Hb&c workshop summary final

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  • 1.         MEMORANDUM    TO:     Jennifer  Finnigan,  Jeanne  Clinton    FROM:     Matthew  Brown  and  Dave  Carey    DATE:     February  23,  2012    RE:     HB&C  Summary  of  the  CPUC  OBR  Workshop        After  a  week’s  discussion  of  On  Bill  Repayment  (OBR)  and  its  appropriateness  for  California,  we  offer  the  following  commentary  that,  we  hope,  will  be  useful.    We  apologize  for  its  length,  but  felt  it  was  important  to  lay  these  points  out  in  some  detail.        We  offer  two  over-­‐arching  points  first  and  then  discuss  several  critical  elements  of  OBR.        1. Terminology  is  tremendously  important  and  parties  were  not  always  talking   about  the  same  thing  when  they  used  words  like  “OBR.”    The  key  difference  was   the  some  parties  referred  to  OBR  meaning  only  a  repayment  mechanism.    Others   thought  of  OBR  as  including  a  repayment  mechanism  that  included  all  traditional   utility  means  to  collect  payment  (for  simplicity  sake  we  refer  to  this  as   disconnection  in  the  remainder  of  this  memo).        2. The  purpose  of  the  CPUC  workshop  was  to  explore  how  OBR  might  help   California  achieve  two  goals:  build  EE  loan  volume  and  increase  EE  project   comprehensiveness.         Discussion  Concept  and  Framework     The  following  logic  supports  the  use  of  OBR:       1.    Given  the  following  goal:    Increase  the  uptake  of  EE  (more  numerous   projects,  more  comprehensive  projects).     2.    A  method  to  increase  the  uptake  of  EE  is  to  provide  energy  users  w   convenient,  low  cost  EE  financing.   Denver+Boston Phone: 720.420.7648 | Fax: 720. 294.9548 www.harcourtbrown.com  
  • 2.     3.    A  method  to  provide  convenient  low-­‐cost  financing  is  to  make  EE   attractive  to  lenders.     4.    A  method  to  make  EE  attractive  to  lenders  is  to:   • Improve  the  credit  performance  of  borrowers   • Create  large  volumes  of  loans     5.    A  method  to  improve  credit  performance  and  to  build  loan  volume  is  to:   • Put  the  payment  on  the  bill  (which  gives  the  homeowner  and  the   lender  the  imprimatur/trustworthiness  of  the  utility)   • Allow  shut  off  (which  gives  the  lender  recourse)   • Provide  bill  neutrality  (because  borrowers  like  positive  cash  flow,   lenders  like  the  monetized  savings)   • Distribute  payments  to  lender  and  utility  proportionately  (because   lenders  dont  want  the  utility  to  get  preferential  repayment  and   lenders  dont  want  to  be  solely  responsible  for  shut-­‐off)   • Allow  the  loan  to  transfer  the  debt  to  the  next  owner/tenant  (because   lenders  dont  want  loans  to  prepay)    Fundamentally,  the  finance  mechanisms  need  to  (1)  build  volume  (2)  make  financing  more  affordable  and  (3)  attract  capital.    The  finance  mechanisms  described  below  are  compared  against  these  goals.        OBR  Absent  Disconnection     1. OBR  (absent  disconnection)  should  build  volume  because  it:   a. Is  an  easy  sale  for  contractors,  since  contractors  are  already   embedded  in  the  energy  efficiency  sales  process  –  the  energy   efficiency  “stream  of  commerce.”     b. Appears  easy  for  consumers  to  understand  their  bill  and  related   savings.       c. Places  the  utility  as  a  trusted  party  implicitly  behind  the  product  (the   imprimatur  of  the  utility,  mentioned  above).       d. Allows  for  some  entities  (Green  Campus  Partners  noted  this  in  the   commercial  sector)  to  more  easily  capture  and  monetize  energy   savings.         2. OBR  (absent  disconnection)  is  not  likely  to  have  a  significant  impact  on   affordability  because  it  is  unlikely  to  affect  either  term  or  rate.    That  said,   OBR  does  absorb  some  collection  costs  that  a  lender  would  have  to  incur  and   these  reduced  collection  costs  may  be  reflected  in  rates,  although  it  is  unclear   that  this  reduction  in  collection  costs  will  be  enough  to  materially  affect  rates.   There  could  be  servicing  savings  but  there  are  significant  interfacing  costs   which  will  likely  consume  the  savings.   Denver+Boston 2   Phone: 720.420.7648 | Fax: 720. 294.9548 www.harcourtbrown.com  
