Philip Henderson, Senior Financial Policy Specialist, Washington, DC
It’s
that time of year – time to look back at 2013. One energy efficiency
deal stands out: In August, the New York State Energy Research and
Development Agency quietly sold a pool of efficiency loans to investors.
Selling loans is unremarkable on its own, but the way NYSERDA made this
deal work was genuinely innovative and offers important lessons to
other states, cities, and utilities for 2014 and beyond.
Background on the loan program before getting to the innovation...
NYSERDA’s
efficiency loan program is typical – they make loans to utility
customers to cut energy waste by repairing or improving their property,
such as by adding insulation, repairing weather sealing, or replacing an
air conditioner with a high efficiency model. Their loans are
generally unsecured (like a credit card), but the model would also work
well with loans secured by a lien (like a conventional “home equity”
loan). NYSERDA also offers an on-bill loan, which means the monthly
loan payments are charged on the customer’s utility bill. Loans can be
made to residential and commercial customers. (Click for more on NYSERDA's loan programs).
NYSERDA
makes efficiency loans using a revolving loan fund -- money goes to the
customer (or to the customer’s contractor) from a large fund, and
borrowers’ monthly loan payments then replenish the fund over the many
years. The total volume of loans that can be made from a fund of any
size is limited by the pace of repayments.
Selling the loans is a
powerful tool -- NYSERDA immediately recovers the entire loan balance,
and it can turn to make new loans right away. This enables much greater
loan volume from the same fund.
Selling loans has been a
longstanding goal for many efficiency programs. The challenge has been
finding investors interested in buying and holding loans of this kind at
a price that works. Investors have not exhibited an appetite for home
improvement loans or small commercial loans with credit risks, low loan
balances, and uncertainty.
Now, for the innovation...
New
York, like all states, maintains a large fund to finance water projects
(it's confusingly called the State Revolving Fund or SRF). It is
capitalized by regular federal and state contributions. New York’s SRF
has net assets over $5.0 billion. North Carolina’s SRF, for instance,
has net assets of about $1.0 billion. These large funds have been used
for years to make direct loans, at low interest rates, to municipalities
or other entities to finance water improvement projects. For example, a
city could borrow from the state SRF to fund a waste-water treatment
plant then repay over time at lower cost than issuing bonds. (For more
on how the SRF works, click here).
NYSERDA's
innovation was to turn to the NY SRF to serve as a backstop for the
efficiency loan sale. The State of New York essentially promised
investors purchasing the efficiency loans that if NYSERDA were unable to
fulfill any of its promises regarding the efficiency loans, the SRF
funds would cover the commitment. It’s like a parent co-signing a loan.
This
guarantee allows NYSERDA to the sell loans to more investors at a
better price. As a result, NYSERDA can make more efficiency loans at a
lower price to customers for efficiency improvements. (For more detail
on how the deal was put together and the other agencies that made the
deal work, see this good paper by CE+BFI)
Two Critical Controls.
Using
a state's clean water fund to undergird an efficiency loan program can
make sense -- making buildings more energy efficient means less toxic
pollution ends-up in water and less water will be used by power plants,
because they avoid burning dirty fuel to make electricity that would
otherwise be wasted. But, the SRF resources are precious and must be
allocated wisely and carefully protected.
Two controls are essential --
1. Tie to clean water. New York’s clean water plan identifies
the goal of improving energy efficiency in buildings, and the U.S.
Environmental Protection Agency validated that NYSERDA’s loan program is
directly tied to accomplishing the purposes of the SRF. For other
states to follow the model, their clean water plans should target
increasing energy efficiency in buildings.
2. Conservative loan terms.
NYSERDA has reserves and protections so that the SRF would only be
called upon in dire circumstances -- stringent credit screens on the
loans, quality assurance programs, loan loss reserves, a regime to
assure energy efficiency results, and overcapitalization (with projected
cash flows from the loans exceeding the amount obligated to investors).
Any state considering the approach outlined here should give
significant attention and weight to these kinds of protections.
The Major Lesson for Efficiency Financing
NYSERDA’s
deal demonstrates a path to reach investors to fund efficiency loans.
It’s doable today, offers many benefits, and it does not hinge on
financial institutions introducing new loan products.
Much effort
has been devoted to recruiting lenders to offer and make efficiency
loans to finance customer projects to improve or repair property. For
example, see the recent decision from the California Public Utilities Commission directing
utilities to pilot loan loss reserves and other tools. These efforts
have value and there are good reasons to try to induce lenders to the
market.
But in places with a well-run efficiency loan program
operated by the city, state, utility, or program administrator,
NYSERDA's model offers a path to replenish a limited loan fund and
offers benefits that private lenders might not be able to deliver.
One
advantage is that a utility or agency like NYSERDA is in a better
position to market efficiency projects to customers, with financing as
an option – the loan is not the primary product, but an enabler, and
it's from a trusted source. A utility or program administrator is also
likely to have rich customer information for marketing, credit screens,
and project assessment. They also can help the customer to navigate and
apply applicable incentive programs. FInally, for banks and lenders to
offer efficiency financing loans will require time to introduce new
products and (probably) additional loan fees.
For these reasons, NYSERDA's deal stands out as likely to illuminate the path ahead fior 2014 and beyond.
[*
One final note: There are important differences between selling whole
loans and selling bonds backed by loans, which is what NYSERDA did. But,
with regard to the questions and issues raised here the distinction is
not material. For NYSERDA and similar programs considering whether to
sell loans or bonds backed by the loans, the differences are mostly
mechanical, legal, and go to pricing. See here for a more full explanation of securitization.]
http://theenergycollective.com/nrdcswitchboard/323246/looking-back-2013-nyserdas-innovation-efficiency-financing-stands-out
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