Lessons & Examples for Establishing Partnerships Between Grantees & Financial Institutions (Text Version)
Below is a text version of the May 26, 2010 Financing Program Support for ARRA Recipients
Announcer: Matthew Brown
We are focused on loan loss reserves and financial institutions. We are going to spend our time, for the next 60-90 minutes, looking at a number of different case studies and some background on the establishment of loan loss reserves, as well as some lessons for establishments of partnerships between EECBG and SEP Grantees and financial institutions. We are very happy to have a terrific panel of folks here to talk today. I'm going to introduce them very, very briefly by name and affiliation, then I will let them provide a little bit more background on their own accord.
Chris Lowman will be joining us, is on the call, he is with the US Department of Energy and is one of the Technical Assistance Leads with the Financial Markets Development Team at the US Department of Energy. Julie Bennett is with Michigan Saves, which is charged with setting up a number of financing mechanisms to support energy efficiency in Michigan. Brett Johnson is with the state of Colorado Governor's Energy Office; he's the Finance Program Manager and has been working to establish partnerships with lending institutions in Colorado, and Howard Tanker (Banker) is the Managing Director at the Energy Programs Consortium and has been focusing in particular on the establishment and development of secondary markets and he will talk about that.
So, our agenda for today is, we will hear from each one of these people in that order, I will actually provide a presentation of the very beginning. A couple of quick notes, you will see on your screen there is a "chat" function and a "Q&A" function, if you have questions that are kind of technical in nature, you're having trouble with audio, in the like, please use that "chat" function, there's a "Q&A" function, and if you have questions that are related or subsequent questions that you like to pose to panelists, please use that function and we will be collecting those questions and posing as many them as we can at the end of all the presentation. So, we're going to run through all the presentations. Note that everybody but the speakers are muted, this webinar is going to be recorded and is going to be available for later viewing. So, thank you all very much for joining us, and I'd like to give Chris Lowman, from the US Department of Energy a chance to kick off this discussion.
Thank you Matthew thanks very much. This is Chris Lowman, I'm with DOE, at headquarters, and I appreciate what Matthew and all the experts are going to be doing here. I wanted to make a couple of quick points for everyone here in the audience. What you will learn here, in the next hour to hour and half is how Loan Officers can be extremely impactful in any sort of program for energy efficiency, because of the way that they magnify what federal dollars are doing by bringing in a lot of private capital to do a lot of the heavy lifting for us. What I want to drive home though, if you take away two elements from this, the end of the day is, implementing these programs is not without its complexities, but for the grantees perspective, it will be easy because the DOE has a team of consultants which include Matthew and the folks that are going to be talking to you today, who are going to engage with you and work with you from the very beginning to the very end of implementing these sorts of programs. In fact we have a very well documented flush style playbook that we're going to open up with you and work with you through every step of the implementation of this program. And the second aspect of this is, we all know that the pressures that we are under for obligations and costing of dollars that are coming through ARRA. Low Loss Reserves Program can be one of the fastest ways to not only obligate but actually the cost dollars. Because of the administrative way in which they are officially costed, they're costed as soon as we sign a contract with a financial partner, committing dollars to a Loan Loss Reserve Program. It can have any number of different contingencies available to it to ensure that those dollars have some flexibility down the road. But, it is a very rapid way to not only obligation but costing. So, I'm looking forward to this talk and I know that you all are also. Enjoy!
Thank you Chris, so I'm going to begin with a little bit of background on what we are talking about when we're discussing Loan Loss Reserves as credit enhancements, and talk generally and then we're going to go into some more specific discussion and examples. I'm not going to spend a lot of detail on this, so let me first off, give the definition. There are a lot of different definitions of Loan Loss Reserves, but let me start off, it is kind of, the Matthew Brown definition, it hasn't been invented by any or through any dictionary, so, but it, Loan Loss Reserves are a mechanism whereby a grantee, so an EECBG or SEP grantee, can set aside funds in an account to cover potential defaults on loans. So, in essence, what is happening is that you would be using some of your loan capital in order to absorb some of the risk that a lender, using its own capital to provide loans would otherwise have to bear. So, that's a very powerful kind of tool that can be used. Loan Loss Reserves are distinct from a loan guarantee, and I wanted to kind of bring this up early on, a Loan Loss Reserve provided contingent upon availability of funds. So, for instance, it might be based on 5 percent of the outstanding value of any loans in a portfolio. But, it would be based on that total amount but capped at that total amount. It's distinct from a loan guarantee, and a loan guarantee is provided to a lender or an investor, regardless of it and not dependent on fund availability. I mention that because EECBG and SEP funding is not, cannot be used for a loan guarantee, can be used for a Loan Loss Reserve. So, a distinction, I think it is important to make one other quick point that you may have heard, credit enhancements, like Loan Loss Reserves are limited to 50 percent of your total award. So, if you have an award of $15 million, you could $7.5 million of that award towards your Loan Loss Reserve. That's an important distinction in a way that the General Council at the Department of Energy has set their rules. Loan Loss Reserves are one type of credit enhancement and just to define, we are going to be using this word I think quite a bit, and a credit enhancement is any measure that is going to improve the apparent credit quality from an investors or a lenders perspective of either a loan or a portfolio of loans. I think that's also an important, just kind