  • 3.     3. OBR  (absent  disconnection)  may  have  a  positive  impact  on  the  ability  to   attract  capital  because  it  is  likely  to  build  volume.    Some  parties  suggested   that  even  if  disconnection  is  not  a  part  of  the  program,  that  many  customers   may  believe  potential  of  disconnection  still  exists,  and  take  the  risk  of  non-­‐ payment  more  seriously  than  another  kind  of  bill.    “People  pay  their  utility   bills”  was  a  common  theme.         That  said,  utilities  noted  correctly  that  although  people  generally  pay  their   utility  bills,  that  they  may  pay  those  bills  late;  PG&E  noted  a  22%   delinquency  rate.    Investors  will  price  in  this  delinquency  because  of  the  time   value  of  money.    And  although  investors  may  view  a  customer  operating   under  the  threat  of  disconnection  as,  ultimately,  more  likely  to  pay  the  bill,   the  fact  that  the  payment  arrives  late  will  add  to  the  rate.    Do  we  want  to  add   “cons”,  e.g.,  the  investor/funder  will  have  to  price  for  remittance  delays  and   the  credit/counterparty  risk  of  the  utility  (PG&E  did  file  for  BK)      OBR  With  Disconnection     1. OBR  with  disconnection  should  build  volume  for  the  same  reasons  cited  above.         2. OBR  has  potential  to  have  a  significant  impact  on  affordability  of  efficiency  (as   a  result  of  either  longer  terms  or  lower  rates).    However  the  extent  of  that   impact  is  uncertain.       a. In  order  to  assess  a  new  financial  product,  the  financial  industry  looks   to  history  of  comparable  financial  products.    To  the  extent  that  a  new   financial  product  can  look  a  great  deal  like  other  products,  financial   institutions  will  be  able  to  assess  its  quality  with  a  de  minimus   premium  for  it  being  a  new  product.    An  efficiency  finance  product   that  essentially  reflects  the  characteristics  of  other  utility  service  may   allow  financial  institutions  to  assess  this  new  product  on  the  basis  of   the  performance  of  the  existing  utility  ratepayer  pool.         b. Disconnection  is  not  in  and  of  itself  well  understood  as  a  security   mechanism  (or  a  proxy  for  collateral).    Financial  institutions  may  not   be  sure  how  to  value  it  in  the  beginning,  although  it  is  likely  that  they   would  give  it  some  credit  as  per  above;  that  credit  will  be  somewhat   discounted  because  of  the  uncertainty.    As  financial  institutions  look   more  closely  at  not  just  disconnection  policies,  but  also  disconnection   practices,  they  may  place  a  lower  value  on  disconnection  itself.    (i.e.   under  what  circumstances  are  customers  disconnected  and  how   reliable  is  disconnection  as  a  proxy  for  security?)     c. In  the  non-­‐residential  sector  there  were  some  questions  raised  as  to   the  value  of  disconnection,  for  instance  it  would  be  likely  that  the   business  would  already  be  in  a  lot  of  trouble  in  the  event   Denver+Boston 3   Phone: 720.420.7648 | Fax: 720. 294.9548 www.harcourtbrown.com  
  • 4.   disconnection  occurred.    We  also  heard  that  many  businesses  that   would  be  likely  to  apply  for  a  loan  would  see  the  threat  of   disconnection  as  one  more  reason  to  be  "serious"  about  the  project   and  not  to  over-­‐commit.    In  a  sense,  the  threat  may  help  to  weed  out   the  poor  credits  from  the  beginning.       d. In  residential  customer  base,  there  appeared  to  be  a  fair  amount  of   agreement  that  disconnection  would  be  a  valuable  an  inexpensive   alternative  to  taking  a  collateral  interest.    Note  also  that  the   disconnection  threat  is  both  inexpensive  and  fast;  it  requires  no   additional  paper  filings  and  no  additional  research.    In  this  sense  it  is   very  different,  and  better  than,  a  typical  secured  loan  that  requires   title  search  and  appraisal  (with  associated  time  of  2-­‐3  weeks  and  cost)   e. Disconnection  for  failure  to  pay  a  third  party  (regardless  of  collection   mechanism)  appears  to  be  contrary  to  CA  statute  for  the  residential   sector.         3. OBR  with  disconnection  has  good  potential  to  attract  outside  capital  for  all   the  same  reasons  cited  above  that  could  lead  to  lower  rates  and  longer  terms   than  are  currently  available  for  financing  product.        