Pennsylvania Executes one of the First Residential Energy Efficiency Loan Bundling Transactions

After long and diligent work, my own Commonwealth of Pennsylvania announced last week that it had successfully bundled 4,700 residential energy efficiency loans, and obtained $23 million in cash and $8.3 million in deferred payments, for a projected total of $31.3 million.  The press release is available here.

This is a holy grail of sorts.  People have been saying for years that energy efficiency loans should be able to be bundled and sold, a la mortgages and credit card loans. In theory, bundling the loans would allow private capital to invest in pools of energy efficiency loans, as opposed to individual projects, injecting more capital into the market for energy efficiency upgrades and lowering the interest rates.

Although it seemed like a workable idea, few before the Pennsylvania Treasury had accomplished it.  Energy efficiency loans were considered too weird, too complicated, too risky, etc. to be bundled.  Most critically, financial institutions mostly considered energy efficiency loans to be too risky because there was an insufficient amount of data on energy efficiency loan defaults.

In light of these issues, the Pennsylvania transaction still does not really recognize energy efficiency loans as a unique asset class.  By this I mean that the stream of income from the saved energy is not being recognized as part of the transaction.  As far as the investors are concerned, the loans could be for HVAC equipment or Manolo Blahniks, they are all just unsecured consumer loans.  In addition, Treasury still had to put up significant credit enhancements to make the loan pool desirable. 

In addition, the transaction took a long time and had high transaction costs.  A private entity probably would not have had the resources or perservernce needed to cross the finish line.  Future transactions will need to be more standardized, both with in terms of assets and documentation.

Nonetheless, the Pennsylvania transaction and the many lessons its staff learned along the way may be a very important step in accessing greater pools of capital for energy efficiency.   


Spending on Industrial EE Programs Tops $1b

A report released last week by the American Council for an Energy-Efficient Economy (“ACEEE”) showed that overall spending on industrial energy efficiency (“EE”) projects is on the rise. 

The report tracked 2010 spending by utilities, state and federal agencies, public benefit fund organizations, and nonprofit entities that was used for providing industrial energy users with incentives, rebates, grants, loans, technical assistance, energy audits, and assessments, among other services to encourage EE. 

Total spending topped $1 billion. While 2010 spending received a boost to the tune of approximately $228 million in funds from the American Recovery and Reinvestment Act (“ARRA”), the rest came from other sources. Research shows that the largest programs, by far, were run by utilities and public benefit fund organizations, who accounted for $737 million of the $1.1 billion pot. 

The report, however, does not account for private spending which would undoubtedly increase that figure substantially. Industrial users of energy have been very pro-active in implementing EE programs to lower operating expenses and protect themselves against spikes in energy costs. The study also leaves out the millions of private sector dollars that are raised through leveraging public funds. However, ACEEE’s data clearly shows an uptick in total industrial EE program spending.

Pennsylvania and New Jersey both finished among the top 10 state spenders. Pennsylvania ranked third, behind New York and California, at about $65 million, while New Jersey spent just under $28 million, providing the Garden State with an 8th place finish. 

The Snowflake Problem: Why Energy Efficiency Projects Are So Damned Hard To Finance

As we all learned in kindergarten, every snowflake is unique.  Now, studies have shown that is not entirely true (see here if you are marginally interested in the science of snowflakes), but close enough. 

Uniqueness may be good for snowflakes, but lousy for financial transactions. At least part of the problem in harnessing private capital to fund energy efficiency projects is the lack of standardization across projects.   Major financial institutions need big pipelines of medium- to large- deals to make the sector worthwhile.  If each transaction is significantly different, it means that underwriting standards, loan documents, due diligence and so forth have to be created from scratch for each transaction.

The solution to the snowflake problem is to standardize the transactions.  It is very tricky with energy efficiency, because each building has different features--age, system types, use, occupants, etc.  Therefore, the technology needed to create the efficiencies also differ. 

To break through the logjam, someone needs to develop one or more reliable algorithms that can be used to evaluate projects quickly, while still respecting the unique features of different projects.  Transactions could be structured around the standardized model, and then tweaked for the particulars of the transaction.  Without a reliable and replicable structure for financing energy efficiency deals, financing will always be limited and expensive.   

If you can't measure it, you can't manage it (and you can't finance it!)

One of the bitter complaints about energy management and energy efficiency has been the lack of standardization in energy benchmarking, management, measurement and verificiation.  Policymakers don't like it because it is difficult to verify compliance, consumers can't trust the information they receive and financiers don't like it because they cannot forecast the risk associated with investment.  This lack of standardization has been cited over and over again.  According to a World Economic Forum analysis for accelerating energy efficiency:

Despite differing views of the market, all stakeholder groups acknowledge the gap between opportunity and implementation, recognizing that a standardized method of measurement, verification and enforcement would help create market transparency, a more stable environment and an upscaling of investments. This should be considered of high priority going forward.

