic development sectors Typically below market rate; does not share risk. Funds provided full recourse to participating FIs Results in more lending and lower rates for priority sectors, e.g., SMEs, agriculture, manufacturing, clean energy Clean Energy examples: State of Pennsylvania, Keystone HELP program Colorado SB 184 for Residential sector with Loan Loss Reserves Illinois Green Energy Program
State Treasurer Linked Deposit Programs, Challenges and Lessons Learned Many States have linked deposit & similar programs These can be applied to EE/RE; may require legislation Can provide low cost funds to reduce interest rates, but not a substitute for risk sharing Need to develop secondary markets for State loan portfolios
Pooled Financing & Performance Contracting for Public Sector Energy Users Public facilities of State & local governments are major energy e users s & good target market for EE/RE investment Fiscal benefits for government Long-term tax-exempt financing possible; EE/RE are eligible projects Pooled bond or lease-purchase financing possible Good stable market for Energy Service Performance Contracting; promotes ESCO industry development
Pooled Lease Purchase Financing: State of Iowa Public School EE Project Lease Program Public School Districts EE Project Leases & Lease payments & State aid intercept project TA pledge of State aid authorization revenues $30 million COP s - A rated COPs sales Investment Bank Retail COPs purchasers State School Facilities Corporation Founding Charter & authorization State of Iowa ( Aa rated)
Example: Washington State Energy Savings Performance Contracting Program Performance Contracting for Public Buildings provides: audits, project development, state-qualified ESCO, contract negotiation, energy savings verification State Dept. of General Administration, Engineering & Architectural Services Office runs program since 1986 Provides project development services to State agencies & more recently to local governments Projects funded with State pooled lease purchase financing ESCO provides turnkey construction, services & savings performance guarantees Successful program model. Earns project development fee. Scalable.
Challenges and Lessons Learned Combine financing with project development services State agency can charge project development fees Serve range of public sector entities State Treasurer can use its credit rating and bonding authority to access lower cost pooled financing Can use State aid intercept as credit enhancement for local government entities Good application for lease-purchase financing
Program Design Strategy: Where to Begin Identify Target & Priority Markets with Effective Demand: Where are EE/RE project economics most compelling? Potential Marketing & Project Delivery Partners Identify Potential Financial Institution (FI) Partners Banks, credit unions, bond authorities, etc. Financial Products & Program Design What financing structures do the priority target markets need? What financial products can prospective FI partners offer? What types of financing & services can the State offer to support FI partners to deliver the needed financial products?
Discussion Questions Which EE/RE business & transaction models are most interesting & applicable, and why? What EE/RE finance programs do you have under development or operations? What is your critical analysis of the options? What challenges do you face in development & implementation? i ; what legal l or legislative l i constraints? What information & support is needed to move forward?