OBR  with  the  Payment  Obligation  Tied  to  the  Meter     1. Tying  to  payment  obligation  to  the  meter  may  have  greatest  value  in   increasing  volume  for  the  rental/leased  space  market.       a. For  further  marketability  it  may  be  important  to  require  that  projects   tied  to  the  meter  and  in  the  rental  market  also  be  projected  as  cash   flow  neutral  or  cash  flow  positive  projects.       2. The  impact  of  tying  a  payment  to  the  meter  on  affordability  is  unclear.       a. In  and  of  itself  (i.e.  Absent  a  cash  neutral/cash  positive  requirement  –   discussed  below)  it  could  have  a  positive  impact  on  affordability  as  a   result  of  extended  amortization  periods.    It  is  likely  that  payments  tied   to  the  meter  would  increase  rates,  because  rates  for  longer-­‐term  notes   are  typically  higher  than  short-­‐term  notes.    Further,  to  the  extent  that   tying  a  payment  to  the  meter  would  require  additional  underwriting,   transaction  costs  could  increase.         3. Tying  a  payment  to  the  meter  could  have  a  negative  impact  on  availability  of   capital.       a. Capital  tends  to  be  easily  available  for  terms  of  3-­‐5  years,  often   available  for  7  years,  and  sometimes  available  for  10  years  or  longer  –   at  least  for  a  traditional  unsecured  financial  product.    Because  tying  a   payment  to  the  meter  creates  an  uncertain  repayment  structure  (how   to  address  changes  of  occupancy  and  resultant  changed  credit  profile,   for  instance),  large-­‐scale  capital  sources  may  not  be  available.     Denver+Boston 4   Phone: 720.420.7648 | Fax: 720. 294.9548 www.harcourtbrown.com  
  • 5.   b. However,  it  may  be  quite  possible  to  develop  a  pilot  program  for  a   specific  market  sector  (e.g.  rental  markets)  using  either  ratepayer   capital  and/or  non-­‐traditional  capital  sources.    Further,  it  may  be   possible  to  structure  a  product  with  greater  recourse  to  the  utility   balance  sheet  for  this  product.       c. Because  OBR  tied-­‐to-­‐the-­‐meter  increases  the  perceived  risk  of  non-­‐ payment  any  method  of  reducing  that  risk  will  be  helpful  in  attracting   outside  capital.    Therefore,  OBR  tied-­‐to-­‐the-­‐meter  will  likely  be  most   successful  if  it  is  also  tied  to  a  threat  of  disconnection.        Bill  Neutrality     1. Bill  neutrality/positive  requirements  could  be  attractive  to  customers  and   would  seem  at  first  glance,  therefore,  to  build  volume.       a. However  a  requirement  for  bill  neutrality  would  likely  be  detrimental   to  building  volume  (effectively  eliminating  many  HVAC  and  emergency   replacement  projects  that  tend  to  dominate  most  efficiency  retrofits),   and  would  likely  discourage  more  comprehensive  retrofits.         2. Bill  neutrality/positive  projects  will  increase  affordability  but  for  a  limited   number  of  projects—but,  again,  only  possible  for  certain  project  types  that   will  tend  to  be  less  comprehensive  retrofits.         One  way  to  increase  affordability  of  the  most  comprehensive  projects  is  to   extend  the  term  of  the  financing  from  the  fairly  typical  36-­‐60  months  to  120   or  even  180  months.    This  longer  term  amortizes  principal  over  an  extended   period,  thus  reducing  monthly  payments  and  enabling  energy  savings  to   approach  or  exceed  principal  and  interest  charges.    The  challenge  with  this   strategy  is  that  capital  providers  view  long  terms  as  higher  risk  than  short   terms.    As  a  result  capital  providers  will  be  unlikely  to  proffer  long  terms,   absent  significant  credit  enhancements  (see  below).         3. Bill  neutrality/positive  requirements  are  likely  to  have  two  countervailing   effects.   a. they  could  decrease  overall  attractiveness  of  a  project  to  capital   markets  because  it  restricts  the  number  of  projects  that  qualify,  thus   reducing  overall  volume.       b. they  could  make  some  projects  more  attractive  to  capital  providers   that  incorporate  the  effect  of  a  reduction  in  utility  bills  on  the  ability   to  pay  debt  service.    As  a  rule,  most  consumer  lenders  do  not   incorporate  the  reduced  energy  bills  in  to  underwriting.    However,   this  effect  may  be  more  valuable  in  commercial  lending  –  where   paybacks  are  shorter  and  lenders  tend  to  spend  more  time   underwriting  and  analyzing  each  individual  loan.       Denver+Boston 5   Phone: 720.420.7648 | Fax: 720. 294.9548 www.harcourtbrown.com  
