Prove Energy Efficiency Finance as a Profitable Line of Business for Financial Institutions
To achieve sustained financing in the clean energy field requires financial institutions to perceive clean energy lending as a profitable, creditworthy, and sizable business. At the moment, only a small number of financial institutions operate in the clean energy lending space.
For example, AFC First in Pennsylvania has a successful business originating and servicing clean energy loans in many different states, and Wells Fargo and US Bank both offer home equity green lending products in several geographic markets. Financial institutions need the comfort of knowing that two primary issues are resolved before they jump fully into the clean energy lending field. Those two issues are transaction costs and deal flow, as described below.
Transaction Costs: The costs to originate a loan (verification of income, examination of credit scores, etc.) can range from $200 to $500 per loan. Loan servicing costs may be between $7 and $15 per loan per month. Those costs make it hard for financial institutions to make a profit on small loans of say, less than $5,000 each. Loan origination processes must be easy, streamlined, and standardized so that financial institutions can review each loan quickly and with enough, but not too much, documentation. Most loans in the residential home improvement market can be closed on the basis of the borrower’s credit scores, debt-to-income ratio, and proof of employment. Grantees can examine ways to work with their partner financial institutions to convince them to use a streamlined process that is based more on what financial institutions call “consumer finance” rather than mortgage finance or other more complex underwriting processes.
Deal Flow: The clean energy lending market is still nascent with just a few successful loan products in existence to show financial institutions that it is well worth their while to establish a lending program to serve this market. Many lenders require a bare minimum $1 million of potential new lending to even begin to consider setting up a program—but most financial institutions will not consider programs to be cost-effective until they reach annual levels in excess of $3 million to $5 million. Large national banks may prefer annual loan levels of closer to $20 million before they develop a customized program.
A key lesson learned from past and current clean energy finance programs both at home and abroad is that financing alone is not sufficient to spur investment in clean energy and transform the residential market. Successful energy efficiency/renewable energy finance programs combine (a) access to finance with (b) marketing, project development, and project delivery. Those last three services ensure that a steady flow of investment-ready projects are available to lenders to be financed. Without those services it would be entirely possible to develop a financing program that had little or nothing to finance. The absence of deals to finance (i.e., credit worthy property owners who want to make energy efficiency/renewable energy improvements)—even in the presence of attractive financing terms—has been a major weakness of many early energy efficiency/renewable energy finance programs. So, the finance mechanism has to be part of an overall program design that drives demand.
Social and Community-Based Marketing and Neighborhood Focused Strategies
For the single-family residential sector, many new program marketing models are being developed that involve social and community-based marketing and concentrated neighborhood approaches, which aim to achieve high levels of market penetration—for example, 20% to 50% in a given area. Implementing them successfully is part of the pathway to self-sustainability. Merrian Fuller and colleagues at Lawrence Berkeley National Laboratory recently released a report on this topic, titled Driving Demand for Home Energy Improvements.
Vendor and Contractor Network
Vendors and contractors in the energy efficiency/renewable energy equipment and service sectors are key businesses that can drive the market. They stand to profit and grow from the work brought in under the clean energy loan program, and they can become program champions. Developing, nurturing, and expanding an effective vendor/ contractor network is essential to program success.
Successful History and Creditworthy Borrower
Although the current, small, energy efficiency lending programs have an excellent history, with default rates well below other comparable consumer credit products, not enough history exists for it to be readily apparent to financial institutions that the market for unsecured lending in energy efficiency/renewable energy improvements is generally creditworthy. financial institutions need to hear about and understand that the vast majority of borrowers for clean energy lending products tend to have good credit and that a substantial market of such creditworthy borrowers exists.
As participating lenders around the country gain experience with the new energy efficiency/renewable energy financial products and financing programs, they will keep records of the collections payment performance. Because energy-saving equipment is essential to the operation of a home or other building—it is what keeps the house warm, cool, comfortable, full of light, and inviting—the borrower’s willingness to pay is strong. This translates into lower default and loss rates, assuming proper collections practices are used. It is important that the grantees collect payment information from their financial institution partner in order to document a strong payment history on the energy efficiency/renewable energy financing instruments.
One element of the U.S. Department of Energy’s work on best practices in clean energy finance is to compile data on collections payment performance for various types of clean energy financial products, such as unsecured residential energy efficiency/renewable energy loans, loan loss reserve fund programs, and property-assessed clean energy transactions. Over time, the availability of data will help primary lenders and secondary investors assess risk and price their financing accurately.