U.S. Department of Energy Guidance on Loan Loss Reserve Funds
The U.S. Department of Energy (DOE) is encouraging the use of American Recovery and Reinvestment Act (ARRA) funds for loan loss reserve funds (LRFs) because those funds can mobilize and support commercial financing for energy efficiency projects and achieve good leverage of public funds. The ultimate goal is to help make energy efficiency programs sustainable through 100% commercial financing.
But all parties must be aware that an LRF, although it provides important credit enhancement, is not a guarantee. There is no guarantor in the LRF structure, and the grantee’s liability for loan losses is strictly limited to the LRF funds provided by ARRA.
Below you’ll find DOE guidance documents on the use of State Energy Program (SEP) funds and Energy Efficiency and Conservation Block Grant (EECBG) funds for loan loss reserve funds.
The following paragraphs summarize a few key points:
- Definition of “spent” for use of federal funds as credit enhancement. ARRA funds being used for a loan loss reserve are considered “expended” or spent as part of a three-step process—funds are obligated, then drawn down, and finally committed to support individual loans. Funds must first be “obligated” to a financial institution partner as a credit enhancement to create a loan loss reserve program that will support a loan or portfolio of qualifying loans. Funds are obligated when the LRF Agreement is signed between the ARRA grantee and the financial institution partner; or, if the grantee is administering the program itself, the grantee can demonstrate obligation by sending a letter to the DOE Project Officer indicating the establishment of the loan loss reserve.
Once the funds are “obligated,” the funds may be drawn down from the U.S. Department of the Treasury’s Automated Standard Application for Payments (ASAP) system to fund the loan loss reserve account(s) or escrow accounts necessary to administer the loan loss reserve. However, under DOE guidelines, the funds are only considered fully “expended” when funds are actually committed to support individual loans or portfolios of loans.
One key administrative advantage of the LRF structure is that funds may be placed in an escrow account with a financial institution as soon as the LRF Agreement is signed and before any loans are made. Funds are then transferred from the escrow account to the reserve account as loans are made. Note, however, that the loans expected to be “covered” by the loan loss reserve must all be made within the ARRA spending deadlines because the funds are only considered “spent” once they are (a) committed, (b) disbursed to the financial institution partner that will offer loans to borrowers for qualifying energy efficiency and renewable energy projects, and (c) committed (placed in a reserve account) to support individual loans or portfolios of loans. (See the EECBG Program Notice 09-002B, August 10, 2010.)
This presents a bit of a dilemma for the grantee: a grantee is encouraged to create maximum leverage with the ARRA funds (a 20:1 leverage ratio means that $20 in loans are made for every $1 in a reserve account); but if a high leverage ratio is established, it will take longer to loan out all of the funds “covered” by the loan loss reserve. Some variations are possible for grantees to consider. For example, the LRF Agreement can specify that loans be made with a 90% loan loss reserve (thus expending 90% of the loan amount when that loan is made and the loss reserve committed). But the LRF Agreement would then further specify that after a quarter (3 months), the loss reserve would be reset to a target amount of, for instance 5%. The difference between the 90% and the 5% would then be placed into an escrow account to support additional lending, but the expenditure targets will be more easily met while grantees benefit from the high leverage.
LRF budget and use of ARRA grant funds for program development and administration costs. ARRA grant funds can be used for finance program development costs that are incurred after the date of the SEP or EECBG grant award. Under federal guidelines, grantees are permitted to use up to 10% of grant funds for program development and administration costs. Grantees should be aware, however, that individual states may vary in their interpretation and application of that guideline.
Limit on total proportion of funds that can be used in an LRF. A grantee cannot use more than 50% of its ARRA SEP or EECBG funds for an LRF.
Interest earnings on LRF funds. Grantees can earn interest on LRF funds in the escrow or reserve accounts. That is, however, a point of negotiation with the individual financial institution selected to administer and house the account, and any interest earned must be used for ARRA-eligible purposes.
Disposition of funds at the end of the LRF Agreement. Funds remaining from an LRF program can be used by the grantee provided they are used for grant-eligible purposes. This interpretation may vary from state to state, as some state governments may want remaining SEP funds returned to the state.
For more information, see the following DOE guidance documents:
All guidance can be found on DOE’s Weatherization & Intergovernmental Program website.