Re amp october 2011 1

RE AMP: NGO ROLES IN FINANCING (PRIMER AND DISCUSSION)Matthew H. Brown, PrincipalHarcourt Brown & CareyOctober 16, 2011

Confidential

2Confidential

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OUTLINE OF PRESENTATION

• Perspective and Context on Financing Efficiency • A Primer on Financing and Capital Sources

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WHY FINANCING??

• EE goals are getting more aggressive in some places.

• Rebates and tax incentives may not be the most cost effective way to do the job. • Leveraged, private capital may be much more

effective. IF it is designed effectively. • The trend towards tougher lighting standards

mean that utilities will no longer have the least costly option available to them to reach EE goals.

• Cost effectiveness tests are getting more challenging.

• Ratepayers are getting more sensitive to higher rates.

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SOME PERSPECTIVE

• Financing is Important. • It is a valuable marketing tool for energy efficiency. • It makes energy efficiency investment possible.

• While literature is difficult to find on the effect of financing on contractors’ ability to “close” an energy efficiency deal, anecdotal evidence is that the influence is strong.• Close rates for a typical contractor deal are about 30%-

40%. • Close rates can increase by 20-30% from that number

with attractive financing.• Interviews indicate that financing is one important factor

that encourages people to make energy efficiency investments.

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SOME PERSPECTIVE

• Almost no one wants financing. • But people want the stuff that financing lets

them buy (granite countertops, furnaces, cars, homes…)

• So: • Financing is NOT a silver bullet• Financing is a means to facilitate an end.

Make financing seamlessly easy to access. • Financing programs need to be tightly

integrated into every other element of marketing, rebates, etc.

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Financing Strengths and Weaknesses

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Strengths Weaknesses

Allows leverage of public or utility ratepayer funds through credit enhancements to attract private capital

Not all consumers have access to finance because of credit quality

Significantly increases the amount of total capital available by attracting new capital sources to fund EE.

Even consumers who may have good credit may not want to take on new debt

Provides for “skin in the game” from borrowers

Cost, time and labor intensive to originate, service loans

Sustainability: Extends the life of limited government utility ratepayer funds and may remove need for rebates in long run

Requires careful design to price risk and figure out who bears credit risks and other features

Can complement rebate programs

Capital Sources•Banks•Credit Unions•Foundations•Bonding•Federal•Treasury•Utilities•Institutional Investors

Lend

Enhance•Loss Reserve•Debt Service Reserve•Loan Insurance•Sub Loans

Repay•On Bill•Property Tax•Other Fee•3rd Party

Security•Tax lien•Mortgage•Fixture lien•At the meter•Unsecured

Sources:•Federal•Foundations•Utilities

Who Lends?• State - energy office

- HFA• Utility• Finance company • Bank• Credit Union• CDFI

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PRIMER ON FINANCING ROLES AND FUNCTIONS

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WHAT IS THE ONE DETERMINANT OF RATE, TERMS AND AVAILABILITY OF CAPITAL?

CREDIT

• Every investor is going to decide whether to invest on the basis of analysis of credit.

• While other factors are important, credit is critical.

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MEASURING CREDIT

There are many measures of credit such as:

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Residential Commercial**FICO Score Investment Grade Rating

Debt-Income Ratio Years in Business

Bankruptcy/Tax Lien Paydex/D&B/Other rating

Home Equity Quality of Principals’ Credit

**Particular measure will depend on size of the business (eg. Small businesses almost never have a rating).

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NATIONAL DATA: CREDIT SCORE DISTRIBUTIONSPercentile % of People Score Delinquency Rate Projected

(Based on historical performance)

2nd 2% 300-499 87%

7th 5% 500-549 71%

15th 8% 550-599 51%

27th 12% 600-649 31%

42nd 15% 650-699 15%

60th 18% 700-749 5%

87th 27% 750-799 2%

100th 13% 800-850 1%

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58% of people above 700 FICO (TransUnion). 73% of people above 650 FICO.

