Key Issues Investors Consider Before Lending
A prudent investor considers several key issues before putting money into loans. In fact, many of these considerations are the same no matter whether the investor is using the money to invest in an energy efficiency lending project or a project having nothing to do with energy efficiency. The investor’s questions typically focus on two major issues: credit risk and comparable products.
Credit Risk Question
“What is the likelihood that I will receive the principal amount of my investment back, and then what is the likelihood that I will earn the promised interest rate on this investment? How do I price the risk that I may not receive either the principal or the interest back?”
Answer: This risk is quantifiable. It is a calculation of the “risk” of not getting the money back, over the term of the loan or loans. A short-term (i.e., 3-month) United States Treasury note represents the least risk of any financial product in the U.S. market. Typically, the “pricing” of any other credit risk is compared to that of the Treasury note. At the opposite end of the risk spectrum is the long-term junk bond (10 years), a security with a very high likelihood of failure. It would incur the highest pricing against the risk. Grantees and primary lenders will need to convince the secondary market investor that the EE loan purchase is closer in risk to a Treasury note than a junk bond.
Comparable Products Question
“How does this particular financial product or set of products compare in terms of credit risk to other like products?”
Answer: If the financial instrument that the investor is purchasing has the full faith and credit of the United States backing it, like a term U. S. Treasury note, the loan could be compared to a Treasury product. Energy efficiency loans, for example, would carry a slightly higher credit risk for the investor, which would be covered by the higher interest rate return required by that investor. For example, instead of 0.025% return typical on a short-term Treasury note, the investor may require a 1% return.