  • 6.   4. See  above  section:    the  rental  sector  may  be  most  appropriate  for  a  bill-­‐ neutrality  requirement  if  the  payment  obligation  transfers  with  the  meter.        Pari  Passu    Pari  Passu  payment  allocation  refers  to  allocation  of  a  consumer’s  payment  to  different  obligors,  when  that  payment  is  made  through  a  single  bill  –  as  would  be  the  case  when  the  utility  bill  is  used  to  collect  energy  and  finance-­‐related  charges.    It  is  particularly  relevant  in  the  case  of  a  partial  payment  that  must  be  allocated  to  the  utility  and  to  the  investor.    A  pari  passu  structure  is  one  in  which  any  payment  is  paid  proportionally  to  the  utility  and  the  investor.    Investors  prefer  a  pari-­‐passu  structure  to  one  in  which  energy  bills  are  paid  before  any  investors.         1. Pari  passu  will  in  general  not  have  a  material  effect  on  volume  or   comprehensiveness  of  retrofits  since  it  is  largely  invisible  to  the  customer.       2. Pari  passu  structures  will  decrease  the  cost  of  capital  because  investors  will   not  be  required  to  price  the  uncertainty  of  repayment  in  the  event  of  a  partial   payment.       3. Pari  passu  structures  will  increase  availability  of  capital  because  investors   will  be  more  willing  to  provide  capital  when  they  can  better  predict  the  flow   of  that  capital  in  the  case  of  partial  payments.        Operational  Issues    It  will  be  important,  no  matter  what  type  of  OBR  structure  that  Commission  elects  to  pursue,  to  be  aware  of  relevant  lending  laws  –  TILA,  holder  in  due  course,  etc.        Credit  Enhancements    Credit  enhancements  can  shore  up  any  weakness  that  a  financial  institution  perceives  in  these  structures.    Credit  enhancements  and  OBR  are  not  mutually  exclusive,  and  in  fact  a  credit  enhancement  can  be  used  to  bridge  the  knowledge,  confidence  gap  as  financial  institutions  assess  the  value  of  OBR  and  other  mechanisms  described  above.    In  a  sense,  credit  enhancements  can  layer  on  to  any  of  the  above  mechanisms  and  could,  over  time,  be  phased  out  as  the  above  mechanisms  gain  a  foothold.        Broadly,  there  are  three  types  of  credit  enhancements  here:     1. An  interest  rate  buydown  (IRB)  that  simply  reduces  interest  rates  by  paying  a   financial  institution  for  the  difference  between  market  and  target  rates.         Although  not  always  viewed  strictly  as  a  credit  enhancement,  this   mechanism  can  nonetheless  make  loan  payments  more  affordable  to  more   people  or  reduce  rates  for  new  financial  products.    A  rate  buydown  therefore   Denver+Boston 6   Phone: 720.420.7648 | Fax: 720. 294.9548 www.harcourtbrown.com  
  • 7.   provides  them  rates  (or  terms)  only  available  to  borrowers  with  a  better   credit  profile.         2. A  loan  loss  reserve  (LLR)  that  sets  money  aside  in  a  special  account  to  cover   potential  losses.    An  LLR  is  a  loss  sharing  mechanism  and  is  not  a  guarantee.       3. Balance  sheet  support  uses  the  utility  balance  sheet  to  support  a  loan   portfolio.    It  is  likely  the  least  expensive  type  of  credit  enhancement  because   it  does  not  require  that  actual  cash  be  set  aside  that  exceeds  expected  losses.     Instead,  it  is  a  promise  from  a  creditworthy  entity  to  pay  for  some  amount  of   projected  losses.    The  financial  institution  prices  the  financial  product  on  the   basis  of  the  strength  of  the  underlying  balance  sheet.    In  the  case  of  a  utility   balance  sheet  support,  that  pricing  would  be  based  on  the  utility  bond  rating.        Each  of  the  above  credit  support  mechanisms  could  be  used,  sometimes  in  combination  with  one  another  to  achieve  the  following  (note  that  the  specific  broad  goal  of  volume,  affordability  or  capital  attraction  is  listed  after  each):     1. Achieve  bill  neutrality  (building  volume  and  attracting  capital  to  specific   markets):   a. Achieving  bill  neutrality  will,  for  many  customers,  only  be  feasible  by   a  combination  of  low  rates  but  (more  importantly)  long  terms.    