of definition, I wanted to have right up front. Now, why do we talk about credit enhancements, why are these so important? There are several reasons; one is that they are that they can attract private capital, so they are a leveraging mechanism by through which you can take $3 million, for instance, of your funds and with a 10 percent Loan Loss Reserve, you could leverage that into $30 million worth of lending. So it's a very useful way to provide a lot more impact with the funds that you have. Credit Enhancements are a good way and an important way to make lenders comfortable with new products or new markets. That's particularly important here; there are not that many lenders that have experience in energy efficiency specific lending or in clean energy lending, so there are good ways to absorb some of the risk that is perceived, even though it may not be a real risk, or at the level that some of them may perceive it. It also provides a way to attract private lending expertise, I probably do not have to really spend a lot of time talking on the phone about the fact that lending and financing is relatively new to a lot of grantees. But the use of private lending experience and underwriting and loan origination of loan servicing, experience is a critical kind of skill that we really want to attract to this market. A couple of really important points, credit enhancements can also be used as leverage to reduce interest rates, so, you are going to hear about programs that are much lower interest rates at, using much lower interest rates that otherwise they would be able to use, because of the fact that a credit enhancement, in the form of a Loan Loss Reserve is being used to absorb some of the risk that lenders would otherwise have to bear. So they could be used to reduce interest rates or they can used to create more flexible terms for lending, that could mean where a lender might ordinarily only do a five year loan and that lender might be able to be persuaded through the use of a credit enhancement to do a seven year loan, or a seven year loan could turn into a ten year loan. Finally, it provides extended access to borrowing, so, where a lender might ordinarily only lend people with a 700 or a 720 credit score, maybe they could be persuaded to use a 680 or a 640 kind of credit score. So, it brings more people into the, it allows more people to borrow. Credit enhancements, there are a number of different types of credit enhancements, but we're focusing on only one of them in this particular discussion. One of them is called Subordinated Debt and a Subordinated Debt kind of structure; you could actually have a single project, but be making, in essence, two loans to that project, one loan might be for say 10 percent of the total amount, so if it is a $10 million project, maybe a $1 million loan. And a senior lender might make the other $9 million. That $1 million dollars, however, would be in a junior position, meaning that it would take on the first 10 percent of any losses that occurred for that lending. So, what that allows is, again, it acts much like a Loan Loss Reserve, but it's in a different structure. Loan Loss Insurance, is another type of structure, it is essentially purchased insurance, much like you would purchase insurance for your car or for your home, not very common at this time, at this point, AIG used to offer it, it doesn't any more, there's really only one company that I know of that's underwriting, that's writing policies for Loan Loss Insurance. Loan Guarantees, once again, we talked about before, another type of credit enhancement but are not relevant for EECBG or SEP funding.
Some issues to consider in the structuring of a Loan Loss Reserve, and I'm bringing these up now, you're going to hear about them over the course of the next couple of presentations, one is the sizing of your Loss Reserve, now some Loss Reserves may be a small as a 5 percent. At a 5 percent level, you're leveraging your funds at a rate of 20 times. Some of them maybe much larger, 20 percent, 25 percent, or larger than that, it really depends a lot on the market you're serving. The greater risk, that is inherited in that market that you're serving, and Julie Bennett is going to talk about some experience in Detroit, the higher level of Loss Reserve, you're likely to have to put up, so, riskier markets equal larger Loan Loss Reserve. It could also be that if you want to get a lower interest rate, you might have to put up a larger Loan Loss Reserve. Another issue is the structure of the Loan Loss Reserve, and there is a host of issues here. Who holds the reserve? Is it held by a third party? Is it held in the account of the entity that is actually making the loans? Is that an interest bearing account? How is the compensation for individual loan defaults structured, so if one loan defaults, is there some "skin" in the game for the lender, to actually really try to collect on the defaulted loan, or the almost defaulted loan, or do you compensate for 80 percent or 90 percent of the default? What is the definition of default? Is it at 120 days, is it at 90 days? Are you setting up your Loss Reserve based upon the portfolio of all loans or is it based on the individual loans that are set aside? So, there are a number of issues which are all addressed in a Loan Loss Reserve Agreement. Another issue, that is important, is the sustainability, a replenishment of the Loss Reserve. In some cases, there may be ways to assess fees on contractors, or on lenders, or on others that can help to keep that Loan Loss Reserve actually whole, more or less, in perpetuity, or at least over a very long period.
Capital sources for a Loan Loss Reserve, now of course EECBG and SEP funds are a great source of capital, but they are not the only source. Rate payer funds, so utilities can set up a Loan Loss Reserve using rate payer funds, with regulatory approval. Other kinds of grant funds can be used, you could also have lender, or borrower, or contractor contributions, all of these are quite commonly used in other contexts for Loan Loss Reserves as well. In general, what you want to be looking for are concessionary sources of funds, meaning, I guess this is again the "Matthew Brown" kind of informal definition, but if these are funds that if you lose them, you are not going to be happy, but you're not going to have to be, you're not going to go into default on a loan, so, they are, you've got some flexibility in these funds. I mentioned before the fact that Loan Guarantees are not allowed. It is important to know Loan Loss Reserves are allowable uses of our funds, and in fact as just by the fact that this webinar is taking place, DOE is strongly encouraging the use of Credit Enhancements and Loan Loss Reserves, with EECBG and SEP funds.
