Colorado Energy Efficiency Finance Summit

August 4, 2010

Sustainable Energy Financing Mechanisms

Gil SperlingSenior Advisor for Policy and Programs

Office of Energy Efficiency and Renewable Energy

Financing is critical to maximizing clean energy deployment

• Financing programs are inherently sustainable whereas grants and rebates are once-and-done

• Leveraging private capital allows ARRA money to make significant impact

• Financing programs provide the capital borrowers need to pursue comprehensive retrofits

• Effective loan programs provide borrowers with positive cash flow (Energy Savings > Monthly Loan Payment)

Slide 3

The ongoing capital availability combined with a clear customer value proposition transforms the retrofit market by providing long-term business and workforce development opportunities

Revolving Loan Fund – Overview

Slide 4

Description • Loans are made to borrowers consistent with standard prudent lending practices. • As loans are repaid by the borrowers, the money is returned to the RLF to make additional loans. • In that manner, the RLF fund becomes an ongoing or "revolving" financial tool. • The interest and fees paid by the RLF borrowers support program administration so that the fund’s capital base

remains intact. • Typically RLFs lend money with specific goals or borrowers in mind. The range of RLFs varies widely including

such diverse area as affordable housing, historical preservation, energy efficiency, safe drinking water, and small business development.

• RLFs are typically administered by government agencies or non-profits with the goal of creating positive change within their community or target lending group.

Strengths Weaknesses

• Simple to set up compared to other options• Many cities and states already have RLFs, so expertise may

exist in-house• Funds revolve indefinitely creating a source of funds that will

be available in the long term• Can shape program design to fit specific markets and

objectives

• Government often acts as the administrator; requires staff time and expertise to set up if there is not an existing RLF

• Does not leverage private capital, limiting the amount of funds available (especially in the near term)

• Must conduct rigorous credit analysis on borrower's ability to pay (or risk a high default rate)

Example • A fund finances energy efficient retrofits for state agencies, public schools, et. al.• Borrowers repay loans through the stream of cost savings realized from the projects

Revolving Loan Fund – Operating Model

Slide 5Slide 5

Default

Borrower

Step 3bBorrowers default on $5K

Step 3aBorrowers repay $95K

Step 4RLF relends $95K

Step 2RLF loans $100K to

borrowersGranteeRevolvingLoan Fund

ARRA Funds

Step 1Grantee capitalizes$100K RLFusing ARRAfunds

Revolving Loan Fund – Grantee Case StudyEfficiency Kansas

Slide 6

• For approved projects, lenders receive 100% of the project cost from the state at 0% interest. Lenders may charge up to 4% interest on Efficiency Kansas loans.

• Kansans can access the Efficiency Kansas loan program through both Partner Utilities and Partner Lenders

• RLF managed by the Office of the State Treasurer, on behalf of the Kansas Corporation Commission (KCC), of which the State Energy Office is a division

• Treasurer’s Office collects principal payments from lenders on a quarterly basis• Maximum amount financed is $20,000 for residential and $30,000 for small commercial and

industrial structures– Average estimated residential project size is $5,000-6,000

• State Energy Office provides rebates to lenders to cover $250 of loan origination fee• Maximum loan term is 15 years, in 180 monthly bill payments

http://www.efficiencykansas.com

Loan Loss Reserve – Overview

Slide 7

Description • Loss reserves provide a liquid, immediately accessible source of cash to offset covered losses incurred by a participant.

• Created at the outset or over time by assessing fees and other charges based upon activity level or other metric.

• Typically protects a portfolio of loans against a limited amount of potential losses (but insufficient to cover large losses)

Strengths Weaknesses

• Excellent way to leverage third party capital• Leverage ratios can be as high as 20:1• Can be sustainable if replenished by third parties (e.g.,

contractors)• Can support secondary markets• Liability is capped at the amount of loan loss reserve

• Can be perceived (wrongly) as a subsidy to financial partners

ProgramExample

• States form an agreement with lenders to set up a 10% loan loss reserve in exchange for providing residential retrofit loans

• In the event of borrower default, funds are taken from this escrow account and distributed to the investors to ensure they receive full repayment (up to the maximum covered by the loan loss reserve).

