Financing Energy Efficiency: Credit Enhancements and Leveraging Strategies Matthew H. Brown ConoverBrown LLC

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? Its 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 theres 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 isnt unreasonable. Pre-agreed underwriting standards are critical. Eg. 680 credit score, 50% debt/income ratio.

Issues to Consider with Credit Enhancements Dont 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 Its not the HDTV purchase…

To Summarize Without financing we cant 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.