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KEYSTONE HELP HISTORICAL CREDIT DATA

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BandOriginal Balance

Current Balance

Wtd Avg. Debt-Income

Cum. Charge Off

Cum. C/O + 90 DPD

<649 $826,686 $493,800 35.9 4.33% 7.15%

650-699 $6,001,189 $4,122,119 37.4 1.51% 3.52%

700-749 $11,762,134 $8,114,884 37.7 0.75% 1.41%

750-799 $16,011,449 $10,004,326 34.0 0.23% 0.71%

800+ $7,507,019 $5,238,058 30.8 0.03% 0.03%

Grand Total $42,108,477 $27,973,187 35.0 0.60% 1.31%

MARKET SIZE BY CRED

IT SCORE: BASED

ON

61 MILLIO

N O

WN

ER-O

CCUPIED

HO

USEH

OLD

S MARKET SIZE BY CREDIT SCORE – BASED ON NATIONAL 61 MILLION OWNER OCCUPIED HOUSEHOLDSCumulative # of Households

% of People Score Delinquency Rate Projected

56 Million 15% 650-699 15%

44 Million 18% 700-749 5%

21 Million 27% 750-799 2%

10 Million 13% 800-850 1%

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56 Million owner-occupied households would have a credit score good enough to minimally qualify for a loan (although credit score is one among many factors).

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RISK AND FINANCING

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Residential Commercial Outcome

Low Risk • FICO score > 640/680

• Debt-Income Ratio no more than 50%

• No bankruptcy

• Home equity

• Investment Grade

• 2+ years in business

• Stable business environment

• Good management

• Paydex etc

Financing available

High Risk Financing may be available, but at high cost

Unmeasurable Risk

No financing available

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SOME OTHER FACTORS • Time Horizon:

• Banks want to be in and out of an investment in 3-5 years. • This time horizon mitigates their risk; trying to predict the world beyond that

time frame is hard.• Unless they have some kind of security (a secured loan) that gives them ability

to foreclose on a residential property. Business loans rarely go beyond 5 years. • Bonds may go beyond that period, but are generally for investment grade only.

• Regulatory Compliance

• State and federal regulators (through law and regulation) often:• Place a cap on certain kinds of assets a bank or other investor can hold (eg. No

more than x% unsecured loans) • Prohibit certain types of companies from holding some asset classes (eg. Credit

Union Service Organizations cannot hold unsecured loans, although credit unions can).

• Require that financial institutions place cash reserves aside to cover the eventuality of loss from certain types of loans.

• Etc. etc. etc. • Regulations and the willingness of regulators to allow financial institutions to hold

the kinds of financial instruments that we are discussing will often dictate what a financial institution can or cannot do in this field.

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WHICH INVESTORS WILL TAKE A LOWER RETURN FOR A GIVEN RISK IN ORDER TO “DO THE RIGHT THING”?

Foundati

on

Credit

Union

Muni B

ond

Comm

unity

Bank

Hedge

Fund/P

rivat

e

Equity

Money

Cente

r

Bank/

Institu

tiona

l Inve

stors

Less More

Socia

lly

Responsib

le

Investo

rs

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WHAT’S AVAILABLE RIGHT NOW?Residential Commercial

Fannie Mae Products available depend heavily on credit of company and size of company. Rated companies have access to low cost capital on their own, through traditional routes. Lease financing is common because many leases can stay off the host company’s balance sheet.

However lease rules are changing, and new methods of financing equipment purchase will become important to locate. Energy service agreements may be the wave of the future for commercial property owners. Availability is subject to accounting rules.

15%+ risk adjusted rate, no contractor buydown available. Up to 10 year term.

Wells Fargo/GE Money

24% rate, risk adjusted, bought down by contractor, term usu. 5 years. Buy-down adds 8-10% to cost of project.

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CHARACTERIZING EE FROM A FINANCIAL INSTITUTION PERSPECTIVE• EE is:

• Niche and small• For the most part residential EE loans are tiny ($7,500)• And total portfolios do not grow quickly or dependably

enough to the size that interests big investors. • New

• Meaning that most investors see don’t see them as a distinct asset class (which I think they are at least in residential), but view them like any other investment.

• Low return and high transaction cost• Most of us want single-digit interest rates. • Transaction costs = $300-$600 to originate plus

$10/loan/month, or $600 to service. $1,200 on a $7,500 loan is tough.

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CHARACTERIZING EE FROM A FINANCIAL INSTITUTION PERSPECTIVE• EE is:

• Requiring thought and a good deal of work.• It’s not a standard, run of the mill product – QECBs,

PowerSaver, loan loss reserves etc. Are tough. • Therefore:

• We need to work with the combination of players who will be able to:• Bring enough capital to the table• Be innovative and willing to think through details • Spend the time to understand the risks

• And we need regulations that allow for:• Use of credit enhancements with ratepayer funds• Ability to consider on bill structures (but not

requiring them).

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CREDIT UNIONS

Moderate to High regulatory compliance burden

Generally not big risk-takers

Generally not big innovators – slow to enter new markets and can be slow to make decisions (esp. big banks).

Low return requirements if credit is well-understood. High return (or unwillingness to lend) if credit is not understood.

Community, “mission” motivation varies, depending on bank size and location(money center, regional, community banks). Often not strong.

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Includes:• Community Banks• Regional Banks• Money Center

Banks

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BANK-BASED PROGRAM: MASSACHUSETTS

• Utilities cover defaults on loans (but do not originate or service loans).

• Participating banks offer a 5% loan with a minimum FICO score of 650.

• Loan terms up to 24 months for small loans (up to $2,000).

• Terms go to 7 years for loans up to $15,000. • Loan products for large residential and large C&I

under development. • Negotiations conducted directly with the

Mass Bankers Association.

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CREDIT UNIONS

Moderate regulatory compliance burden

Willing to take on new projects if they align with mission.

Tremendous variability, but some are willing to take on new products even if they require significant work.

Low return requirements if credit is well-understood. High return (or unwillingness to lend) if credit is not understood.

Community motivation varies, depending on bank size and location(money center, regional, community banks).

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Fast-changing industry (decreasing by 300 each year) while total lending stays steady. A mix of traditional, old CUs and more ambitious new ones.

MICH

IGAN

SAVESMICHIGAN SAVES: CREDIT UNIONS

• 60 million loan facility based on $3 million loan loss reserve .

• 7% rate to borrower. • 10 year max loan term. • 640 and a higher FICO score required (about

56% of MI population qualifies). • Marketed through a contractor network. • Launched Sept 2010.

• 56% approval rate. $3.5 million in loans made thus far.

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FOUNDATIONS

In addition to grants, Foundations make Program Related Investments (PRI)

PRIs need to be consistent with the Foundation mission

PRIs are investments of capital, and while foundations may be willing to take some additional risk, their risk appetite is quite limited.

Foundations may also be willing to put up balance sheet coverage for some investments.

Multiple foundations are now investigating ways to put up Foundation capital in EE.

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Consist of:• Local• Regional and

National

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MACED (KENTUCKY)

• MACED, a Community Development Financial Institution (CDFI), received a grant from the Ford Foundation.

• MACED then made loans to cooperative utilities that agreed to pay those loans back to MACED.

• The utilities created an on-bill financing structure for energy efficiency retrofits in homes.

• Utilities install energy efficiency measures as part of their essential services to customers.

• Utilities can disconnect customers for non-payment.

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BONDS

Bond investors require the same credit quality as any other investor.

Certain types of bonds offer government-subsidized interest rates – eg. Qualified Energy Conservation Bonds.

Bonds offer access to long-term capital – generally significantly longer term than is available from a bank loan.

Bonds rarely make sense for less than about $1,000,000, given issuance costs.

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Consist of:• Taxable• Tax Exempt• Tax Credit

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BOND FINANCING EXAMPLE: ST. LOUIS COUNTY

• St. Louis County issued Qualified Energy Conservation Bonds (QECBs) in amount of $6,000,000.

• Interest rate on bonds was ____. • St. Louis County takes credit risk on the bonds, and

guarantees the repayment through an annual appropriation (not quite as strong as a blanket guarantee that isn’t subject to annual appropriation).

• Federal government subsidizes the bond interest rate by paying the County 70% of an index (or between 3% and 3.5%).

• Volume in the first month was ____. • We are working on establishing a similar program, but

marrying QECBs with FHA PowerSaver, in Salt Lake County.

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QECBS: H

OW

DO

THEY W

ORK?

Federal Government

Investor

EE / GHG Reduction Project

Issuer (State/Local Government

Entity)

30% of interest and 100% of principal

70% of interest

QECB principal (loan)

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CAPITAL SO

URCE

: QU

ALIFIED

EN

ERGY

CON

SERVATIO

N

BON

DS

(QECBS)

State QECB Allocation State QECB AllocationAlabama 48.4 New Hampshire 13.7 Alaska 7.1 New Jersey 90.1 Arizona 67.4 New Mexico 20.6 Arkanasas 29.6 New York 202.2 California 381.3 North Carolina 95.7 Colorado 51.2 North Dakota 6.7 Connecticut 36.6 Ohio 119.2 Delaware 9.1 Oklahoma 37.8 District of Columbia 6.1 Oregon 39.3 Florida 190.1 Pennsylvania 129.1 Georgia 100.5 Rhode Island 10.9 Hawaii 13.4 South Carolina 46.5 Idaho 15.8 South Dakota 8.3 Illinois 133.8 Tennessee 64.5 Indiana 66.2 Texas 252.4 Iowa 31.2 Utah 28.4 Kentucky 44.3 Vermont 6.4 Louisiana 45.8 Virginia 80.6 Maine 13.7 West Virginia 18.8 Maryland 58.4 Washington 67.9 Massachusetts 67.4 Wisconsin 58.4 Michigan 103.8 WyomingMinnesota 54.2 Mississippi 30.5 American Samoa 0.7 Missouri 61.3 Guam 1.8 Montana 10.0 Northern Marianas 0.9 Nebraska 18.5 Puerto Rico 41.0 Nevada 27.0 US Virgin Islands 1.1

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UTILITY FUNDING

Typically will view lending and financing as outside their purview.

Generally not big risk-takers, but IOUs will respond to a regulatory mandate, esp. with cost recovery. Coops and Munis can often be greater risk-takers.

Public power and coops often very high on the “mission-based” scale. IOUs vary. Mission: Depends on utility type and need but generally view EE as secondary and financing as a bother.

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Consist of:• IOUs• Public Power• Cooperative

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MIDWEST ENERGY

• Tariff-based; obligation passes with meter. • 3% for most loans.• 15 years for residential.• 10 years for commercial. • Capital source: utility, ARRA. • Disconnection for failure to pay. • Financing charges cannot exceed 90% of

average annual energy savings. • About 500 projects completed worth $2.5

million. • 0 defaults as far as known.

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INSTITUTIONAL INVESTORS

Risk Averse

Regulated: Cannot typically invest in non-rated securities (eg. unrated loan portfolios)

Typically require large investments before even thinking about investing.

Residential appetite: Unless secured and bundled in large quantities, almost 0.

Commercial appetite: For large, rated deals: signifiant.

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Consist of:• Pension Funds• Insurance

Companies• Other Large

Investors

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BANK/UTILITY: ILLINOIS

• Legislation required utilities to develop efficiency financing programs -- $2.5 million each utility for a statewide total of $12.5 million.

• Utility ratepayers would cover 100% of defaults. • A 3rd party entity conducts all loan origination and

servicing. Capital source is still uncertain. Loan terms TBD. Contract awarded but not public.

• Program size is limited to $12.5 million statewide.

• Banks’ perspective:• Small, at $12.5 million• Looked only at credit of the utilities.• If they had had to look at individual credit, would not

have done the program. • A program similar to this could be of interest to

institutional investors – although it is too small to be of great interest.

CREDIT U

NIO

NS

FUNDS FLOW: SMALL LOANS <$20,000

Full Loan Origination/Servicing

Property Owners

Origination and Servicing

Loss Reserve

Non-CU and Subordinated

Investors

Capital-Providing

Credit Unions

Funding Pool

Approved Contractors

Green Energy CUSO

HB&C

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CAPITAL SOU

RCE: COM

MERCIAL BAN

KS

- Bank that provides general business banking services – transactional, savings, mortgages

- Generally do not provide energy efficiency-specific products, but do finance mortgages and underwrite loans

- Generally focused on short-term lending

Major Firms Risk Tolerance Involvement in the EE sector

Opportunities

Bank of America, Wells Fargo, U.S. Bank, Capital One, Comerica

Relatively low • Financing ESCo contracts for MUSH clients

• EE mortgages• SBA loans

• Secondary market development would encourage involvement

• Standardizing and pooling loans

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CAPITAL SOU

RCE: INVESTM

ENT BAN

KS

- Bank that enables corporations and/or governmental institutions to raise capital via stock or bond sales. Also manages sales and trading of securities, and generally house an asset management group.

- Investment banks are the intermediaries for bond financing (including QECBs)- Have historically eschewed EE because deal size was too small, security was weak and

loans were non-standard

Major Firms Risk Tolerance Involvement in the EE sector

Opportunities

Goldman Sachs, JP Morgan, Morgan Stanley, UBS, Merrill Lynch, Citi, Deutsche Bank, Barclays, Credit Suisse, plus regional firms

Depends on group within the bank, can be low to high

- Early loan pooling efforts

- Secondary market development would encourage involvement

- Partnerships with financing companies (e.g. Ygrene Energy Fund + Barclays, Hannon Armstrong and Metris)

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CAPITAL SOU

RCE: BON

DS

• Project cost greater than $800,000• Expected useful life of assets being financed is greater than 5 years• District has enough cash flow (i.e. net revenues) to pay debt service• Other lower cost sources of financing are not available

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CAPITAL SO

URCE

: QU

ALIFIED

EN

ERGY

CON

SERVATIO

N

BON

DS

(QECBS)

National bond volume cap for QECBs: $3.2 billion

Annual cash subsidy: 70% of interest costs

Structure: Originally a tax credit bond, QECBs were converted to cash subsidy bonds in March 2010. This means a larger investor pool and lower rates on QECBs.

Qualified purposes: Reducing energy in publicly-owned buildings by at least 20%; green community programs (including loans and grants to implement such programs); rural renewable energy; any qualified renewable energy facility; research on cellulosic ethanol, carbon sequestration, fuel efficiency, car batteries or building efficiency; mass transit facilities, demonstration projects, public education campaigns for energy efficiency.

Eligible issuers: Cities, political subdivisions and conduit issuers

Use of available project proceeds: 100% used for capital expenditures for qualified conservation purposes

Allocation of volume cap: Allocated among states in proportion to the population, then allocated by population to cities and counties of more than 100,000.

Private activity bonds: Up to 30% of each state or large local government allocation may be issued as private activity bonds, , where proceeds of the QECBs are loaned to non-governmental entities and used for energy conservation improvements on privately owned property. Private activity bonds may only be issued to finance capital expenditures.

Issuance date: No expiration, proceeds must be spent within three years of issuance

IRS notice on QECBs guidance: http://www.irs.gov/pub/irs-drop/n-09-29.pdf

http://www.irs.gov/pub/irs-drop/n-09-29.pdf

Re amp october 2011 1

Economy & Finance

Transcript of Re amp october 2011 1