2. Agenda
2
The Problem and Goal
● Pollution Credits
● Loan Guarantees
● Other considered and not
considered options
Structure of Public
Private Partnership
Advantages and
disadvantages of
proposals
Wrap up and Q&A
Introduction Proposal Structure Pros and Cons Conclusion
01
02
03
04
05
3. The Goal3
By 2025 all of the cheapest runoff
reducing projects will be implemented.
Thus need to build growth opportunities
into system
Develop and outline different financial
mechanisms that MD could use to leverage
greater capital and direct it, more efficiently,
toward runoff projects
4. Pounds of Pollution - The problem
4
2025
$1 bn
$2 bn
$1 bn
$ 4 bn
$5.28 bn
$3 bn
EFC estimates that, in aggregate, projected total nitrogen
and phosphorus in MD are on track to achieve 2025 final
targets
EFC estimates that it will cost approximately $5.28bn to
reach 2025 pollution target level for each sector but only
have $1bn to spend from now till 2025
Need to offset 100% of additional pollution due to
growth after 2025
5. The Solution
5
Public Private Partnership
Public Private Partnership that is capitalized by the State of
Maryland and uses these funds to attract private investment
that reduces runoff pollution entering the Chesapeake Bay
Efficiency Matrix to determine investment decisions
All investment decisions include efficiency matrix of ratio of
dollar per pounds of runoff pollution reduced
Focus on Unregulated Pollution
Targets the unregulated pollution
6. Proposed Financial Products
6
Pollution Credits
Other Options
Loan Guarantees
01
02
03
Leveraged by a quasi-private bank that partners with local MD community banks and credit unions
Pollution Credits
Loan Guarantees
Other Options
01 02 03
7. Proposed Structure of Financial Institution7
Separate Public Private Partnership0
1
New/converted public institution managing crediting
function and loan guarantee function is delegated to SRF0
2PROS:
• Flexibility/Growth to include other
financial product as necessary
• Crediting system is more likely to
succeed.
CONS:
• Requires more political will.
• Appropriation must be guaranteed
PROS:
• Politically more feasible
CONS:
• Lack of flexibility, Lack of incentive to
make crediting system work.
9. Pros and Cons of PPP structure9
Separate Public Private Partnership0
1
Cost efficiencies
Move at the speed of business
More flexibility and potential product options
Governance consisting of scientists and
bankers
Risk sharing with private sector
Invest in disruptive technologies
(i.e. assume greater risk)
PROS
CONS
Hijacking from State Government
If not designed properly, private banks won’t
come to table
If there is not enough demand, private capital
will not materialize
Slow speed and unable to adapt
Might be more politically difficult
10. Pollution Credits10
Description
•Market-based tradable certificates, also referred to as water quality credits
•Represents the achieved amount of pollution reduced or the permit
representing the right to pollute
•Mostly applied to nutrients such as nitrogen and phosphorus calculated by
dollar value per pound (Conversion rate for different nutrients needed)
Introduction plan
•The PPP bank will serves as an issuer, administrator, and settlement agent in
the pollution crediting system
•Establishing the pollution credit market in the service area by 2025
•No trading of credits until 2025
•Cap &Trade Approach with Baseline & Credits Approach for non-point
sources such as farmers
11. 11
Pollution Credit Market
s
Pollution Credit Market
BUY
Credits
SELL
Credits
SELL
Credits
Baseline
Cap
CapCap
Cap
Baseline and Credit Approach with C&T
Non-point Sources
(Agriculture)Point SourcesPoint Sources
Factory 1 Factory 2Factory 1 Factory 2
Non-point Sources
(Agriculture)
Cap & Trade Approach
Two approaches for Pollution Credits
12. Pollution Credit System: Creating the market
by 2025- No Trading
12
The Bank will buy third party certified credits
• At a negotiated price per reduced pound of pollution
• Bank sets yearly pounds of pollution target publically
• Price can be negotiated via reverse auction when sellers
incur facility installation costs
• Purchase credits from approved projects in yearly
amounts with recertification
Retire the credits
• Retire by selling credits to the State government at cost
Credits
Baseline and credit
• Incentivize non-point sources of pollution especially agricultural
industry by providing them with opportunity to sell credits
13. Pollution Credit System: Trading Mechanism
after 2025
13
The Bank may act as “a broker” or “an exchange”
• Keep credits as asset in a segregated account
Pricing and allocation of credits
• Fixed price per unit (cost + fees)
• Market price based on supply and demand
• Auction
Credits
Credits
Supply of credits to the market
•Baseline and credits for non-point sources
•Cap and trade for point source
14. To make the system work
- Lessons from other water quality trading experiences
14
Need a very effective regulatory framework in addition to monetary incentives
Need effort to reduce transaction cost for market participants
Expand the number of sellers and buyers - potential credit swap market among
existing water quality trading system in other states
Need close coordination with the agricultural policy - technology and knowledge
required in water quality management in agricultural industry
Eliminate future uncertainty of the crediting system due to a short-term
maturity of credits
15. Bank of North Dakota and Community Bank
of the Chesapeake
15
Bank of North Dakota is fully public; Community Bank of the Chesapeake
is a private bank
Bank of North Dakota is a model to leverage but only to an extent as it is fully
public
Success is due to the fact that it does not compete with the private sector
$7B under management; $1B in profit returned to state
17. Bank Partnership: Loan Guarantees
17
Timing:
• Best used 2015 – 2025
• After 2025 credit trading
will likely become most
emphasized product
Why?