Now, we're going to talk about this more in detail, but who are the lender partners, who you might have work with, and this is from experience and working and negotiating with the different types of lenders. Credit unions tend to be very good partners in this, especially residential lending, they understand small loans, they tend to be heavily engaged with their community, they tend to be much more flexible, in general or many of them do, we've found them to be very good partners. Specialty lenders, though there are Fannie Mae certified lenders, there are three of them are out of the country, they are national. Very highly experienced in energy financing are Fannie Mae certified lenders. CDFI's, Community Development Financial Institutions are non-profit lenders that have access to either no-cost or low-cost capital. They tend to be somewhat constrained in terms of their resources for actually processing, for originating loans, for servicing loans, but they can be very good partners and very flexible, especially working with lower income communities. Public lenders, so state chartered bonding authorities, housing financing agencies, Brett Johnson is going to talk about partnerships there. And finally, banks, especially I would empathize Community Banks can be particularly good partners, much like Credit Unions. In working with a number of lenders, excuse me, in a number of different markets. What's going to bring these markets, bring these lenders to the table? Number one is a market for loans I call it "deal flow", there are lenders out there who are hungry, right now, for a good quality loan. Bad quality loans, you know, not so much, good quality loans are very attractive, so if you can demonstrate you've got a good "deal flow" of upcoming loans and you've got a way to deliver those loans to lenders they're going to be, it's going to make it a very attractive prospect. The secondary market for those loans may be important in some cases and to some lenders. I didn't include another bullet, but one thing we've found also, is the idea of cross-selling. So, if you have lenders who might be willing to do a $7500 loan, they might not only do it for that loan, but for the hope that they could also cross-sell their or whoever is borrowing the $7500 into a home equity line of credit or some other kind of product.
Finally, bringing them to the table is the idea of credit enhancement and that is really the topic we are focusing on here. A couple of final points here on the structure of credit enhancements, and just some thoughts. You are going to hear more about this. One is, make sure that there is a real benefit to the enhancement, in other words, remember that you as a state or city offering a credit enhancement actually have a point of leverage and a point of negotiations, so make sure that it is resulting in a lower interest rate in more loans perhaps to a group of people who wouldn't otherwise qualify for loans, a longer term, etc., make sure there is a benefit. Look at ways to customize the enhancement and we're going to talk about this in other ways. In other words, don't assume that there is a single kind of credit enhancement; don't assume that credit enhancements are 7.5 percent, or 5 percent, or 10 percent. Understand the market you are going for, and then design that credit enhancement for that market. That will help you find the maximum leverage that you are going to be able to get, now I have this 5 percent number, which means 20 times leverage for certain higher credit quality of residential markets that may be very possible, 10 percent maybe quite common, and you may find times when there is substantially less. And then, finally there are, there's a set of underwriting standards that need to go with a credit enhancement, so, for instance, a certain credit score, a certain debt-to-income ratio, those need to be developed and matched with the credit enhancement. Finally, a couple of other thoughts, "don't give away the farm", this kind of goes back to an earlier point, but make sure there is way to have, to leave some "skin" in the game for the lender. The lender needs to have a continuing incentive to collect funds and so that is why in some cases you may not want to in all cases offer 100 percent re-imbursement for a defaulted loan, it might be 90 percent, it might be 80 percent. Look at the structure of that enhancement; look at structuring on a basis of a portfolio, rather than on a per loan basis. Again, focus on the sizing of that credit enhancement. I am going to "shut up" now and I'm going to turn it over to, first, Julie Bennett from Michigan, and then Brett Johnson from Colorado, and Howard Banker, whose working with the energy programs consortium, and first I'm going to move it to Julie and please do, if you have questions as we're going along, please use the "chat" function, we'll be collecting those questions and putting them together and asking them at the end of the presentation. Thank you very much, and Julie, take it away.
Ok, thanks Matthew. Hi everybody, I'm going to talk to you about an experience we are having in Michigan. Okay. So, first, I'm going to start by giving you some background about Michigan Saves, they're a pretty new organization and then I'm going to go over specific examples about how we've used Loan Loss Reserve funds to develop some loan programs here in the state. First, Michigan Saves is a non-profit organization, we're dedicated to making energy efficiency and renewable energy upgrades easy and affordable for all types of Michigan energy consumers, so this ranges from commercial energy users, residential, educational institutions, and so the whole range of energy users in Michigan. We've started, or founded last June, actually, by a Public Service Commission grant, the firm that I work for called "Public Sector Consultant", for a research firm in Lansing, Michigan, we partnered with the Delta Institute, which is a non-profit located in the Chicago area, but with offices in Lansing. We partnered on a grant proposal to the Public Service Commission, they had asked for an organization to help with establishing energy efficiency and renewable financing program in Michigan. We applied, we were successful, and that grant came with some program administration funds that we used to set up the program in the organization. It also came with separate trust fund of $6.5 million and we were given great flexibility and what we did that program, as long as in the end we were establishing a financing program, so we could have done a traditional revolving loan fund and financed improvements directly but instead, you know, working with folks like Matthew Brown, looked at some more innovative ways to use that funds to really leverage the funds and decided to use it for credit enhancements, and I'll talk more about that in a minute. Also, I wanted to mention that we're always continually trying to grow the trust fund and recently we were co-applicant with the state of Michigan and were successful and thank DOE for a $30 million grant under the retrofit ramp-up initiative that will help grow the program. So, in general terms, what do we do with an organization? We provide a credit enhancements, we tracked dollars and we used those as credit enhancements in terms of Loan Loss Reserves. We also have a program that is doing an interest rate buy down with one of the specialty lenders that Matthew mentioned, through retrofit ramp-up work, we're also going to be doing some rebates. So, we're doing a variety of credit enhancements, I'm going to focus on Loss Reserves obviously in this presentation and we provide these credit enhancements to qualifying lenders so these are lenders that meet the program requirements that we've established, and I'll talk more about that in a second. Also, our model is based on contractors really marketing the financing, and this is kind of a "deal flow" that Matthew was talking about, so it's really important not only to establish the loan program, define the product, and the lost reserve terms, you need to also think about, the contractor's side. Lenders are very concerned with, you know, whose marketing their financing so they want to make sure that they're qualified, not just in terms of building science but, you know, insurance and licenses and that sort of thing. We train these contractors on how to offer the financing and then we continually will be monitoring the contractors to make sure they're doing quality work. In addition, one of our rules is cultivating the secondary market, being cognizant as we design our loan products of potential investors that maybe interested in purchasing these loans. Howard Banker, you know, is an expert in this and will be talking more about this later, but that is part of our role as well as to stay in touch with those efforts. Also, coordinating similar and complimentary programs, we have a couple of different financing programs, for our Housing Authority, also USDA has a number of financing programs that will make energy efficiency improvements, so we want to make sure we are partnering with them, but also, our financing programs so there are some customers that aren't going to qualify for our program but may be more suited for the Weatherization Programs, so we make sure that we're coordinated with those folks. And then finally, obviously we're sustaining and growing a program and we also have a process evaluation and tax evaluation in place, so we can do continuous improvement.
So our critical partners then besides what we do, we need lenders to provide the capital and originate and service the loans. Utilities are strong partner in our state the utilities are required to do energy optimization programs, and with those come a lot of rebates and outreach energy measurement and verification, so we partner strongly with them so we're plugging our financing into those energy optimization programs. Also, you know, ____ financing is on our radar, we do have one pilot in place in Michigan right now where the utilities actually servicing the loans, and the capital is provided by a credit union in the area, so that is something that we're focused on as well. As I mentioned before, contractors are out there marketing the program and performing the work. Customers are hiring the contractors, obviously, selecting the measures and repaying the loan and then this idea of the investors that are purchasing previously issued loans, the secondary market that we are talking about, so those are all the major players in our model. So, what I wanted to talk about, more specifically, is the process that we use to developing partnerships with lenders, and I would say, you know, this is Julie Bennett and I guess as Matthew was saying, process of making these programs work. The first I think you need to define a market, I mean you need to design what types of energy you are targeting with your financing a Loss Reserve Program. Some of you may have a more defined scope and you already know you're developing a commercial program or a residential program, for us we weren't given that kind of focus so we had to make that choice on our own, and this is really critical, to do this, because it's really going to drive the second step, which is identifying the lending partners, and this is because, the market and the needs of that market, meaning, you know, what types of improvements does this market want and loan sizes are needed to make these improvements. It's critical information when you are identifying what type of lender and Matthew already went through the different types of lenders, banks, credit unions, CDFI's, Bonding Authorities, they each are more suited for different types of markets and different types of loans, for example, I don't know how many times I heard this in conversations with lenders but, it costs them as much to originate and service a large loan, as it does a small loan, so of course most of them are inclined for the larger loans because there is more interest income to be obtained on that. So, for larger banks, they're more interested in the larger loans, but as Matthew was mentioning, credit unions, you know, are okay with the smaller loans because we have more of a community focus, so, just being aware of your market is important. Also mentioning that the different types of lenders typically have some kind of state association you can work through, so that you are not having to call each individual lender these associations can be really helpful in you identifying those lenders.
So, I would say then the next step is actually designing the loan product that would be supported by you Loss Reserve, and this includes the architecture of the loan and also the lender requirements. So, these are the guidelines participating lenders would need to follow to access the Reserve you're providing, so, things like what types of loan is eligible, secured, unsecured commercial loans, what amounts are part of the program, what terms, you know, what is the maximum interest rate that a lender can charge, what properties, what types of properties, what improvements are eligible, underwriting, credit scores, etc., and so then, once you know more about the loan product and the lender requirements, then you can really get into constructing the terms of your Loan Loss Reserve. Addressing things like what percent of the total loan value will be set aside, how will adjustments be made to the reserve amount, when can the lender access the reserve, how much of the loss can they claim, how much is available to put in the reserves and reporting, how will you know what loans they've made and how will they know how much is left in the reserve, so, these are the types of things that you'll need to address in that step. So, now, kind of putting this more into an example of a specific program that we have, we're about to launch our first state wide program and to develop this program, you know, we first did our market research and we looked at energy efficiency financing programs across the country and there are some, and Matthew really helped us connect to those. But, it seems like most of the activity and best practices were coming from programs focused on the residential market and there seem to be barriers relative to other types of markets, so we decided to start there. From this research we learned, you know, these are typically unsecured loans around $6000, so, you know, then we were able to start talking to lenders, knowing what kind of what program and what the range was and, you know, explain this program to them and it was clear from these conversations as we thought that credit unions and some community banks are much more interested than the larger banks again, because of the kind of a profit margin.
So, we looked at the Michigan Credit Union _______, you know, one of those associations and they were really excited about the program. They marketed it to all their Credit Unions, we had an informational meeting, we brought Matthew in, you know, you have to always bring in someone from more than 50 miles away to talk about something to be an expert. So, he came in and talked about other energy efficiency financing programs from across the country. What our concept was and kind of what the market potential was here, and this resulted in a group of about 15 lenders that then continued to work with us to develop the loan product, the lender requirements and the loss reserve terms. And once that was finished we kind of had an open enrollment and invited those lenders to be part of our program. The result of that process is on these next 2 slides, so, we have a statewide home owner program, and the loans are for energy saving home improvements. These improvements have to be performed by Michigan state qualified contractors, as I kind of discussed earlier the importance of that. The loans are provided by a network of lenders, so, out of the 15 folks or credit unions that work us as so far we have 5 that have signed up to be part of the program and provide the loan capital. The loan size that we agreed on was from a $1000 to $12500, the maximum interest rate any of the lenders can charge is 7 percent. The term is a minimum of 1 year for every $1000 until you hit $5000, and then the term can extend up to 120 months, so this is really nice for being able to get low monthly payments down where the energy savings can cover the cost of the loan.
Applications are taken through the Michigan Saves Application Center, because we have a network of lenders and because we want to make this program really easy for customers to use. We've hired a third party called Lending Solutions Inc.; it is actually acting as an application center and is matching borrowers with the appropriate credit union out of our network. The loans are closed through electronic means or through the mail. We don't want to have the borrower have to come into the branch again, keeping this easy, lender services the loan and we have minimum underwriting standards in terms of debt-to-income on credit score. And then, in terms of the Loss Reserve details, the way that we structured it is that each participating lender has their own reserve funds and the Michigan Saves balance sheet so we retain those funds but we account for them. We gave them each an advance of $10,000, just in case there was an early default and they had no money yet in their reserve fund. Then after they've made $200,000 in loans, we placed 5 percent into their reserve loan, 5 percent of the total value of each loan made into their individual reserve fund, so that is how the reserve fund grows but it is also reduced as losses are paid out and as loans are paid off, so that we are continually adjusting their reserve funds on a monthly basis so that it equals 5 percent of outstanding loan principle minus those defaults that we've already paid out. Lenders can claim from their reserve fund when loans are 90 days past due, this is really critical that it kind of defines what exactly a default is and we've decided it is 90 days past due. We'll pay back 80 percent of a loss for borrowers that had credit scores of 680 or higher, 70 percent for those with lower credit scores. We have $3 million dedicated to this reserve fund, so we are hoping it will leverage $60 million in private loans. Another loan program that we have just to give you the flip side, I mean that 5 percent reserve is great; we also have a small commercial pilot program that we're working with in partnership through one of our energy companies, energy optimization programs and Shore Bank Enterprise Detroit, which is a community development financial institution in the state and Michigan Saves. These loans are for energy saving improvements in small businesses to provide some type of community benefit in the city of Detroit and this is because the capital that's running through the CDFI is from foundations and that is an objective of theirs is to serve non-profits, churches, schools, those types of community benefit organizations. So, these loans are provided directly by Shore Bank Enterprise Detroit, they're commercial loans and the range we settled on is $10,000 to $150,000, maximum interest rate is 5 percent, they are able to charge at 1 percent or $500, whichever is greater one-time application fee, and this is really nice working with the CDFI that's, you know, more interested in the mission, in the community. They're willing to stretch terms out so that the savings from the improvement exceed the loan payment, but they won't go out more than 7 years, and we have some minimum underwriting standards that are pretty flexible actually, because of them being a CDFI and with foundation dollars. This again is backed by a loss reserve from Michigan Saves and you'll notice that this one is a little bit less leverage here, but again as Matthew said that is because of the market, the reserve fund we've set at $160,000, as the maximum, that is because it is a pilot and this is going to leverage about $320,000, so that is a 50 percent loss reserve, and again they can claim losses of 80 percent of unpaid loan principle and 90 days past due is our definition of default in this program. So, just wrapping up, I'd say some of the issues, challenges, lessons learned from standing up some of these programs, this is critical, a loan loss reserve is not a loan guarantee and no matter how many times and how many different ways I explain it to lenders, I know they hear what I am saying, in their minds they're thinking loan guarantee and I think that is because there are a lot of, you know, SBA Loan Programs and federal loan programs out there that do provide a guarantee, so, just, you know, make them say it back to you, after you explain what you are doing, because the confusion that's pervasive. Engage potential lenders and program development, I talked about the process and I think you heard that we really did engage lenders throughout the process, in every aspect of program, and I think that is really critical to get buy-in and plus to get really important input. Matthew already touched on this reserve percentages are driven by lender perceived risks of a loan program in the city of Detroit for non-profits, it's going to be a different percentage than a state wide program or you're serving people, credit worthy home owners. Use default rates from other similar loan programs, when negotiating. Lenders are going to want the reserve percent to be higher but if you can come back and say "you know there are programs around the country where the default rates are around 1 percent, so why would we tie up all this money in the loss reserve, when we could be leveraging more loans?" That seems to really work with them, but also respect their familiarity with the market, like in the city of Detroit, we wanted to lower a reserve but, you know, it's a challenging place to make loans, so we respect that. When designing a loan product, consider the secondary market, Howard will talk more about that later so I won't dwell on that. Matthew already touched on the "skin" in the game, and there is no reason to pay them out 100 percent for their loss, when they're going to be more careful on their underwriting if they have some skin in the game and they're only getting 80 percent back and losing 20 or some ratio like that. A Loss Reserve Program it includes the reserve terms and the loan product, again I am just re-iterating the contractors are really critical for the "deal flow", you have to monitor them and set up qualifications. What improvements are eligible, the lenders really care about that side of the deal and then finally, hold funds until default claims are made, keep those funds with you as long as possible, lenders will want to have, to hold onto their reserve fund, you know, because they're making earned interest on it, but you need to be able to sustain your fund and interest and _____ is one way to do that. I'm getting into the weeds here, but, when you're setting these programs up you're going to, you know, need a legal agreement and I'm happy to share with you a copy of ours but the legal agreement should really just talk about the loss reserve itself, the terms and conditions of that, it should incorporate and reference, your program requirements, keeping those on a separate document is easier because you can make changes to those without having to go through another legal agreement signing process. Be aware of anti-federal trust laws, I learned about this, you know, having a bunch of lenders in a room, developing a loan product can be seen as kind of price fixing and there are the Sherman Act implications of that, so setting your requirements up as minimums and maximums and to say you have to charge 7 percent interest you can't use, instead you say "you can't charge more than 7 percent", allowing some flexibility there will help you avoid that sticky issue. Think carefully about how you structure the Loss Reserve, it's not just 5 percent say of outstanding loan value, it increases and decreases as loans are made and as loans are paid out, so, you know, if you have specific questions about how to do that, I can answer those later. Provide an advance for an early default, as I mentioned, and the home owner programs are doing that. Be aware of due diligence requirements, lenders are being scrutinized heavily by regulators, credit unions are required specifically to conduct certain types of due diligence with anybody they enter into agreement with and this will include, you know, showing copies of your audits, insurance, just making sure that you're a reputable organization that you should be working with and it can be a little bit onerous, so just be aware of that. That's it for me, and I'll be happy to answer questions at the end. Thanks for the opportunity.
Julie, thank you very much. We're going to move to Brett Johnson, and Brett is with the Governor's Energy Office, Finance Program Manager at the Governor's Energy Office in Colorado, so Brett, take it away.
Thank you Matthew, again my name is Brett Johnson, and I work for the Governor's Energy Office out in Colorado. I'm the Finance Manager working with a lot of these creative finance issues as we all that a lot of these green initiatives often have that upfront cost that is really the challenge to figuring out a way to do it. This webinar, as well as my presentation, I hope to cover at least that kind of component of the Loan Loss Reserve. In terms of what I'd like to cover in a summary here is, in general, we had, we have about $13 million dollars worth of state energy planned dollars and kind of the holistic process of what we went though, some of the priorities we and mission that we wanted to accomplish, some of the policy issues, some of the goals we'd like to achieve as well as the partnerships we'd like to have. So, I'll go through that evolution defining the leverage program design and the thoughts that we put into that. Our partnership with Colorado Housing Finance Authority that we're developing, and in kind of discuss a little bit between Loan Loss Reserves and Direct Lending or revolving loan lending and the advantages of both, because what we ended up, coming up with is, kind of a hybrid of both.
So, in general, I also want to emphasize that our approach is non-residential, we really wanted to focus on commercial because we had lots of programs under the governor's energy office per view on the residential side but, really wanted to take a non commercial standpoint. So, in terms of the evolution of the use of these funds, totaling about $13 million, and I've served as finance manager for about 7 months here. When I came on board those monies were stipulated for some kind of a _________ revolving loan fund. As I started to get my hands around this and working with Matthew, Matthew was our consultant and a great help as well. At a similar exact time, we saw some encouragement from the Department of Energy to figure out other possible ways of leveraging this and to possibly think outside of the box of how we can use these funds in terms of some different finance mechanisms. Which was pretty exciting to figure out what other things we could do with this money and were there other options, and so, we decided to move forward in terms of seeking new innovative ways to leverage these funds. So, in terms of defining the leverage program and design, I wanted to talk a lot about what we had discussed as possible general outcomes that we'd like to see. Kind of our mission statement here at the Governor's Energy Office for these funds and what things that we thought we could accomplish with these funds. The first is, leveraging potential, we, you know, as we worked a lot with the Department of Energy, there was a lot of emphasis on what we could leverage, how much we could leverage, and what that amount would be. Of course, when these funds are ARRA related and stimulus related, another component is Speed of Loan Deployment. How fast can we find eligible loan partners, and are we finding ways to construct a finance program that may find 1 or 2 loans, or are there really, is there really that need out there and how quick can we start that "deal flow" as Matthew called it? The third, one perspective from our office was really how do we grow that fund, make it a sustainable fund and possibly even building a future revenue stream for this Governor's Energy Office. There's always the political variability's of future administrations, future budgets, as an office that is 99 percent federally funded right now, there has been some thought about, you know, what do we do post stimulus and so if there were opportunities to grow this fund and possibly have a small revenue stream come out of it, that was also something we considered in this process. So, as we started delving into what we could do with this money, how we could leverage it, in general we were on kind of a two-pronged approach and that two-pronged approach is, first of all what are the financial partners in the financial structure that would be best to use and also that "deal flow", what are the true capital challenges that we could really find the niche that we would be helping out certain markets that don't have that access to capital. And so, going back to the financial partners' component, wanted to put some examples of just different groups, and we really "pounded the pavement" in terms of different groups and talking to different financial partners, anywhere from venture capital partners to investment banks, commercial banks, community development, financial institutions, I know that Matthew has mentioned that a lot of times credit unions can be great partners for these funds, and I agree but unfortunately, we have some limitations in Colorado that don't allow us to quite partner with credit unions as other states do, and so, that was something that we could not look into. And I'll go into this on future slides and touch on this but, the way I put these examples here, between venture capital to some smaller community based financial institution is that, there is level of autonomy there more you go down the line in terms of how we want these funds to be lended and the mission of those funds as opposed to a venture capital group who may just manage the money and make all those determinations for us. And as I mentioned for the "deal flow", the markets, in terms of capital challenges, we're talking about, are there certain developers, project developers, industrial manufacturers that either can't access capital, they just physically can't find somebody provide a loan, or is it more an issue of they can't borrow at certain high interest rates because the financial institutions view it as too high of a risk. Whatever that is, we really wanted to find those challenges to help them out, we also wanted to find in markets that are replicable, if there are other energy offices on this call I am sure you've seen plenty of people come through your door, they know you have the these "pots of stimulus money", but in general, they may say we have this really good project in so and so county, but is it replicable, is it an onetime thing or is it something that we can prove that there's a niche where we could make these loans over and over again to specific different groups that may not have those accesses to capital. And what we generally identified were small commercial groups, industrial groups, non- profit groups and 501c3's, and different groups like that are really who we ended up targeting.
The additional loan design considerations were that, and I mentioned this briefly, how we enhance programs that our office already has running, that are good programs, that may lack that access to capital component. We wanted the ability to really mold this to things so that our office was already doing successfully and add those new opportunities for access to capital where we didn't have it. Wanted to list some examples of just a handful of things that our office is doing that could be great partners that could really benefit from offering some kind of finance option. We received EECBG funded programs, such as Main Street and other commercial programs where there is a local emphasis on small businesses, helping them out, for example the City and County of Denver is really working with different areas to have "mom and pop" small commercial businesses really think about how they can save energy and at this point they can offer them a certain matching grant to get their feet wet, but having a program, a finance program to say "by the way we can follow up and have a very low cost loan on top of that", was an important component to that.
We also have 900,000 used for, what we call our Governor's Industrial Energy Efficiency Challenge Audit Program, but once again, and the next one is the Energy Outreach Audit Program as well where, we're offering audits, but we aren't necessarily offering a finance option to figure out how to pay for the upfront costs in a way that may be perhaps they're unable to access capital themselves. So, that was something that was important to us and to have that autonomy, in general. So, as I've mentioned we ended up determining that a large portion of the funds can be most effectively used by the Colorado Housing Finance Authority. As I mentioned, that ability to leverage our own programs that were already up and running, were important to us and the more we got in tune with a financial partner that had similar missions as us, that seemed to work out better in our favor to leverage those programs. So, what we ended working with is the Colorado Housing Finance Authority, and it was advantageous for us to this in several different ways, it provides certain banking services that the Governor's Energy Office is just a little bit more difficult for our office to become a bank and so, they provide as a semi-governmental authority, a better way, a quicker way to service loans in which the Governor's Energy Office can't necessarily service loans long term. We also share similar missions and in terms of what we're looking for, that a private lender may not share as much as the bottom line of their cash flow and their profits. As we all know there's always the future prospect of different administrations, different political wins, different political atmospheres, in which, how do we create a program that can sustain itself, but also sustain those unpredictable political variables that we don't quite know about, and CHFA as a semi-governmental authority really provided us to do that. So, similar to, I would imagine a credit union could be beneficial; our state housing authority was also a great option for us.
So, in terms of what we came up with and I want to emphasize back to those 3 guiding principles of the potential for this fund and what we felt we could do with this fund and is was leveraging potential, speed of loan deployment and fund growth and future revenue stream. In general, what we learned was the more we focused on one particular guiding principal of these 3, the more the other 2 would sacrifice a little bit. For example, the more we would want to leverage these funds, say on a Loan Loss Reserve, a 5 percent loan loss reserve, there may be a 20 to 1 leveraging potential, but depending on other lenders to make these loans, and in general, it's not necessarily a revenue generator. The higher the leverage, the more the other 2 suffered, so they are not mutually exclusive, and we continue to build these, build a program that kind of answered both. So, what we came up with was a combination of a Loan Loss Reserve and direct lending format that allows us to kind of obtain these objectives. It also allowed us to provide more of a diverse group of loans, in which, there may be some certain loans that would be more effectively made through a Loan Loss Reserve, there could be some other larger loans that certain financial institutions just aren't interested in making in which we could be the direct lender through CHFA, and truly solve an access to capital need out there.
So, some of the advantages to each one of these, as you see down here where we ended up working with 2 different components, a green color at a credit reserve, which is a loss reserve, and a direct lending program. We ended up for the types of loans that we'd like to do, we expect to provide somewhere between a 10 to 20 percent Loan Loss Reserve match for green loans, with participating lenders through CHFA, much of this will be provided through community development finance institutions, that Matthew had mentioned as well, in which they will be the primary lender and we will match the Loan Loss Reserve in that fashion. This particular program is already a program running at Colorado Housing Finance Authority and this would be the green component, but there's, it's been up and running for about 8 months and they've had I think somewhere almost in the amount of 100 loans and ultimately this would be small dollar loans that we really expect to leverage different programs like our Main Street Program, to have small dollar loans available to people. Then the, and please note that the advantages to this are the leveraging components, we expect somewhere between a 10 to 1 leverage and a 5 to 1 leverage. Next, we have our CHFA Direct Loan Program, in which, we're looking at larger loans, and we are looking at an industrial manufacturing loans that produce certain renewable energy equipment. There's the advantages to this is that we have a much higher rate of return, probably somewhere between four and a half and five and a half percent, so we do create that growth and we can grow our fund accordingly, and when we're dealing with acting as the direct lender on larger loans, there's a larger potential for economic development impact and a quicker way, in which we can act as the lender through CHFA. So, ultimately this has allowed us to provide a wide range of possible loans anywhere from somewhere around $5,000 loans for a very small business, up to a several million dollar loan for an industrial manufacturer and that diversity has been important, and it best reaches those three goals that we're trying to accomplish in leveraging loan deployment and in revenue growth and recapturing the income of this fund and make it grow continually and really become sustainable.
I expect to have questions later, but that is kind of the discussion of where we went and the policy implications and the goals that we wanted to accomplish.
Well thank you very much Brett, that's a very helpful perspective on a different market. Next I'd like to move to Howard Banker and Howard Banker with the Energy Program Consortium to talk in large part about secondary markets and the relationship of secondary markets to the kinds of lending programs that they you all may be setting up.
Thank you Matthew and energy for those unaware; Energy Program Consortium is a non-profit organization. Our board of directors is made up of the different national networks, state energy officials of various kinds. So, NASEO or the State Energy Directors NASCAP or Weatherization and Community Service Directors, ____ the Public Utility Commissioners, _____ the Low Income Energy Assistance Program state folks, so Energy Programs Consortium, EPC, is a state based research and implementation tank, if you will, and I manage the finance group for Energy Programs Consortium, and some time ago, we were looking around at the different state supported energy efficiency loan programs and determined that the best one to begin working on was the residential programs, and what was missing from the construct was a secondary market. There are a great many, and there are, a great many existing programs that many states and local governments and utilities and Public Service Commissions or Public Utilities Commissioners support, but there was no unifying principle among them, there was no way to organize all of that lending into a more unified, a good word is conforming structure, that would allow those loans to be aggregated, that is to say join together and sold to the infamous secondary market. And so, and by secondary market what we mean are investors that buy large packages of loans or other kinds of investments. And so, we decided to start working on that project to create a secondary market for energy efficiency loans, and interestingly in our conversations with investors, they would all nod their heads that, "yes" they had been approached before about this and "yes", they've heard a lot of chit-chat about the delivery into capital markets, but they've not seen yet, anything to scale. So, what we took from that is that our efforts here to be successful had to reach a lot of people very quickly and needed to produce a fair number of loans in a pipeline that could be sold going forward to these interested investors. And so, our funding to pull this together is from the Department of Energy and Environmental Protection Agency and a range of foundations, including Ford Foundation and some state energy programs and governments, and so our funding is not tied to the sale of loans or the aggregation of loans. Our job is to organize and implement such a program and so that's we've done. Our, after another small number of conversations with potential loan aggregators, we joined with the Pennsylvania Treasurer, that is to say the treasure of the state of Pennsylvania who is currently purchasing loans from a very fine lender, in Pennsylvania, that does everything we needed the program to do. So, these are energy efficient loans, they're unsecured, they're point of sale, which means that the contractor that shows up at the consumers home, whether they show up because the consumers boiler broke down, and it's February, or they showed because it was a home performance audit of the home, and the home owner wishes to make some improvements, based on that audit, either way, the contractor that shows up and gives a bid on these improvements, then introduces the consumer, the home owner, to either a lender, or to a group of lenders who are approved to offer high quality loan products. Let's stop there for a second.
There also presently exists a number of unsecured energy efficient residential loans, and the interest rates on these loans are quite high. Some lenders that are offering them pose some of their loans as a zero interest loan or there about, but the truth is, when you part the curtain, the rates on these loans are anywhere between 11 percent, up to 18 percent, which is the GE capital rate, so there are lenders that making these loans, at a very high interest rate and there is, in fact, an institution buying some of these loans, that is Fannie Mae. So, they are buying unsecured energy efficient loans, but nobody aggregates them and sells them into a waiting capital market, and the result of this, is that these loans are very high interest, so the states that have been participating in doing these programs, have to use public money to buy the interest rate down, way down, so that consumers, "A." are interested in doing this loan, or "B." that they can qualify, because the higher the interest rate on the loan, the more difficult it is to qualify a homeowner for a loan. Your income doesn't change, but if the interest rate is high, it's much more difficult to qualify for a loan. So, there are lenders and we've looked at these different programs and compared the Pennsylvania program, the existing one, with the Fannie Mae program and some others, and we've organized a set of conforming loan standards, and I saw in the questions box, somebody had a question about underwriting, and so in the package that we have available, for anybody that is interested at the end of this call, we'll list for you, we do list for you, what the underwriting standards are for the loans, but, so that information is in the package and we look forward to your following up, if you have particular questions about it. But, the point of conforming standards is that whether the loan is originated in Oregon, whether the loan is originated in Maine, or Florida, or Texas, or Alaska, or wherever it is, that the same standards hold for the borrower, in all of those places, because if that is not true, the investor does not know what it is buying, and if the investor has any doubts about the underlying credit risk that the loans represent, they will charge a much higher rate, if they even choose to buy the loan. So, one of the points of conforming loan guidelines and underwriting standards is to try to get uniformity in loan making by approved lenders to keep the price down.
So, one of the other interesting things that we liked about the Pennsylvania program, is that, they both purchased loans from a lender and they also purchased loans from the State Housing Finance Agency, so, and had conversations in other states, with State Housing Finance Agencies, as well as lenders, so, Brett's comments about HFA's we would agree with, and we've worked to include those into this architecture. The second is that it's tiered loan pricing, so, without getting into too much complexity, let me say that, our work with the Pennsylvania Treasurer and investors to buy the loans that are purchased, is built around the notion of what does it cost, what is the right interest rate to charge for these loans, that equals the cost of making the loan to the consumer and selling the loan to the investor. Right now, our estimate on that is somewhere between 7.99 and 8.99 as a fixed rate loan for the consumer. So if the loan can be made at that interest rate, then it only requires a relatively modest Loan Loss Reserve account to be established, so that those loans can be sold. So, that's important to know, so what that gives everyone an understanding of is, if the rate is higher than that by these other lenders that are currently offering these, much of that is either profit or going to cover higher loan losses that the existing state programs endure.
So, tier loan pricing is, as Pennsylvania does and as probably your states and localities are thinking about is you want to offer different rates for different kinds of loans, so if someone, it's in the middle of winter and somebody wishes to replace their failed HVAC with an ENERGY STAR appliance, that rate perhaps, could be 7.99 percent. But, if somebody does a whole home retrofit, by that loan rate should be 3 percent, so that's Pennsylvania's opinion and that's several other states opinion as well, so, this, by understanding what the par rate is of the loan, you, the government agency can decide, how you wish to discount the loan rates of the consumer to the right number, in your opinion, and then it's an easy math equation to figure out, how much it costs to do that. Again, it is just less money to discount a loan from 7.99 percent down to 3 percent, that it is this kind of loan from 13.99 percent down to 3 percent. So, our program has been designed to save you money and allow a secondary market get to exist to purchase these loans. So, with that being said, the Pennsylvania Treasurer has agreed to purchase loans from other states, could be your state, could be your locality, if you wish. They will purchase loans from an approved lender that either are one of the 3 that have already been approved, and those 3 are, AFC First Financial, which is a bank based in Pennsylvania, the second is View Tech, which is a finance company based in Los Angeles, California, and the third is, