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Financing Energy Efficiency: Credit Enhancements and Leveraging Strategies

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Credit Enhancement Structures for Clean Energy Lending PPT. created for CESA Produced by www.harcourtbrown.com

Credit Enhancement Structures for Clean Energy Lending PPT. created for CESA Produced by www.harcourtbrown.com

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Financing Energy Efficiency: Credit Enhancements and Leveraging Strategies Financing Energy Efficiency: Credit Enhancements and Leveraging Strategies Presentation Transcript

  • Financing Energy Efficiency: Credit Enhancements and Leveraging Strategies Matthew H. Brown ConoverBrown LLC [email_address] 720 246 8847
  • ConoverBrown LLC
    • Consulting firm with a specialty in financing for clean energy & environmental strategy.
    • Domestic and International government, non-profit and private clients.
    • Clean energy finance clients include U.S. Dept of Energy, Iowa, Colorado, Michigan, utility, lender, national and regional associations and advocacy organizations.
    • Working with these clients to set up or assist in establishing new financing programs.
  • Why Financing?
    • It’s all about going to scale (a residential EE example):
      • 100 million households in the United States.
      • Typical basic-only efficiency installation investment is $7,500, including HVAC, duct sealing, insulation -- but can range higher, up to $10,000.
      • Total market, on this basis is $750,000,000,000-$1,000,000,000,000.
      • Utility, government capital will not be sufficient to meet this goal. Private investor capital is critical. (And this is only the residential side)
  • Leveraging Potential
    • In its simplest form, leveraging on basis of a 5% loss reserve=20x
      • $1,000,000 leverages up to $20,000,000
    • Common leveraging could be based on a 5% to 10% credit enhancement.
    • Some higher deals or markets may need higher enhancements – up to 20%-25%.
  • Who are the lender partners?
    • Credit unions: Understand small loans, community-minded.
    • Specialty Lenders: Know energy finance very well
    • Community Development Financial Institutions (CDFI) lenders: low cost, but limited amounts of capital
    • Public lenders (state or municipal bonding authorities such as housing finance agencies): low cost capital availability
  • What will bring these lenders to the table?
    • A market for loans – deal flow. (Many lenders hungry for good quality loans).
    • Good quality borrowers with good credit.
    • A secondary market for loans (a place to sell the loans).
    • Credit enhancements.
  • Credit Enhancements Come in Several Forms
    • Loss Reserves or Guarantees
    • Subordinated Debt
    • Loan Insurance
    • Interest rate buydowns sometimes fall into this category
      • Not addressed in detail here.
      • Typically structured as a payment to the lender based on NPV of difference between market and target interest rate.
  • Why Are Credit Enhancements Attractive?
    • Help to make lenders comfortable with a new and unfamiliar product.
    • Help to extend the range of potential borrowers to those who might not otherwise be able to borrow.
    • Increases amount of capital available to lend by attracting investor and lender interest in a product.
  • Issues to Consider with Credit Enhancements
    • Make sure that there’s a real benefit to the enhancement -- eg. a lower interest rate, more loans.
    • Consider ways to customize the enhancement (eg. Reduce reserve size based on improving default rates).
    • Find maximum leverage – 20x leverage based on 5% loss reserve isn’t unreasonable.
    • Pre-agreed underwriting standards are critical. Eg. 680 credit score, 50% debt/income ratio.
  • Issues to Consider with Credit Enhancements
    • Don’t give away the farm: a full guarantee may not leave enough “skin in the game” to encourage appropriate underwriting and collections.
    • Recommend structuring the enhancement on the basis of total loans outstanding (a portfolio) rather than on a per-loan basis.
      • Eg. A loss reserve set at 5% of total outstanding loan balance, with lenders able to recover up to 80% of the balance of any individual loan in default.
    • Reserve levels will vary depending on target market risk. Could be as high as 20% for certain markets served by CDFI lenders.
  • Reserve vs. Guarantees
    • Loss Reserves are provided contingent upon availability of funds (eg. 5% of outstanding loans).
    • Guarantees are available regardless of fund availability.
  • Michigan Example of Loss Reserve (proposed)
    • 5% loss reserve based on the total portfolio of loans that lender holds.
    • Lender would be able to recover up to 80% of defaulted amount (skin in the game).
    • Unsecured loan – although possibly tied to a meter and disconnection threat.
    • For this, lenders willing to offer 5-7% unsecured loans. (about ½ market rate).
  • Senior/Sub Debt Structure -- WA State Housing Authority (in process)
    • ARRA funds used to provide a subordinated debt at 0% in amount of $1 million. This sub-debt absorbs first loss (ie. before any losses accrue to senior debt).
    • Reflows create a loss reserve.
    • Private investor funds provide $9 million of senior debt (much more secure and lower rate).
  • Loan Loss Insurance
    • Very limited availability of any loan loss insurance now – used to be available in the past.
    • Insurance that is available is quite expensive.
    • Not a recommended option at this point.
  • Default Rates for EE Tend to be Low – these results should guide level of enhancement
    • It’s not the HDTV purchase…
  • To Summarize
    • Without financing we can’t make our climate, energy independence or other goals.
    • Financing requires working with financial institutions in new ways.
      • And educating finance institutions in part through use of credit enhancements.
    • Credit enhancements, structured properly, provide significant leverage opportunity.