Structuring Credit Enhancements for Clean Energy Finance Programs (Text Version)

Below is a text version of the January 15, 2010 Structuring Loan Loss Reserve Funds for Clean Energy Finance Programs.

Announcer: Matthew

Welcome everybody, today we are continuing our series of webinars that will....that are designed to address issues that will be of interest to stimulus fund recipients; both EECBG and SEP fund recipients.

We are very pleased today to have a panel that will address one very important and emerging issue which is structuring credit enhancements for clean energy programs. The registration for this particular webinar is right around 200 people. We are very pleased to have so many people who are interested in this topic. This is an area that's of particular interest to the US Department of Energy. There are some $700 million that is committed to various types of financing programs around the country using our funds and one of the key things the US Department of Energy is looking to do is to use that funding not just as loan capital but to look at ways to use it as a credit enhancement to leverage that money; to leverage that ARRA money in order to bring in investor capital. It's possible to use credit enhancements to partner with lenders and investors to multiply by a factor of 10 or more, the amount of money that is put out to support energy efficiency or renewable energy. Credit enhancements, in addition, can serve to increase the availability of loans to a broader spectrum of the population who might not otherwise qualify for financing. Credit enhancements are very important part of what the US Department of Energy is looking to promote for use of ARRA funds. One other note about the use of credit enhancements is that using the ARRA funds, as a credit enhancement, can actually make the funding guidelines more flexible. It allows you to for instance use EECBG funds in a more flexible, 20% or $250,000 maximum amount of money that applies to the amount of total funding that any grantee; has and can use for financing programs. If the EECBG funds are used in a credit enhancement that 20% or $250,000 maximum does not apply. So there are a number of ways in which the use of financing actually makes your use of funds much more flexible.

We have two people presenting who have experience both in the domestic and international realm both with unsecured and secured loan products. We are very pleased to have John MacLean and Joanna Karger. John is with the Energy Efficiency Finance Corporation. Joanna Karger is with Renewable Funding. I'm going to let each of them do a self-introduction, each of them is going to speak for approximately 15 to 20 minutes and we will take some questions right after John's presentation, just for clarification purposes, but our main goal is to have both people speak and then we will have questions come right after that.

So, John.

John MacLean:

Thank you Matthew. I'll introduce myself first; my background is in investment banking and municipal finance; meaning tax exempt bond markets and energy project finance mostly for senior debt and originating transactions. I've been doing energy efficiency finance work since 1982, using an arrange of finance structures ____ go finance, utility based finance programs, pool bond issues, vendor finance, running a project investment fund. Since 1995 I've been doing international development finance work with the World Bank International Finance Corp ____ Development bank and others to set up energy efficiency and small scale renewable finance programs; where some concessional or donor or development or public funds would be used strategically to mobilize and leverage commercial finance; very often working with local financial institutions or setting up ___ financing for capital markets; transactions. So I think that same theme is the key theme here for this topic of structuring loan loss reserve funds.

Next slide please.

Next Slide: Credit Enhancement Overview

John MacLean:

As Matthew said the goal of credit enhancement is to mobilize and leverage financing from commercial or private capital sources with a goal to support them to offer financial products, expand their risk horizons, broaden access to finance to more borrowers, extend the loan tenors so that energy savings benefits can be matched with the finance payments and to improve the terms and lower the rates.

The credit enhancement structures can support a range of finance models; the examples that I'll be giving are primarily a loan loss reserve supporting financial institution commercial bank facilities but they can also be used for bond issues, for project finance, for utility on bill financing programs etc.

A range of different credit enhancement structures exist including subordinated debt and guarantees all focus on loan loss reserves.

Next slide please.

Next Slide: Loan Loss Reserve

John MacLean:

So loan loss reserve takes the concessional money and uses it to provide partial risk coverage to support the financial institution partner to offer clean energy finance products. The concessional funds can come from a number of sources, our first case source here is the RF funding through the state Energy Program, and our Energy Efficiency Conservation Block Grant. Other sources of funds to support loan loss reserve can also be ____. ____, utilities, contributions from who participate in the program and so forth.

Next slide please.

Next Slide: Loan Loss Reserve Funds

John MacLean:

The key for loan loss reserves is that it's best applied using a portfolio approach to credit structuring. It's best applied where the finance products and the market retreating consist of very large numbers of small projects so that some money is available to cover the first losses on the portfolio and will be meaningful as a credit enhancement support to the lender. The size of the loan loss reserve relative to the total principal amount of the lending and the portfolios is typically in the range of 2-10%. That implies leverage ratio of 10 to 1 up to as high as 50 to 1. Because we're supporting the financial institution partner to pioneer a new product, typically the ratio of the loss reserve fund to the total target lending amount is higher to begin with and can be lowered as experience is gained with collections payment performance and loss experience.

The starting observation is that the loan loss reserve fund structure can achieve very significant leverage of public funds. I would also add that there's no guarantor involved so this structure is eligible for use of ARRA funds even though ARRA funds cannot be used to support guarantees, it can be used to support loan loss reserve funds which essentially have a similar effect.

Next slide please.

Next Slide: Bellingham/Whatcom Co., WA: Loan Loss Reserves, with 3rd Party Lender

John MacLean:

The first example that I want to give, and this will illustrate the work that we're doing here in Washington State, is for the city of Bellingham and Whatcom County in the northwest corner of Washington. It's a program that targets residential and small commercial. The program sponsor is a non-profit organization working together with the local weatherization community action agency and they're providing a one-stop-shop to help energy users prepare their projects for investment. They provide a hand-holding type service through the full project ______ starting with audits, helping the energy user make a decision, help them ____ qualified contractors and then arrange for the financing.

Next slide please.

Next Slide: Bellingham/Whatcom Co., WA: Loan Loss Reserves, with 3rd Party Lender

John MacLean:

The Whatcom/Bellingham program is using Energy Efficiency Conservation Block Grants as a loan loss reserve fund- and in Washington State, also the State Department of Commerce is using a portion of their SEP monies as an energy efficiency credit enhancement grant. The same structure is being used to support programs in Spokane County, King County, Thurston County and Pierce County as well as a program we're working on with our Washington State Housing Finance Commission to target lending to 501C3's and multifamily low-income housing projects. So in the Bellingham case the city ___ County are using their Conservation Block Grants as a loan loss reserve to support their financial institution partner to offer finance product to the residential and small commercial market. An RFP and Request for Proposal Process been used to procure the financial institution partner and that was part of the scope of our firm as financial advisors is to do the program design, prepare the RFP, help the city and county conduct the financial institution RFP Process, evaluate proposals and now negotiate and conclude loan loss reserve fund agreement.

Next slide please.

Next Slide: Loan Loss Reserve Structure

John MacLean:

Here's the structure: the contribution block grants will be placed on deposit with the financial institution partner into a deposit account and then as the financial institution partner originates the loans, and makes the loans, the agreed and appropriate proportional amount of funding will be placed into the loss reserve fund and then available to pay for losses as agreed by our definition of ____ loss.

Next slide please.

Next Slide: Potential Impacts on Underwriting Criteria

John MacLean:

A key term, next slide please. Can you switch to the next slide please? A key term is the... I'm sorry I'm ... showing the next slide.

A key term...____, we have the potential underwriting ...a key goal, thank you now. A key goal of the loss reserve fund approach is to modify the underwriting criteria to help as a credit risk management tool the financial institution partner to stretch their risk horizons and modify their underwriting criteria. In our negotiations to date we're seeing several good results ___ ___ to reduce the required credit score, to increase the debt income ratio which are key to lengthen the loan tenors up to 10 years to allow unsecured loans that are larger in the residential sector, perhaps as large as $10,000 to even eliminate the loan to value ratio as regards the property value itself to lower the rates and the customer contribution.

Next slide please.

Next Slide: Program Implementing Agreements

John MacLean:

To implement the loan loss reserve program two agreements are being put together. One is the loss reserve fund agreement between the donor, in this case the City and the County, and the financial institution partner, that creates the deposit account and the reserve account. Secondly there's a less formal agreement that lays out the terms of cooperation between the financial institution partner and the program administrator and the energy service providers who are marketing the loans and that second agreement covers all steps involved in the loan origination process.

Next slide please.

Next Slide: Structure and Terms of EE Loans, to be defined in LRF Agreement

John MacLean:

Key terms of the loss reserve fund agreement; eligible borrowers, eligible projects so all of the ARRA definitions as to eligible energy efficiency projects are included.

Minimum, maximum loan size, these could be negotiated with the financial institution partner. We're looking in our case at minimum loans in the $2,000-2,500 range and maximum loans unsecured of; it varies between $10,000-15,000 and in some cases a secured alternative for the residential sector of 20-25 where folks mainly___ on efficiency investments.

The terms of the loan product are included as an ____ to the loan loss reserve fund agreement laying out all of the key terms of the loan product itself.

Next slide please.

Next Slide: Structure and Terms of EE Loans, to be defined in LRF Agreement

John MacLean:

Those terms would include: the payment schedule, the required customer capital contribution, loan underwriting, and loan disbursement. Generally we're having the contractors fund construction so that the loan from the lender is term finance is taken out only with liberal prepayment options.

Next slide please.

Next Slide: Risk-Sharing Formula: Main Components

John MacLean:

The risk sharing formula and this gets to the loss reserve funds that will be put on deposit in ratio to the total original amount of principal being used supported in the loan portfolio.

In the Bellingham case we're starting at 10 to 1 but we have provisions to monitor the payment performance of the portfolio and increase the leverage ratio to 15 to 1 and potentially 20 to 1 as the payment performance is proven out. We then also have a first loss percentage and in this case it's 10% so the loan loss reserve would cover all the losses up to 10% of the original amount of loan principal. Again that ratio is reset as the loss payment performance is proven out.

We're also looking at ways to have others parties contribute to the loan loss reserve.

Next slide please.

Next Slide: Risk-Sharing Formula: Main Components

John MacLean:

There's trade-offs obviously between the leverage ratio and the risk sharing formula. The lower the leverage ratio the more risk protection is offered. The key principal here is to achieve alignment of incentives with the financial institution for good loan origination and administration. A key point is that any losses after the loss reserve fund are exhausted would go fully to the account of the lender so that they do ____ strong incentives for good loan origination in compliance with the underwriting guidelines that are part of the agreement.

Next slide please.

Next Slide: LRF Agreement: Key Terms

John MacLean:

A key definition in the loss reserve fund agreement is the definition of event of loss. What triggers the ability of the lending partner to draw funds from the loan loss reserve? What we're using there is loan acceleration mapped out __ ___ cycle that the bank goes through, the bank is fully responsible for collections and recoveries at the point where the borrower has failed to cure in a default situation; then the lender would accelerate the loan and it's at that point of loan acceleration that the financial institution partner would have the right to draw from the loss reserve fund.

It's a very clear designation, there's a paper trail, it's easy to prove out, easy to administer. So that's the definition of event of loss that we've used.

Following a loss the financial institution will continue their recovery activities and recovered monies would be placed back into the loss reserve fund so that's the distribution role.

Next slide please. The next slide, there we go.

Next Slide: LRF Agreement: Key Terms

John MacLean:

There's reporting and monitoring requirements consistent with the obligations of the local government to report to the State and Federal Government on their use of our funds so the reporting covers the portfolio, the accounts in the loss reserve fund, aging receivables on collection performance, the status of recoveries and so forth. All of the financial institutions are financing data that gets collected there and that's an important value that will come out of these programs, the data on collection performance. We also have targets for the amount of lending if the partner doesn't meet those targets; we have the ability and the right to reprogram the funds.

Next slide please.

Next Slide: EE Lending Program Agreement: Key Terms

John MacLean:

So the program agreement between the financial institution partner and the program manager; sustainable connections, in the case of Bellingham, defines all the roles needed to be played in the distribution of those roles during the loan origination and the project development process. It includes marketing, loan application, loan origination, and loan documentation. One of the goals is to reduce transaction costs for the lender so if some of the marketing is occurring by the vendors and by the program administrator at the point of sale; point of contact with the customer, and that's a benefit to the financial institution and part of what's used to recruit them to the program.

Next slide please.

Next Slide: EE Lending Program Agreement: Key Terms

John MacLean:

All of those loan origination functions then are covered and there's training; actually cross training, between the two parties, between the financial institutions on financing to the program administrator and from the program administrator to the financial institution on the project origination process.

Next slide please.

Next Slide: LRFs: Lessons Learned & Challenges

John MacLean:

So lessons learned: first of all there's other examples: the Pennsylvania Keystone HELP program which is an exemplary program for residential unsecured energy efficiency lending has a loan loss reserve fund originally at 5% of the total loan principal, that program's performing well.

We're setting up programs with other local governments and non-profits here in Washington State, there's work in Colorado, work in Michigan, work in Virginia so there's a lot of international experience with this mechanism, that's what I've been ___ on having done my first loan loss reserve fund in Hungry in 1999 and a series of others in Philippines and India.

The loss reserve fund structure is best applied to portfolios of loans where we have large numbers of small projects and can take the portfolio approach to credit structure. It works where you have concessional funds available to provide the seed financing for the loss reserve fund and again possible to get additional contributors. The leverage ratios can be increased with experience and it's possible to include that reset calculation and those portfolio performance targets in the loss reserve fund agreement.

Next slide please.

Next Slide: LRFs: Lessons Learned & Challenges

John MacLean:

It's important to make the loss reserve fund assignable that would support the secondary market development where your primary loan originator would have greater flexibility to sale off that portfolio and assign the loss reserve fund as part of that sale.

Loss reserve funds: they're relatively easy to set up and administer, in our case we're using the lending institution also as the administrator of the loss reserve fund but it's also possible to use a separate escrow agent. To some extend there's an inherent conflict of interest of the lender between their role as the ____ managing the loss reserve fund versus their role as the lender, we've distinguished in our loss reserve fund agreement those two responsibilities and rely on the reputation and rely on the clarity of the loss reserve fund agreement terms itself to manage that risk. We're also looking at ways to set up these programs that would allow us to use multiple financial institutions coordinated under a single loss reserve fund agreement or escrow agreement.

That in some is the experience to date, we're working on a similar program now again with the Washington State housing finance commission, are getting low-income multi-family housing and supporting tax exempt bond financing do that's another avenue to apply. Loss reserve funds is working with State chartered bond authorities for the various markets that they can fund using tax exempt bond finance, lots of applications there.

Thank you very much and look forward to your questions.

Matthew:

John, thank you very much that was a terrific presentation. I think that that demonstrated a couple of things. One is the very significant leverage that can come out of these _____of a loss reserve fund and the other thing that I think is very important here is realizing that there are many ways to structure a loss reserve fund. John has given some terrific examples including a number of ways to not only for instance set a percentage of loss reserve at the start but also to establish a method for adjusting that percentage and therefore adjusting the leverage that you can get from the loss reserve fund.

Audience speaker: And those criteria can be set up in the financial institution RFP process as well and solicit creative proposals from the community of interested financial institutions.

Matthew: Yep. I want to do two things, one is I want to address a kind of a housekeeping item for those of you, well for a fraction; everybody seeing this you'll note that on the bottom right hand corner of your screen there's a Q&A bar. That's where you can submit your questions for the presenters as we go ahead. You can submit them and then I will moderate those questions after Joanna gives her talk. Secondly there were a couple of items that came up through some of the questions that were submitted. One is that somebody had asked about a point that I had made at the beginning about a 20% or a $250,000 restriction on EECBG funds and the amount, that total amount of an allocation that can be applied to financing programs, the question was whether that same restriction or what restrictions applied to SEP funds and that same restriction does not apply to SEPE funds. EECBG and SEP have very different statutory regulatory histories and SEP does not have that same 20%/$250,000 restriction.

The other thing I wanted to mention, that's relevant to this is that, and John reference this briefly, you have to be careful that in your structure that you structure the use of ARRA funds as a loan loss reserve and not as a loan guarantee. The key difference here is in the case of a loan loss reserve, you're setting aside a certain amount of funding and the availability of that funding up to a financial institution. In the form of that loss reserve it based on the amount of funding available so there's no guarantee it is based on available funding that is placed into that account. That's an important distinction that you need to be aware of.

Our next speaker is Joanna Karger and so if we can bring up that presentation. Joanna is with Renewable Funding and I am going to again let Joanna introduce herself but Joanna has worked a great deal with PACE programs, Property Assessed Clean Energy, the specialty of renewable funding and we have asked her to focus on her perspectives on different credit enhancements and then to think and talk specifically about the application of these programs to PACE programs.

Thank you very much Joanna, take it away.

Joanna Karger:

Good morning or good afternoon to some of you, as Matthew said I work with your Renewable Funding, I'm the CFO here. Just briefly my background is I've spent the last 15-20 years as an institutional money manager, specifically in the fixed-income world. Specializing in securitized bonds, mortgages ___ ___ and ____. I've joined Renewable Funding last October and have been working with our team here to implement PACE programs in California and elsewhere.

So what I'd like to discuss today is first of all I just want to give everyone a brief overview of what PACE is and then I'll go into how, how it's being financed. There's a few different mechanisms that municipalities are looking at and then I'll focus in on where we see DOA grant money, how it can be used to really increase affordability of PACE programs for participants and municipalities.

Finally I'll just briefly conclude with an introduction to renewable funding and who we are.

Next slide please.

Next Slide: About PACE

Joanna Karger:

So first of all what is PACE? Well PACE is an acronym for Property Assessed Clean Energy and what it is, is it's a way for municipalities to finance clean energy improvements through their taxing authority. It's just like when they would do a sewer or water improvement and each property owner would have an assessment added to their property tax.

PACE is the same, the main difference is that participating properties and property owners would opt into the district; so unlike with sewers where everyone has to sign on the property owner has the option here and by doing so they consent to having a lien placed on their property that acts as collateral to secure the financing.

So the important distinction here is that the debt is attached to the property, it's not attached to the property owner. We don't underwrite the property owner, we underwrite the property and so when the property owner sales the property the debt stays with the property; it's transferable. The way that the debt gets financed or gets paid down is via an increase in your property tax bill. That increase would last for anywhere from 5-20 years and that term is determined by the useful life of the improvements that have been put on the home.

PACE laws are generally enabled by State legislation, right now there's been 16 states that have authorized PACE, the creation of PACE financing districts. PACE is recently endorsed by the White House in the announcement of its recovery to retrofit plan.

So there's a lot of ___ ___ right now with PACE, a lot of attention, energy and excitement around it and one of the big questions has been how do we finance PACE and how can we make use of the stimulus funds to kick start these programs and make them affordable for the ____ ____?

Flip to the next slide please.

Next Slide: Nature of PACE Financing

Joanna Karger:

There's lots of ways in which PACE can be financed but I really want to focus on using the capital markets. There's a couple ways you can issue a general obligation bond or a revenue bond. Most of what we're seeing being done is revenue bonds; cities don't want to issue using their general obligations.

Finally also you could use; there's lots of avenues for take out of the bonds. Private placement is one and an alternative would be to do a public bond issuance.

The goal here is finding really the most cost effective way for municipalities to deliver this product to their constituents. We're focusing on the financing that will deliver the lowest rates to the market place.

So if you could flip to the next page. The goal is PACE.

Next slide please.

Next Slide: PACE Goal: Affordability

Joanna Karger:

The goal with PACE is really to create affordability and the terms underline the financing structure, really critical to how the interest rate gets set on that ultimate bond. There's lots of ways in which the DOE funds can be used to help bring down this cost. This market's evolving and it needs scale and ____ for the rate to align with the risks of the underlying bonds. Because they're securitized or collateralized by this assessment there really are ___ but it's a product that's very unfamiliar to the market so we see a really wonderful opportunity here for stimulus funds to be used to help create this market for PACE bonds. There's lots of ways in which they can be done, John's already covered a lot of them. One would be the use of a reserve fund, we have loan guarantee on this ___ as well as Matthew mentioned that all is dependent on how it's structured and then finally another example in which stimulus funds could be used to improve affordability of the PACE bond is what we call surplus fund. I want to go into examples of each one of these.

If you flip to the next slide.

Next Slide: Loan Guarantees

Joanna Karger:

The first would be using a loan guarantee kind of structure which would; it's really an external source of ___ that's used to back the obligation. We don't really think these are necessary for PACE bonds because of the quality of the collateral backing the debt to obligation but an example would be a municipality could pledge DOE grant funding in support of its PACE program. The property owner would still have primary repayment obligation but there could be some kind of guarantee, if you will, on if there's an an event of a default. This is beneficial because it reduces the risk to the investor which would lower the rate on the bond that could then be passed through to the property owner.

Another potential is on the next slide which is the establishment of a reserve fund.

Next Slide: Establishment of Reserve Fund

Joanna Karger:

This is a direction we see a lot of municipalities that we've been talking with are going with, is using their grant money to establish a reserve fund.

John's already gone over this but a reserve fund is a dedicated source of capital that ultimately smoothes out the payment source to the bond holder. So it serves as a secondary source of debt service payment in the event of short fall due to delinquency.

So in a way this would be used in a municipality adopting a PACE program is instead of charging property owners a percentage of the amount they financed to establish a reserve fund the municipality could use grant fund to establish that fund in lieu of having the property owner do it. Provides additional security to the end investor and as a result would lower the rate required on the bond.

Finally, there's one other potential use for grant funds that we see and that's on the next slide.

Next Slide: Surplus Fund

Joanna Karger:

This is what we call a Surplus Fund, the way it would work it would work in conjunction with a debt service refund, excuse me, a debt service reserve fund in the same way that is would smooth out the investor payment stream. With the surplus fund it's often established outside the bond ____ so the municipality would have a little bit more flexibility on how it's used. On an example of this would be a municipality could establish the surplus fund and use the money to support a subordinate bond and we haven't gone into this too much but there's a structure where you could have a senior bond that would have very low risk and then you would have a subordinate bond. That subordinate bond acts a bit like a debt service reserve fund and that it would take first losses on any defaults. So what it does is it provides support to the senior bond and allows us the municipality to issue that bond at a much lower rate. The blended rate would be lower to the participant and once again it would drive down the cost early on in the program to the property owner.

Finally, if you switch to the next slide.

Next Slide: Other Leveraging Strategies

Joanna Karger:

Some of the other ways in which some of the municipalities that we're working with are looking at leveraging grant money, isn't so much in terms of providing direct credit enhancement but it's to subsidize some of the cost involved in pass through to the borrower to participate in these programs. This would include things like energy audits, various closing costs and other items that all gets rolled into the cost to the consumer.

So some of the municipalities are using their grant money to pay for some of these costs up from so that the effective rate to the consumer is much lower. As I mentioned earlier, this market's evolving and we believe that over time as the investors become much more familiar with this credit, with its risks and with its potential return that the rate will decline over time and that grant money won't be needed as much as it is early on when it's a very unknown market and unfamiliar to the investor base. Also doesn't have a lot of ____, doesn't have any ____ right now but as the market grows ____will improve.

So there are lots of options and they're all aimed at increasing affordability and to encourage participation early on as these programs are developed. As participation increases as I said, we believe it will be to development of a PACE bond market and a PACE bond ___ class that will be very attractive to the institutional investor base. That over time via service ____ of the product and bringing it to scale will bring the rate down to the borrower to the point where grant funds won't be as necessary.

If you flip to the next page I just want to give you a little bit of a background about renewable funding.

Next Slide: About Renewable Funding

Joanna Karger:

Renewable funding pioneered the use of the first PACE financing in Berkley via the BerkleyFirst Program. We have a knowledgeable staff with experience both in capital markets and ____. We are the leading firm in PACE design and administration, we're currently the team leader on the California State Wide communities PACE programs which is targeted to be a $250 million financing effort. We've also embarked on fairly deep level discussions with the bond rating agencies and an effort to get PACE bonds rated. We're trying to create a standardization by which PACE bonds would have a generic rating attached to them.

So we're doing a lot of work with the rating agencies to move that along. We've also established partnerships with major financial institutions that, would enable us to create flexible financing structures. One of those is the micro-bond that we've developed and what that is is it's a mini bond that is created each time we fund an individual project in a PACE program. Our goal is to be able to aggregate those micro bonds across municipalities, across counties, across states to create diversity within a pool of PACE bonds that are relatively standardized and can be sold into the secondary market with a high rating.

So that is Renewable Funding, we are working heavily in California right now, soon to be in New Mexico and several other states. There's a lot of ways to use these stimulus monies both for both for collaterized and for an unsecured loans to promote clean energy financing. We've just offered; we have one product, John's offered another product and I think there's a lot of capacity here and a lot of ways in which this stimulus money can be put to very good use.

Thank you for allowing me to present today.

Matthew:

Joanna, thank you very much, that was a terrific presentation and we've got a number of questions that are coming in and actually the first one I'd like to have both Joanna and John focus a minute on because I think that the loan loss reserve structure is something that I think is relatively straight forward, the senior subordinate structure may be would ___ just a little more discussion and I think...I know that John has experience in this particularly in Washington State working with the housing finance agency and private placement there and so I'm thinking that it might be helpful John for you to provide an example and for Joanna you might be able to elaborate just a little bit.

So maybe John first could you maybe offer your thoughts on the senior subordinate structure and explain a little bit from your experience how that's worked.

John MacLean:

Ok, first let me say this is a program that's under development so it's not operating yet. With the state housing finance commission we do have an award of a million dollars from the Washington State Energy Efficiency credit enhancement grant program which is funded by our SEP monies. That million dollars will be used by the housing finance commission to support a 10 million dollar finance facility. The financing will be structured as a private placement to a single purchaser of tax exempt bonds. The bonds will be done deal by deal, case by case so it'll actually be a series of small private placements but pursuant to a facility agreement. The bond purchaser will fund the bond purchase 9 million with their own funds and a million dollars with the ARRA funds coming through the housing finance commission that will, those proceeds will then be lent to eligible borrower and we're targeting 501C3's and low income multifamily housing that are eligible for tax exempt bond finance.

We may also do some taxable bonds as well. As the debt service on those loans come in the bond purchaser monies will be treated as senior and be repaid first. Secondly, the ___ to the subordinated debt, the junior portion due back to the Washington State Housing Finance Commissions sustainable energy trust fund, those monies will be reserved as a loan loss reserve. The subordinated loan is going to be at a very low interest, likely to be zero interest, so that there's a blended rate to the borrower that's a little bit lower than what they would otherwise get. So that structure has two credit enhancement effects. One is an improved the debt service coverage on the portfolio of loans, these would be the level of debt service needed to repay the senior ___ and second it creates a loan loss reserve with the ____ on the subordinated debt. Those monies to the extent they're never used will be retained permanently with the housing finance commission as part of their sustainable energy trust to support further work.

Two more points quickly, one there a local energy service company mechanical contractor who's a partner to help with the project development, they're our client. Secondly the Housing Finance commission not only the ____ on the financing but is also serving as a marketing partner. We're targeting their existing client, their existing portfolio of multifamily housing and borrowers and 501C3 borrowers.

Matthew:

Joanna would you like to add to that discussion on the senior support.

Joanna Karger:

Yeah I can add how we would envision it potentially working with the PACE model. As John mentioned this is all still in development but our model essentially requires a, well it doesn't require but we think the best approach is to provide some type of warehousing like you would in a mortgage origination where you have some interim financing that you use to fund individual property owner loans until you create a critical mass that you can in pool into a structured security that you then sale out.

One of those structures could be this senior subordinate structure. As an example we may have two options, we can take all the loans we've originated, combine them into one bond and sale that bond with an A or a AA rating and say a 7% interest rate that would be passed through to the homeowner.

The other option would be to split those bonds into a senior piece so let's say 90% of the pool is put into a AAA bond that has a rate of 5% and then you have another 10% piece that is your subordinate piece that takes first losses. That might have a rate of say 10% so that your blended rate on the combined pieces is around 5 1/2 % less. There's a possibility that the blended rate could be less than the rate you would get if you did one; you combined all of these loans into one bond.

That's the potential benefit of a senior subordinated structure and the reason you can get a lower rate is that your marketing to different investor classes and in certain situations and circumstances it may be beneficial to issue it in that way.

Matthew:

Joanna could you spend just a second maybe speculate on the role that States or EECBG fund recipients might be able to participate in a senior subordinate kind of structure using those funds?

Joanna Karger:

Well one would be to provide debt service reserve fund on the entire ___ but specifically toward the subordinate piece to keep that rate low. The application of the funds would be really the same, it would be using it for debt service reserve fund for credit enhancement to one or both of the pieces; to enable you to issue at a lower rate.

Matthew:

Ok.

Joanna Karger:

And then you could also of course still use the funds to subsidize the some of the other costs that the property owner will incur.

Matthew:

Great, ok. Another question came in regarding insurance and types of funding for or programs for credit enhancements that exist. One is the senior subordinate structure; the second is the loan loss reserve. A question came in is, could this money be used in this way and I'll answer that “Yes, that is an eligible use of such funding”. The consideration is that the providers of such loan loss insurance are really much fewer and further between than they used to be and much more expensive and even for the greater, for the higher premium amounts, for the higher cost you're actually getting off in the less coverage then you were maybe even 18 months ago. It's maybe in some ways a less attractive kind of mechanism that it used to be and less available mechanism then it used to be maybe 2 years ago.

Joanna or John do you have perspectives on the use of loan loss insurance?

Joanna Karger:

The only thing I would add is I think you can effectively buy loan loss insurance via the debt service reserve fund and the way that would work is by getting a better rating, well for us for on bonds _____ _____ bonds would be getting a better rating on the bonds, buy down the interest rate. It's effectively the same thing but I think it's a simpler and straight forward way of achieving it and it's a way of achieving it in a manner that's very familiar to an institutional investor.

John MacLean:

I would agree with Joanna and I'm not aware of any folks offering that type of insurance, it's doesn't mean it doesn't exist I'm just not aware of it, the loss reserve fund or the debt service reserve fund it's a form of self-insurance to cash in the bank; it's understood by the investment community and I think generally the preferred approach.

Matthew:

Right, ok. A question came in about where formal guidance addressing EECBG or SEP eligible uses and regulations and so on is available. I will give you that website address and just verbally and then put it out through the over the email. That guidance is available through www.eecbg.energy.gov, that's the easy part and then......”/about/program_guidance.html”. There is very new EECBG guidance there, there's information on Davis Beacon, very new information on Davis Beacon available there and there will be guidance coming out shortly on SEP, use of SEP funds in financial programs as well.

There was a question, John I think this is more directed towards you, the question was what's the Whatcom County loan volume to date; I might rephrase it in what might be expected loans volume or hoped for loan volume to date and secondly what might be considered a large enough loan volume to attract lenders or investor interest.

John MacLean:

The Whatcom Program is in negotiation with the selected financial institution partner. It's not yet operational so there's no loans that have been made so far although our lender may start making loans soon with the ____that those loans could come under the coverage of the loss reserve fund agreement when it's executed.

We're setting up a facility with the minimum size of $5 million; some of the funds will be used for interest rate by downs as well to stimulate the uptake of the loan product.

What was the other aspect of that question?

Matthew:

What kind of expected or what might be a definition of what might be large enough.

John MacLean:

Large enough to track the financial institutions. The $5 million dollar target is fairly low, this is replicable so that's a part of the pitch to the financial institution, there's a lot of good PR value for them, there's ability to ___ ___ other services, there's ability to lower transaction costs by having a lot of origination functions performed by the vendors and the program partners so there's a strong case to be made. We're also looking with the financial institution part of helping them offer a clean energy certificate of deposit to mobilize local community capital so there's a number of ways that this program will serve the financial institution interest.

I think 5 million is on the low end, probably what is needed to attract a partner.

Matthew:

Another question came in saying asking about the best way to fund or the timing of funding of the loss reserve in other words would that loss reserve be fully funded based on a proposed size of the reserve or might it be funded on the basis of outstanding loans of commitments made as the loans commit.

John MacLean:

Well and we're still working through the disbursement process of ARRA fund for the conservation block grants but our intent is to fully fund the program into the deposit account, if you recall there's two account structures into the deposit account at the ___ of the loan facility and LRF agreement. As loans are made, transfer the appropriate ____ funds from the deposit account into the loss reserve account, once the funds are in the loss reserve account they'd be considered spent for federal purposes, they're linked directly to certain loans that we can, that can be document for....documented for reporting to the Fed's and those monies remain through the maturation of all the loans in the portfolio and if those funds remain afterwards they get remitted back to the city and the county for use according to ARRA guidelines to support similar programs.

We also have a special provision for the build out of a portfolio to have a higher portion of the original principal of the first loans be shifted into the loss reserve account as the portfolio is built out so that we can take that statistical approach to credit structure of the portfolio as a while.

Matthew:

Another question related to this by the same person, can you talk about return on any based on interest for instance on funds deposited into that account?

John MacLean:

So far and this perhaps reflects a misunderstanding we had about ARRA guidelines the interest earnings on the two accounts; deposit account and reserve account we assumed had to be zero. That was used as a point of negotiation with the financial institution to lower any fees they might charge on administration. We since been come to understand that interest earnings on the ARRA funds can be kept by the grant recipient provided their used as part of the program so we may, we're working on several other of these transactions here in Washington State and elsewhere, set it up so that the interest on those accounts will accrue to the program and just be part of the program funding.

Matthew:

And just to clarify that indeed it is correct that it is allowable for to earn interest on those funds. Not that the interest on those funds is going to be tremendously lucrative at this point.

There was a suggestion that we make some sample RFP's and contracts in the like available to for perspective financial partners that we make those available on the EECBG website and that's something I think it's a very good thought. We will also pull together the proper guidance and make that much more clear and available for a couple of those who are looking for that.

Another question that came in, what happens to grant funds that are used for loss reserves when the period of performance for the grant is completed and the loan is completely repaid, can they be rolled over or in either of the programs that Joanna or John that you were talking about, can they be rolled over in the future loss reserves or can they be reprogrammed into other projects? And Joanna do you have perspective on that and then John maybe you can talk a little bit about some of your experience there?

Joanna Karger:

My understanding is it can be rolled over into future programs but to be honest I'm not 100% sure on that.

John MacLean:

Our understanding is that, well first of all the terms of the agreement is that those reflows are owned by the city and the county as the original donor and that the city and counties intentions are to continue to use those to support further similar energy efficiency finance programs and that's our understanding of the ARRA guideline.

Matthew:

I think this is, one of the things that we are doing for with Department of Energy right now is that we are identifying some of these, a few of these detailed questions that are coming up. A couple of these things such as this may need to be defined and I think and we have actually asked for guidance to come out on this...in this area. So I think very, very shortly there should be additional guidance coming.

Another question that came out is, what has been the reaction, this is for John primarily, what has been the reaction of the perspective investors to the plan to withdraw the loan loss reserve funds as the portfolio establishes its credit history?

John MacLean:

What we've actually done is see if the loan loss reserve funds could support an increased loan facility ____ and increase the amount of lending. Generally the reaction's been fine but the intent is to have that same amount of loan loss reserve funds support and expanded amount of lending. We're also looking for ways that the loan loss reserve fund can scale with the loan volume with contributions from vendors, there's a trade off there because they would recover that in their cost and we've also been in discussion with utilities to see if they can use some of their efficiency and demand ___ management budget or rebate incentive funds to support the lending program by also making a contribution to the loan loss reserve fund and those latter two approaches could scale so that the program has legs and can be continued on a commercial basis beyond the level that supported with the initial EECBG grant.

Matthew:

One more question that I'd like perspective from both of you on this, what would be the benefit or the considerations related to either the use of the DOE loan guarantee program in this area as a credit enhancement or potentially the role of States in offering a moral obligation or other type of guarantee or credit enhancement. Maybe you could both starting with Joanna offer some comment on, on that.

Joanna Karger:

Well as far as a moral obligation, we've had now a lot of the municipalities that we've spoken with are just not in a position to do that, they don't want to do it, they want it to be self funded through access to public market. We've had a couple municipalities explore using this money to subsidize a county or city's loan program but once again they bump up against this goal issues when they propose that to their boards. Really hasn't gone anywhere in the discussions we've had.

Matthew:

Ok, and you're thoughts on a DOE loan guarantee if such a thing were offered?

Joanna Karger:

Yeah, I think the best use of that would be to support this senior subordinated structure because I think if it provided some support to the subordinate bond it could really bring down the ____ rate to the property owner more so than we could do with just issuing a straight senior bond or just a straight bond.

Matthew:

Great! John, thoughts?

John MacLean:

One of the virtues of the loan loss reserve fund is that for the government entity, the local government the grant recipient that is using the grant funds it is, it establishes a clear limit on their liability. So they have a half a million dollars, there are a million dollars, they use that as a loan loss reserve fund they have that in cash. That's their liability limit; they're not assuming any other liability beyond that. I think that's a virtue.

Regarding DOE loan guarantee I'd agree with Joanna, I think the loan loss reserve and the DOE loan guarantee are complimentary that the loan loss reserve can support the primary market with the first originator of the loans. If it's made assignable it can then be used to support the secondary market and then be retained as part of the secondary market deal structure as the first line of defense so to speak to cover losses and that the DOE loan guarantee which surely like the other renewable loam guarantee will have some partial element. It's not a full 100% guarantee that loan guarantee could be for the senior piece and support the secondary market transaction, so I see them as complimentary.

Matthew:

very good. Well I think we have come to the end of our...

John MacLean:

Matthew if I may I saw one more question earlier in the questions, there was a question about how long a secure period before acceleration, may I address that?

Matthew:

Sure, I missed questions, yeah.

John MacLean:

Ok. It's real important in the definition of ___ loss and the loss reserve fund to have a date certain when the lender can draw on the loss reserve fund so they can rely on it as a credit risk management tool. Typically the ___ period is based on the lender's normal practices, somebody's late they get a notice they fail to ____, we're typically in the 60-90 day range before loan acceleration would be given. Usually there's a call to see what can be done to work out but typically about 90 days...60-90 days. The loss at that point would be evidenced for the purposes of the loss reserve fund by the acceleration notice given by the lender to the defaulted borrower and that would then trigger the right of the lender to draw from the loss reserve fund they then continue to be exercising their recover remedies but we do not require the lender to exhaust their recovery remedies before drawing on the loss reserve fund and that's real important to make it meaningful as a credit risk management tool.

Matthew:

Great, thank you. Both John and Joanna, I'd like to really thank you for your participation, this is a very interesting webinar topic and I think as I was describing and talking about an issue where there's a lot of potential; certain amount of complexity it's a new area so I thank you very much for some very good, very clear presentations.

I'd like to highlight in addition, of course this is part of series of webinars, there will be new webinars coming up on the 21st of January, a webinar coming up about 2nd....at least a couple of webinars on energy savings performance contracting on the 22nd of January, A webinar talking about the use of secondary markets for these loan products which relates very closely to the discussion we've been having today about credit enhancements. On the 28th we'll be talking about the Pennsylvania energy efficiency loan program; the Keystone HELP Program and on February 4th we'll be talking about the in more detail about the Whatcom County Bellingham Washington loan program and these are all....should all be visible, the registration, for all these should all be visible on your screen right now and we will look forward to those future webcasts. Thank you very much for your participation and we will look forward to speaking to you more on future webcasts. Thank you very much.

John MacLean:

Thank you very much for the opportunity too.

Joanna Karger:

Thank you.