A new tool for industry and regulators alike was issued last week.  The International Standards Organization launched ISO Standard 50001 for energy management.  Unlike LEED or Energy Stat, the ISO standard does not set energy targets or how to comply, but rather provides a standardized framework for planning, measuring, verifying and improving energy performance. 

Pilots of the ISO 50001standard demonstrated  cost and energy savings in large and small businesses:

 One of them was a plant owned by a major company, Dow Chemicals. The plant reduced its use of energy by 17.9 % over two years. At the same time, ISO 50001 principles are also successfully implemented by small businesses as shown by the experience of the other plant, CCP, of Houston, Texas, employing 36 people. In two years, it achieved energy savings of 14.9 %, worth USD 250 000 a year with zero capital investment.

Why does it matter?  According to the ISO, Up to the end of December 2009, at least 223,149 ISO 14001:2004 (environmental management standard) certificates had been issued in 159 countries and economies.  ISO 50001 is designed to work with the other ISO management system standards, including ISO 9001 (quality management) and ISO 14001 (environmental management).  In addition, in at least several studies, ISO 14001 has been statistically correlated with significant positive market reaction, increasing the value of the companies that implement it. 

In theory, new regulations could be based on energy performance measured and verified using the ISO 50001 standard.  Financial institutions could have greater security if energy savings, verification and management were based on  the ISO 50001 procedures.  If you can't measure it, you can't manage it...and you can't regulate it and you can't finance it!

Part 3 Of Green Finance--Bumming Money From Your Uncle (Sam)

In Part 3 of GBLB's green finance series (find Part 1 on Top 10 Rules of Green Finance here and Part 2 on Alternative Green Financing Mechanisms here), I will address government incentives and other programs.  I will also highlight some factors that may make green incentives go from rare bird to endangered species. 

As always,  I am not a finance professional, and the goal of these posts is simply to give a high-level overview of government incentives.  As with all financial decisions, please consult your financial professional and attorney for advice specific to your project. 

The Good News About Government Incentives

  1. Programs are available at almost all levels of government--The Federal government offers grants, tax breaks, loan guarantees and technical assistance for green building and renewable energy components of commercial, residential and industrial projects.  The Office of Energy Efficiency and Renewable Energy has a pretty user friendly site. States also run incentive programs, and many states have renewable energy credit trading programs (also known as RECs or green tags or SRECs, etc.) which enable producers of renewable energy to get an extra stream of income from their property. For special groups, like Native American Tribes and Veterans, additional resources are available.
  2. Some programs come from unusual sources--Not all green building and renewable energy incentives come from government.  Utilities sponsor a lot of programs for both commerical and residential projects (for example, see the programs available from PECO here).  Some non profits and even faith-based organizations are providing green incentives.  A loyal Twitter follower highlighted this program by the Jewish Free Loan Association (available to those of any faith) that provides interest free loans of up to $5000 for energy efficient upgrades for homes and small businesses in the Los Angeles area.
  3. Don't neglect technical assistance programs-- One of the most underutilized incentive is technical assistance. Of course, homeowners and businesses can access technical assistance programs, but also municipalities, small businesses  and Native American Tribes can get thousands of dollars in technical assistance for free or reduced cost.  For example, in New York Con Edison provides small businesses with a free energy audit. This can ensure you maximize the benefit of your green project both environmentally and financially. 

And The Bad News

  1. The new House is seeking to cut almost all Federal green incentives--According to Green Building Chronicle,The Republican Study Group, made up of more than 100 GOP House members, is targeting the wholesale elimination of funding for:

• Department of Energy Grants to States for Weatherization, $530 million annually;

• EPA’s Energy Star Program, $52 million annually; and

• federal office space acquisitions (which have helped the government build a market for LEED-certified buildings), $864 million annually.

Just to be clear, in a bill seeking $2.5 TRILLION in cuts, these total savings would account for .14% of the savings.

  1. States and municipalities are strapped for cash--Like the Federal government, states and municipalities are strapped for cash, and may cut their green incentives to provide things like trash pick up and police.  
  2. Some programs are not worth the effort to apply--All programs require paperwork, verification and in some cases, prevailing wage rates.  Sometimes the benefit is not worth the hassle.  
  3. Some programs reward green bling rather than cost effective green improvements--Some programs reward the installation of renewable energy components or other "green bling" as opposed to better  insulation or new windows.  It is key to do a cost benefit analysis of any proposed green project to ensure that it has the greatest return on investment.