• Loans continue to be made until the loan loss reserve is exhausted or refilled from other sources (e.g., fees from contractors participating in the program)

Loan Loss Reserve - Operating Model

Slide 8

Step 2Lender loans $100K to borrowers

Default

BorrowerPrivate Lender

(using their own capital)

Step 3bBorrowers default on $5K

Step 3aBorrowers repay $95K

Step 6Lender relends $100K

ARRA FundsStep 1: Grantee uses ARRA funds to create $10K Loan Loss Reserve

Loan Loss Reserve

Step 4Loan Loss Reserve reimburses lenders for $5K defaults

Contractors / Banks

Step 5: Participating contractors and banks recapitalize fund through fees

Loan Loss Reserve – Grantee Case Study

Slide 9

– ARRA Funds Employment• Michigan Saves provides 5% loss reserve

– Capital Source• A local bank provides loan capital• The local bank owns the loans and has access to loss reserve

– No plans currently to access to secondary markets

– Terms• Loan terms out to 10 years for larger loans • Unsecured loans• Generally higher FICO scores

– Administration• Central loan origination through a national company that takes call and on line

apps • Local bank performs loan servicing and collection

Julie Bennett, Michigan Saves, from DOE Financing Webinar 29 July 2010

On-Bill Financing – Overview

Slide 10

Description • Utility or other entity (such as a third party financial institution) incurs cost of efficiency or renewable improvement and the customer repays the investment through a charge on their monthly utility bill.

• Allows for a streamlined process as utilities already have a billing relationship with their customers, as well as access to information about their energy usage patterns and payment history.

• Eliminates upfront consumer cost for clean energy improvements by financing all costs not covered through rebates.

• Stretches financing costs over a sufficiently long period to make repayments less than the savings. • Typically enjoys lower default rates due to the association with the customer’s utility bill.

Strengths Weaknesses

• Savings paired directly with repayment on the same bill• Can use capital from a variety of sources• Can be tied to the “meter” – transferring liability for the loan

to the next owner• Provides a secure revenue stream since failure to pay is often

tied to disconnection• Can use past bill repayment as a proxy for credit• Allows for longer term investments and can address rental

properties (on-bill tariff only)

• Utilities are often reluctant to take on role of financing entity; potential exposure to consumer lending laws and alterations to billing systems are required.

• Can be extremely complicated to set up the multiple transfers of funds among different entities (on-bill tariff especially)

• Limited to shorter term financing (on-bill loan only)• When liability cannot transfer to new owners, the business or

homeowner must pay off entire loan upon sale of property, which could result in not all of the energy savings being realized (on-bill loan only)

On-Bill Financing - Operating Model

Slide 11

Pending from Matthew Brown

On-Bill Financing – Grantee Case StudyClean Energy Works Portland (CEW/P)

Slide 12

• Joint venture launched late 2009 between Energy Trust of Oregon, the City of Portland, and ShoreBank Enterprise Cascadia

• Customers repay loans through their regular utility bill • 500 home pilot to be complete Fall 2010• Single-family homeowners can receive 100% financing to implement energy efficiency

measures• Loans provided at fixed interest rates (2-7%) and amortized up to 20 years

– 5.99% on weatherization, space heating and water heating upgrades– 3.99% for all upgrades for income-qualified participants

• Average loan amount to date is $10,700• Eligible measures include: weatherization (insulation, air sealing, duct sealing), space heating

(furnace, heat pump), and hot water (gas, electric, tank-less gas). – Will incorporate solar hot water, solar PV, and energy efficient windows in the future

On-Bill Financing – Grantee Case StudySeattle’s Energy Efficiency Service Charge

Slide 13

• Direct version of the energy efficiency Power Purchase Agreement• Finance retrofits in 800 single family homes and 35 multi-family buildings with electric

heating.• City will purchase, install and monitor retrofits• City will enter into long-term contracts with owners (or renters) • Owners will pay monthly service charges for upgrades, equal (or less than) savings achieved

on their Seattle City Light utility bill

Secondary Market – Overview

Slide 14

Description • Secondary markets enable allow lenders to sell the loans originated to investors, providing an ongoing source of capital to fund additional lending