Credit   enhancements  could  be  provided  for  the  markets  that  are  most  in   need  of  bill  neutrality,  such  as  rental  markets  or  mid-­‐income   customers,  especially  in  multi-­‐family  properties.         2. Reaching  deeper  into  credit  buckets:   a. Credit  enhancements  can  be  risk-­‐adjusted,  with  larger  credit   enhancements  set  aside  to  cover  losses  from  loans  made  to  lower   credit  individuals  or  other  hard-­‐to-­‐reach  markets.         3. Providing  temporary  rate  discounts  (building  volume):   a. An  interest  rate  buydown  for  a  specified  period  of  time  could  be  used   to  offer  a  “no-­‐no”  product  –  no  interest  no  payments  for  6-­‐12  months.     Some  contractors  use  these  products  now  as  an  enticement  to   customers.         4. Overcome  in  ability  to  provide  pari-­‐pasu  payment  allocation  structure   (attracting  capital  and  affordability):   a. To  the  extent  that  financial  institutions  will  price  the  risk  that  they  are   unable  to  be  assured  of  a  pari-­‐passu  repayment  and  to  the  extent  that   the  Commission  does  not  grant  pari-­‐passu  repayment,  then  a  credit   enhancement  could  be  established  to  compensate  for  that  risk.         Denver+Boston 7   Phone: 720.420.7648 | Fax: 720. 294.9548 www.harcourtbrown.com  
  • 8.   5. General  rate  reduction  or  term  increases  (volume,  affordability,  attracting   capital):   a. Credit  enhancements  have  been  used  in  numerous  other  states,   including  for  local  governments  in  California,  to  attract  participation   of  financial  institutions,  simply  because  the  product  is  new.    Note  that   the  credit  enhancement  structure  will  vary  depending  on  the  type  of   capital  that  it  is  trying  to  attract.    As  a  rule:   i. Institutions  investing  depositor  capital  (especially  credit   unions  and  some  community  banks)  will  likely  be  most   responsive  to  a  credit  enhancement,  and  will  respond  to  credit   enhancements  in  the  range  of  10-­‐20%.       ii. Capital  markets  have  a  broader  array  of  uses  for  their  capital   and  absent  OBR  with  disconnection  (which  they  will  often  view   as  a  substitute  for  security/credit  enhancement)  may  require  a   credit  enhancement  approaching  30%.          Conclusions    Perhaps  the  best  way  to  summarize  is  to  review  (a)  what  we  know  we  know  and  (b)  what  we  think  we  know  but  really  don’t  know  for  sure.         1. What  we  know  we  know       a. OBR  in  any  form  will  help  to  build  volume.     b. Volume  will  attract  capital  and  create  competition  to  supply  capital.       c. More  capital  will  eventually  reduce  the  cost  of  capital.       d. But  that  will  take  time.     e. Pari-­‐passu  structures  are  much  more  attractive  to  financial   institutions  than  non-­‐pari-­‐passu  structures.       f. Bill  neutrality  requirements  will  generally  reduce  the  number  of   eligible  projects  and  decrease  volume  –  absent  credit  enhancements.       g. Credit  enhancements  could  help  to  bridge  this  gap  in  time  and  the   uncertainty  over  pari  passu.    However,  collecting  the  data  to   demonstrate  the  gradually  decreasing  need  for  credit  enhancements   would  be  critical.    Strong  credit  enhancement  structures  can  be   developed  to  enable  long-­‐term  capital  to  come  to  the  table  to  enable   long  amortization  periods  and  transfers  with  the  meter,  and  provide   for  a  broad  array  of  projects  to  qualify  even  in  the  face  of  bill-­‐ neutrality  requirements.            2.    What  we  think  we  know  but  really  don’t  quite  know  for  sure       Denver+Boston 8   Phone: 720.420.7648 | Fax: 720. 294.9548 www.harcourtbrown.com  
  • 9.   a. OBR  with  disconnection  threat  will  reduce  the  cost  of  capital  and  will   attract  capital.       b. OBR  with  disconnection  will  therefore  also  increase  volume.       c. Financial  institutions  may  be  able  to  live  with  non  pari-­‐passu   structures,  but  will  price  that  additional  uncertainty  in  to  their   financial  offering.       d. To  the  extent  that  financial  institutions  are  uncertain  of  the  value  of   disconnection,  credit  enhancements  can  help  to  bridge  that   uncertainty  gap.       e. Those  credit  enhancements  will  be  smaller  (perhaps  significantly  so)   than  would  be  required  in  the  absence  of  a  threat  of  disconnection.       Denver+Boston 9   Phone: 720.420.7648 | Fax: 720. 294.9548 www.harcourtbrown.com