For more information, the DSIRE database of Federal and state renewable energy and energy efficiency programs is always useful, and be sure to check your state and local environmental departments and local utilities.

Part 2 of Green Finance--Alternative Financing Mechanisms For Green Projects

Because of the enormous popularity of last week's post on green project finance--Let's Make A Deal--Top 10 Rules Of Green Project Finance--I have decided to do a series on the various aspects of green project finance. 

Today we will discuss alternative financing mechanisms for green projects.  Over the next few weeks, I will do posts on incentives available for green projects, an update on the PACE controversy, and the basics of renewable energy finance.  If you have suggestions for other posts you would like to see as part of this series, feel free to email me. 

Please note, I am not a finance professional, and the goal of these posts is simply to give a high-level overview of potential financing mechanisms.  As with all financial decisions, please consult your financial professional and attorney for advice specific to your project.  And now, without further adieu, a primer on alternative green financing mechanisms.

Basically, there are only a few mechanisms for financing projects.  Self-finance (your bank account); equity finance (someone else's bank account); debt finance (the bank); government finance (Uncle Sam's bank account); and grant finance (your parents' third party bank accounts). 

These basic mechanisms are no different for green projects.  However, there are some interesting variants that have developed for financing green projects of various types. Many of the financing concepts are not mutually exclusive.  To the extent that one of the models, like energy efficient mortgages, is applicable mostly to a specific sector, it can be used as a model for a specific project's financing arrangement with a particular financier. 


For commercial scale (and even residential) green and renewable energy projects, variants on leases have become an interesting project financing model. Essentially, a provider leases the equipment (typically  to the owner of a facility through a long term lease), which reduces the up front costs.

There are a wide variety of leases available, and the decision among which lease is the best solution is largely based on tax and payment considerations.  Most leases radically reduce or eliminate up front costs.  Some leases allow the lessee to take advantage of the tax incentives, renewable energy credits and depreciation on the green equipment, others do not. 

For a great overview of lease variants for renewable energy projects, see here.

Performance Contracting

Performance contracting is essentially a loan from the provider of the green/renewable equipment (known as an Energy Services Company, or ESCO) that is paid for out of the savings or benefits of the green project.  For example, suppose you want to install energy efficient improvements on a facility which will cost $1000 and will save $100 per year.  Typically, the ESCO arranges the financing, and you pay the ESCO through reduced energy bills, sharing the energy cost savings over a predetermined length of time, after which all of the energy savings revert to you.  The ESCO often guarantees the energy savings from the project. This mechanism is used for both energy efficiency and renewable energy projects, and can be used with projects of almost any scale. The DOE has a handbook on performance contracting available here.

Grants In Lieu

 As part of the Stimulus bill, the Department of Treasury made available "1603 grants" which are grants in lieu of tax credits which reimburse up to 30% of the cost of installing certain renewable energy projects. Environmental Leader summarizes the 1603 grant program here:

The grant is 30 percent of the full cost of the intended solar system. Without the grant, system owners could still claim the 30 percent as a tax credit, but some businesses weren’t profitable enough to make use of the full tax credit. This grant now keeps all businesses eligible for the 30 percent incentive, not just those with enough profits (or those with financing partners with enough profits).

The full description of the program is available from the Department of Treasury.

 Energy-Efficient Mortgages And Energy Improvement Mortgages

A form of debt financing, energy efficient mortgages (and their friend, Energy Improvement Mortgages) work on the premise that implementing energy efficiencies on a property will free up cash which can pay down a debt.  The Department of Energy has a great handbook and other resources available here. HUD has qualifications guidelines, approved lenders, etc. available here. has a nice overview here:

Green, or “Energy efficient” mortgages, let you borrow extra money to pay for energy efficient upgrades to your current home or a new or old home that you plan to buy. The result is a more environmentally friendly living space that uses fewer resources for heating and cooling and has dramatically lower utility costs...At this time, Energy Efficient Mortgages aren’t second mortgages. Though they are created separately from your primary mortgage, they are ultimately rolled into your primary mortgage—so you only make only one payment per month.

Technically, energy efficient mortgages:

give borrowers the opportunity to finance cost-effective, energy-saving measures as part of a single mortgage and stretch debt-to-income qualifying ratios on loans thereby allowing borrowers to qualify for a larger loan amount and a better, more energy-efficient home.

And energy improvement mortgages:

are used for existing homes and allow borrowers to include the cost of energy-efficiency improvements in the mortgage without increasing the down payment.

