Review Leverage Ratios and Establish Financial Metrics
One strategy for creating a self-sustaining clean energy finance program is to review and reset leverage ratios for the first generation and establish financial metrics for measuring program risks and success.
Clean energy lending programs that rely on a credit enhancement from the grantee’s American Recovery and Reinvestment Act (ARRA) funds can leverage modest amounts of grant capital into much larger amounts of lending capital. For example, Michigan SAVES has a $3 million, 5% loan loss reserve with a leverage ratio of 20:1, enabling financial institutions to lend up to $60 million. Some leverage ratios may be much smaller than this, however, because lenders are not yet comfortable with the new lending product or they perceive greater risk than did the Michigan lenders. For instance, one program in the southwestern United States has a 4:1 leverage ratio based on a 25% loan loss reserve.
The leverage ratios in the early stages of this clean energy lending market may be lower at first as lenders get comfortable with the market. As mentioned earlier, during the course of the U.S. Department of Energy’s energy efficiency/renewable energy finance program, financial institutions will be collecting data on loan payment performance, and grantees can use that data to reset leverage ratios if the evidence proves that borrowers are creditworthy and defaults are low.
As part of the loan loss reserve fund (LRF) Agreement with the financial institution, the grantee can establish lending volume targets and include provisions to evaluate the collections payment performance data. If the collections payment performance hits a defined target, then the leverage ratio can be reviewed and reset.
For example, if an financial institution starts with an LRF of 10% of the total loan portfolio, perhaps after 2 years of experience and evidence that actual loss rates are say, below 1.5%, then the size of the LRF relative to the loan facility could be reset at 5%. That would permit the same amount of LRFs to support a doubling of the total lending amount. In fact, the incentives for the financial institution and the ARRA grantee are aligned in this regard. If the financial institution learns that energy efficiency/renewable energy financing is a profitable business, then it will want to increase its lending and include more loans in the portfolio covered by the LRF. At the same time, the ARRA grantee will be interested in increasing total lending to meet its program goals and serve more homeowners.