• Attracting private capital
• helping increase lending
activity by local, community
banks
• Fee revenue
Partners:
local banks, credit
unions and other loan
guarantee programs
Purpose:
encourage
environmental cleanup
via increased lending
Partners
Timing
Purpose
Why?
18. ✓ Max loan guarantee ratio: 85%
✓ Fee structure
✓ Tiered Origination Loan Structure
✓ >$250K = 2%
✓ $250K - $500K = 2.5%
✓ $500K - $1M = 3%
✓ Annual Servicing Fee = 0.25%
✓ How do they work (structure)
✓ in case of default Chesapeake Bank absorbs the loss
✓ LTV: requires 10% borrower equity
✓ Risk/Reward
✓ 3.98% default rate on guaranteed loans (source: sba.gov)
✓ Risk -- w/o strong underwriting process default could be higher
✓ Case Study (compare to SBA.gov)
Product #1: Loan Guarantee18
19. ✓ Unsecured Financing
✓ Risk/Reward
✓ Risk: All assumed by originating bank
✓ Reward: Encourages pollution reduction activity
✓ Interest Rates
✓ 500bps below unsecured rates
✓ Loan Amounts
✓ $1,500 - $20,000
✓ Loan Terms
✓ 10 year amortization (no prepayment penalty)
✓ How do they work (structure)
✓ Loan rate is ‘bought down’ benefitting lender & borrower
Product #2: Loan Subsidy19
20. Loan guarantee service
20
03
Most banks leverage capital at a rate of 8-10:1 so if we capitalize the
bank over several years, the loan guarantee program could grow at a
rate of $8-10 for every $1 reserved for lending
Target green projects and encourage ‘greening’ of other projects by
using money to attach watershed pollution requirements into loans
Private banks would originate the loans but the loans would only be
made because of the guarantee
21. Standard Ratio %
Initial Capitalization = $100M
Participatory Loan Funds = $15M
Loan $ Guaranteed = $50M
Interest Income at 4% * $15M = $600,000
Fee Revenue at 2% * $50M = $1,000,000
Loan Loss Reserve (as % of
Assets
at 4% * $15M = $600,000
Interest Expense at 2% * $15M = $300,000
Net Income $700,000
Pro Forma Financials
21
22. Other Options – for consideration
22
Green Bond – 15 years – issued by state or bank with the state’s guarantee;
refinanced by new bond issuance
Transfer of Development Rights – the right to build on rural land is transferred to
a site that is under density cap so that site can become more dense. Creates
perpetual conservation easements in rural site
Tax Credits – stronger incentive for businesses to retrofit existing structures than
other options. If a business receives a guaranteed loan, they will be eligible to
receive tax credits in proportion to the pounds of pollution they reduce.
23. Other Options – not considered
23
Direct Grants
Direct Loans
Participatory Loans
Link Deposit Program
25. ✓ How do they work (structure)
✓ Private banks originate the loans
✓ Bank contacts ‘The Chesapeake Partnership Bank’ to share in the risk
✓ Revenue - % of interest income based on participation
✓ Profits go to grants or purchasing credits from farmers
✓ Types of loans to participate in (risk profile of each loan type)
✓ LTV
✓ Risk Management
✓ Underwriting
✓ Loan Default
✓ 1st and 2nd lien positions
✓ proportional risk sharing
✓ Risk/Reward
✓ Case Study Figures - get default rate from BND financials
Other products: Participatory Loans25
26. Lending (Participatory Loans)
26
The PPP bank would partner with private banks on loans that the private
banks do not feel comfortable making
The profit on the loans would be returned to the state, used for operational
expense and to expand loan programs
Yearly money injections must be ensured
27. Small Biz: Loan Demand
27
01
04
03
02
✓ consider focusing on
state credit unions
✓ Do they want to
lend more
✓ Is the credit union
being state backed
a positive or
‘double dipping’?
✓ biz2credit.com
Month Big Bank
Approval %
Small Bank
Approval %
Credit Union
Approval %
Alternative
Lenders Approval %
Institutional
Investors Approval
%
Mar. 2015 21.60% 49.5% 43.10% 61.20% 60.90%
Feb. 2015 21.50% 49.60% 43.30% 61.40% 60.70%
Jan. 2015 21.30% 49.60% 43.20% 61.60% 60.50%
Dec. 2014 21.10% 49.70% 43.30% 61.80% 60.10%
Nov. 2014 20.80% 49.80% 43.40% 62.00% 59.90%
Oct. 2014 20.40% 50.20% 43.50% 62.10% 59.70%
Sep. 2014 20.60% 50.30% 43.40% 62.60% 59.50%
Aug. 2014 20.40% 50.60% 43.40% 62.70% 59.40%
July 2014 20.10% 50.90% 43.50% 62.90% 59.30%
June. 2014 20.00% 51.40% 43.70% 63.20% 59.20%
May. 2014 19.60% 51.60% 43.60% 63.30% 59.10%
Apr. 2014 19.40% 51.10% 43.50% 63.50% 58.30%
Mar. 2014 18.80% 51.60% 43.60% 63.60% 58.10%
28. Standard Ratio %
Initial Capitalization = $100M
Participatory Loan Funds = $15M
Loan $ Guaranteed = $50M
Interest Income at 4% * $15M = $600,000
Fee Revenue at 2% * $50M = $1,000,000
Loan Loss Reserve (as % of
Assets
at 4% * $15M = $600,000
Interest Expense at 2% * $15M = $300,000
Net Income $700,000
Pro Forma Financials
28