• The market is created by creating homogenous loans through establishing a set of conforming underwriting standards (e.g., FICO score, eligible activities) which can be easily valued, pooled and sold to investors

• Near-term investors include institutional investors (e.g., banks and pensions) and as the market becomes more liquid, smaller investors will be able to participate

Strengths Weaknesses

• Provides a continuous flow of private sector capital to support energy efficiency lending

• Increases lender participation by creating liquidity and providing lenders a risk management tool to balance their portfolios and an exit strategy

• Reduces consumer interest rates because investor demand for loans reduces liquidity premium to banks

• Enables development of mass market consumer lending products as additional lenders opt into the market

• Drives significant cost reductions in manufacturing and installation due to increased retrofit demand

• Requires lenders to adhere to standardized program terms,which limited flexibility

• May not reach certain high priority segments (e.g., low-income) in the near term

• Negative public perception of “secondary markets”

Common underwriting criteria are the lynchpin of a secondary market

Secondary Market - Operating Model

Grantee Funds

Step 1: Grantee uses funds to create $10K Loan Loss Reserve

Loan Loss Reserve

Step 2Lender loans $100K to borrowers

Borrower

Default

Step 3bBorrowers

default on $5K

Step 3aBorrowers repay $95K

Investor (using its capital to

purchase loans)

Step 3Borrowers Now Make Loan Payments to

Investor

Step 4Loan Loss Reserve reimburses Iinvestors for $5K

Private Lender (using their own

capital)

QECBs / New CREBs – Overview

Slide 16

Description • Qualified Energy Conservation Bonds (QECBs) may be issued by state, local and tribal governments to finance qualified energy conservation projects, with a minimum of 70% used for governmental purposes.

• Qualified projects are defined broadly (detailed discussion to follow). Examples of qualified projects include energy efficiency capital expenditures in public buildings, green community programs, renewable energy production, various research and development, efficiency/energy reduction measures for mass transit, and energy efficiency education campaigns.

• Treasury allocated $3.2 billion in bonds to states based on population • New Clean Renewable Energy Bonds (New CREBs) may be issued by public power utilities, electric coops, state and local

government entities, tribes, and certain lenders to finance renewable energy projects. • Qualifying technologies are generally the same as those eligible for the federal renewable energy tax credits.

(i.e., solar, wind, biomass, solid waste, hydro, etc)• Treasury allocated $2.4 billion on a competitive basis. Bonds must be issued by October 27, 2012.

• QECBs / CREBs were originally structured as tax credit bonds but have been converted to direct subsidy bonds whereby the issuer pays the investor a taxable coupon and receives a direct rebate from the U.S. Treasury.

Strengths Weaknesses

• Provides significant source of private capital for state and local governments for an array of clean energy products

• Allows state and local governments to achieve extremely low financing rates for clean energy projects

• Enables to access the much larger taxable investor community to raise capital

• Relatively complicated to issue; bond counsel, financial advisors, and ratings agencies should be involved in early discussions

• Capital raising is limited to amounts allocated by the Treasury

QECB and New CREB Bond Mechanics - Operating Model

Slide 17

The diagram below outlines QECBs/New CREBs cash flows as direct subsidy bondsi. U.S. Treasury allocates QECBs/New CREB bond volume to a Qualified Issuerii. The Qualified Issuer sells taxable QECBs/New CREBs as a 17 year bullet maturity to investorsiii. Bond proceeds are used to fund a qualified projectiv. The issuer pays a taxable coupon semi-annually to the investor and repays principal at the end of 17 yearsv. U.S. Treasury pays issuer the lesser of the taxable coupon rate or 70% of the tax credit ratevi. Net Interest Cost (example only):

6.00%----Taxable rate3.70%----Minus Direct Subsidy (5.29% tax credit rate x 70% subsidy )2.30%----Equals Net Interest Cost (Taxable Rate- Direct Subsidy)

Qualified Issuer

Qualified Project

U.S. Treasury

Taxable Investor

3.70% Direct Subsidypaid semi-annually

Bond Allocation

6.00% taxable couponpaid semi-annually(2.3% Net Interest Cost)

$$$$ Bond Proceeds

$$$$ Bond Proceeds $$$$ Principal RepaymentYear 17