The problem with energy efficient mortgages is that they are pretty small scale. For example, the FHA program only backs EEMs for one to four units.



Let's Make A Deal--Top 10 Rules Of Green Project Finance

The first step to any green building or renewable energy project of any size is finding the financing to make it possible.  Since the bottom fell out of the economy, finding investors and financial institutions willing to finance building projects of any sort has been close to impossible.  Real estate finance prognosticators, however, indicate that 2011 will be a year to buy back into the real estate market.   According to a Wells Fargo report:

In 2011, we expect trends in commercial and residential real estate, two areas of the economy that have been significant drags on headline growth, to turn positive for the first time since the beginning of the recession. Despite being near record lows, housing starts will begin to gain momentum breaking 700,000 in 2011. The turnaround in housing is largely attributable to gains in employment, consumer income, as well as favorable demographic trends. Meanwhile, from the financing perspective, mortgage rates remain low and housing affordability remains high. Though broadly positive, these trends do not reflect a return to the boom years, which were characterized by excessive liquidity and perverse incentives.

Commercial real estate should begin to contribute to growth by the second half of 2011. Operating fundamentals for all major property types are either improving or showing signs of stabilizing. Leasing has picked up, rents are rising or stabilizing and sales have increased. Demand for high quality properties in choice locations remains exceptionally strong, which has helped pull prices higher for non-distressed deals. There are still plenty of troubled projects that need to be disposed of, however, and prices for distressed projects are likely to fall further once lenders become committed to cleansing their portfolios.

Green projects are an increasing percentage of new and rehab projects, and renewable energy projects have very attractive balance sheets in certain areas.  However, structuring financing for green building and renewable energy projects requires more legal creativity and effort than financing other types of more traditional projects. 

Let me give you an example.  Banks have been loaning money to companies to buy equipment for hundreds of years.  Every bank has a set of documents designed for this purpose, and a specific set of rules and requirements for deciding when to take on the financing risk, and how repossession would work in the event of default. 

Let's say Company A wants to borrow money from Bank B to buy a truck.  Company A gives Bank B information on the value of the truck, the value of Company A's other assets, and so forth.  Bank B goes to its set of standard form documents for equipment loans, confirms Company A's credit worthiness, and knows that it can repossess the truck and sell it for some known value in the event of default. 

Now let's say Company A wants to borrow money from Bank B to finance a solar array.  First, Bank B has to figure out what, exactly, it is financing.  Is a solar array equipment, like the truck, or construction?  Then, what value can Bank A put on the solar array?  The value of the solar panels on the resale market? The value of the electricity the solar array produces? How about the renewable energy credits (Banker A says to Banker B, "What's a Renewable Energy Credit?") Then comes the issue about how to handle default.  The solar array is worth a lot more in situ than it is as scrap, but Bank B has to figure out how to structure the relationship with its now-defunct borrower which would allow Bank B to get the benefits of the electricity and the RECs. 

The same concept is true for green building projects.  When examining a green building deal, what value, if any, should Bank B put on the potential energy savings from a high performance building?  Will the high performance building command higher rents?  LEED Certified or not certified? What happens in the event of decertification?

 A few rules for green project finance:

  1. Find a bank or financial institution committed to green projects--Some banks now have financial arms that are dedicated to financing renewable projects.
  2. Pick a model--It's easier to tweak an existing project finance model than to create a new one from scratch.  Construction? Equipment? 
  3. Recognize the need for tweaks--Whatever the model (see #2), it will need to be tweaked for the unique features of green building and renewable projects.
  4. Set out the deal terms in advance, particularly the obligations of the parties in the event of default.
  5. Identify and address the roles of the lender and borrower with respect to any incentives or other government financing that is part of the project.  Each incentive has its own requirments regarding transferability and assignment, and ownership status is often an important factor.
  6. Make sure your green project pencils out--Seems simple and obvious, but when seeking financing, it is important that the project actually be a wise investment. 
  7. Provide as much data about the beneficial financial features of the green project as possible--The growing body of data about the financial benefits of green buildings and the balance sheets of renewable energy projects should enable borrowers and lenders to better evaluate the risks and benefits of green projects. 
  8. Where available, use green specific financing tools, like energy efficient mortgages.  A good primer is available here.
  9. Be prepared to cross-collateralize--There is so much risk aversion, that many financial institutions are seeks cross-collateralization of non-green projects to alleviate the fear, real or imagined, associated with financing green projects.  
  10. Acknowledge a longer financing timeline--Getting all parties on the same page regarding the financing deal and the documentation may take longer than traditional projects.  But, as lenders and borrowers get more projects under their belts, this timeline will shorten.