Needs of Financial Institutions
The following are among the first questions that lenders will want answered at the beginning of their discussions with grantees about residential clean energy lending products, loan loss reserve funds (LRF), and other credit enhancements.
What is the size of the energy efficiency loan program?
Financial institutions need to know that they are devoting time and energy to a new program that is likely to generate new deals exceeding, in the initial phases, a few hundred thousand dollars of lending. It is rarely worth the financial institutions’ time to conduct negotiations and assemble the infrastructure needed to roll out a new loan product if it is only going to generate a small number of loans. That said, financial institutions understand that it may take some time to generate a lot of clean energy loans—there will be a period of growth—but having the reassurance up front that they, as lenders, will eventually have a market of at least a few million dollars is very important to them.
What is the size of individual loans to homeowners?
Financial institutions need to understand that most lending in the residential sector for energy efficiency projects involves small loans that are usually less than $15,000 (unless the projects include solar photovoltaic installation). Grantees will want to make it clear to financial institutions that the business proposition involves a large number of small loans, which means the financial institutions will need to think creatively about ways to reduce their transaction costs for processing individual loans. In most cases, energy efficiency loan programs will fall under the financial institutions’ consumer lending departments, which already have expertise in providing small loans to consumers.
What are the characteristics of the target market?
Financial institutions will want to know the likely credit characteristics of the target market, meaning the expected credit scores and other similar measures of credit quality of the borrowers to be supported by the loans.
What are the loan origination expectations?
Grantees must explain to financial institutions that these small energy efficiency loans are very often point-of-sale transactions that are typically marketed by a contractor and originated over the phone or the Internet. They require very fast response times. Failure to provide a fast response will often lose the deal. Imagine a contractor trying to convince a customer with a broken furnace in mid-January or a broken air conditioner in mid-August to purchase the high-efficiency furnace or air conditioner though a special financing program—yet telling the customer that the wait time for loan approval is more than a few hours.
Describing a clean energy loan as analogous to a used car loan will be helpful when talking with financial institutions. Used car loans close at the car dealership, require fast closing, and are often for a similar dollar amount, around $7,500 average per loan. One crucial difference between energy efficiency loans and used car loans, however, is that the lender has the ability to repossess the car in the event the borrower defaults. Energy efficiency loans are usually “unsecured”—meaning the lender has limited or no ability to repossess the insulation, duct sealing, or other home efficiency measures. That is one reason to propose a loan loss reserve fund to make lenders more comfortable with the unsecured nature of these loans.
What are the expected roles of the financial institutions and the grantees?
Financial institutions need to understand what grantees expect them to do and what the financial institutions’ legal responsibilities will be under an energy efficiency loan program. Typically, financial institutions do not want to be responsible for making sure that the loans do, in fact, cover “qualified measures” as defined by the U.S. Department of Energy (DOE) or the grantee. Financial institutions will expect contractors to make that type of assurance to the grantees. Financial institutions will want to know their reporting requirements, any loan marketing requirements, and other expectations. That includes knowing the level of flexibility financial institutions will have to accept or reject loan applications, along with a clear understanding of the grantees’ expectations for loan denial/acceptance.
Who bears the risk and for what? What is the size of the credit enhancement and how is it structured?
Financial institutions must be told how much risk they will bear for loan defaults and how much risk the grantee is willing to assume. For instance, an energy efficiency/renewable energy lending program that puts aside a 10% loss reserve fund (LRF) is willing to cover up to 10% of the losses on an entire portfolio of loans. But in the case of an individual loan defaulting, the financial institution needs to understand three things: (1) the definition of default (usually 90 days overdue); (2) the percentage of the outstanding loan value that the financial institution must recover (80%–100% is typical); and (3) the process to follow when a loan is declared “in default,” but the borrower subsequently pays the overdue portion and brings the loan current again. Grantees must make it clear to financial institutions that the LRF is by definition a reserve account, not a guarantee; DOE funds cannot be used to establish loan guarantees in this case. The reserve is capped at a predetermined amount, and the financial institution will be responsible for any losses in excess of that predetermined amount.
What are the expected rates, terms, and other conditions of the EE loans?
Financial institutions need to know the grantees’ expectations for interest rates and loan terms. This information will allow the lenders to understand how profitable the energy efficiency loan program will be, at least on the basis of the interest earnings from the loans.
Are the financial institutions that make the initial loans to residential property owners as part of the grantee’s energy efficiency program allowed to subsequently sell those loans to other investors?
Some financial institutions will choose to hold their loans in their own portfolio until maturity. Others may want the option of selling the loans to an investor, using the proceeds of that sale to make other loans. The model for this type of secondary transaction is similar to one in the home mortgage industry, whereby an investor purchases a number of mortgages from the primary mortgage lender(s) and then bundles those mortgages to create a mortgage-backed security for sale to other investors.