STATE FINANCING OPTIONS FOR CLEAN ENERGYMatthew H. Brown www.harcourtbrown.com

Harcourt Brown & Carey: Energy & Finance

Consulting and financial advisory firm with a specialty in clean energy financing & related energy policy.

Published numerous papers on clean energy finance.

Clean energy finance clients include states, utilities, lenders, federal agencies, national and regional associations and advocacy organizations.

The Challenge

To stimulate economic growth To improve the quality of buildings in

which we work and live To reduce the amount we spend on

imported energy. And to put people back to work through

investments in the above. But States have very limited resources to meet this challenge.

The Solution

Energy efficiency investments paid for by leveraging public money with private capital.

Some Tools Low-cost capital sources Leverage of public capital through credit

enhancements Utility on-bill financing structures

Presentation Outline

Brief review of typical financing structures and elements

Examples of financing tools Capital sources including low cost capital

sources -- QECBs Leveraging strategies Utility on-bill structures

To Begin: Pros and Cons of Finance as a Policy Mechanism

Strengths WeaknessesAllows leverage of public or utility ratepayer funds and increases access to attract private capital

Not all entities have access to finance because of credit quality

Provides for “skin in the game” from borrowers

Even entities who may have access to finance may not want to take on new debt

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

Cost, time and labor intensive to originate, service loans

Can complement rebate programs Requires careful design to price risk and figure out who bears credit risks

Allows the private market to assess and price risk.

Who Lends?• State - Energy Office

- Finance Authority

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

Capital Sources•Banks•Credit Unions•CDFIs•Bonding•Federal•Other (Treasury)•Utilities

Lend

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

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

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

Sources:•Federal•Foundations•Utilities

CAPITAL

3 Types of Capital

Traditional

Low-CostSpecialty

Capital source determines: cost of funds, term of financing, underwriting. Determined by credit quality.

Capital

Traditional capital sources are most plentiful and provides the bulk of capital for lending. Might be structured as the senior tranche of

funding in a junior/senior financing structure.

Strategic Use of Specialty Capital

Specialized capital sources include Grant funds (grants, DOE stimulus funds, utility

ratepayer funds, foundation funds) Requires partnership with CDFIs, utilities. Some specialized capital sources can be used

to:o 1. make loans in a junior position to senior capital o make loans to below-typical credit quality borrowers.o 2. make loans for extended periods (eg. 15+ years

in residential programs)o 3. provide financing where the obligation to pay

stays with the meter

Low Cost Capital: QECB Overview Qualified Energy Conservation Bonds: QECBs represent

some of the lowest cost financing options available today

QECBs reduce the issuer’s borrowing costs by a direct subsidy from the U.S. Treasury (currently approximately 3.8%) leading to issuer costs starting at 1.5%

This level of subsidy is far greater than the current taxable/tax exempt spread

QECB allocations of $3.2 billion to the states with sub-allocations to municipalities based on population greater than 100,000

QECB Overview

In addition to formula allocations, municipalities can subsequently seek to gain allocation that has been waived by other municipalities or states can issue out of state “holdback”

Projects financed with QECBs must comply with Qualified Energy Conservation Purpose: Energy efficiency, renewable energy generation and

green community programs Public sector projects in Colorado, private sector under

development HB&C is working with Abundant Power to help state

and local governments with QECB-based programs.

LEVERAGE

Leverage using public or utility capital sources

Credit enhancements Money that a government or utility sets aside to cover

potential losses that a lender might incur, up to some maximum amount.

If losses are less than the amount of the credit enhancement then the utility gets its funds back or the funds can be used to support additional lending.

If losses are greater than the size of the credit enhancement, the lender bears the loss.

Ratepayers/shareholders funds are leveraged by a multiplier (5% reserve = 20x leverage) while capping the amount of ratepayer/shareholder exposure.

Leverage Public Capital

Utility or government provides funds to cover loan defaults up to a certain level. Typical levels for residential lending are 5%-

20%, depending on credit quality. In exchange, lender offers a reduced

interest rate, longer loan term or broader access to capital (relaxed underwriting standards).

Pennsylvania: 3rd Party Lender

Leverage: Loan loss reserve of 5% Typical loans are from $5,000-$7,000

over a 4-5 year term. Originally capitalized with $20 million +

from State Treasurer. >$50 million loans made since 2006. Typical credit is >700 FICO. Allowable

down to 640 FICO

Pennsylvania: 3rd Party Lender

Among most successful ee financing: simple and effective with an innovative capital source.

Keystone HELP offers unsecured personal loans at rates ranging from 4.99%-6.99%. 4.99% for whole-house, audited measures. 5.99% for advanced measures. 6.99% for straight-up ENERGY STAR® measures

Administered by a 3rd party lender that specializes in energy lending.

Delivered through a certified contractor network& 1-800 number.

Michigan Saves: Residential

Leverage: $60 million loan facility based on $3 million loan loss reserve .

7% rate to borrower. 10 year max loan term – being raised to

longer term. 640 and a higher FICO score required

(about 50% of MI population qualifies). Marketed through a contractor network.

UTILITY-BASED FINANCING STRUCTURES

On Bill Finance (utility

bill/utility capital)

On Bill Invoice

(utility bill)

3rd Party Bill (Utility Capital)

3rd Party Bill (Utility Credit

Enhanced)

The Spectrum of Utility-Based EE Financing

Move to the right and the utility role diminishes while non-utility role increases.

“Utility” could be shareholder or ratepayer funds.

Utility Invoicing-Only

Utility Invoicing Set up so that utility does not provide capital, but

only bills on behalf of a 3rd party lender. Since the utility is not the creditor, it should avoid

regulation under TILA. One variant is to have two EFT payments (one for

lender and one for utility bill). Under consideration in Indianapolis (IPL).

3rd Party Billing w/Utility Capital Not aware of any such programs in operation.

Mass HEAT Loan Program

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.

Illinois Utilities

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. Loan terms TBD. Contract awarded but not public.

Our firm working to develop capital source.

A Focus on Commercial Lending

Attractive because of larger project sizes and much better paybacks on energy efficiency investments.

Credit is more difficult to evaluate than residential.

Ownership structures are often complex. Loan sizes are often odd (too small for

most lending).

Commercial Program Model (Metrus)

Metrus

Engineering Firm

Bank

Special Purpose Entity

(Established by

Metrus for customer)

Customer/Host

(Seeking Energy Efficient Solutions

and Equipme

nt)

$ (Debt)

$ (Equity) $ (Service Charge)

$ (Fee for Service)

Provides Initial System Audit and Performance Guarantee on system upgrades

Customer takes on no additional debt and instead pays a monthly service charge.

Conclusions

Many sources of funds can be used to provide leverage to attract private capital.

Capital sources and combinations of capital sources are the key to successful financing.

Finance programs need to be designed to put different parties and different kinds of capital in their proper roles.

Conclusions

Financing programs can work, if they are streamlined and marketed not just as financing but as a means to better equipment, more energy savings.

Financing is necessary but not sufficient to meeting energy policy goals.

3rd Party Lender Origination/Servicing

Recruit lenders to do loan origination and loan servicing.

Use flexible capital to credit-enhance: Attract private lender capital by covering a

portion of losses (risk). Convince lenders to reduce their interest

rate Convince lenders to extend loan terms Convince lenders to loan to a broader

spectrum of the population (riskier loans).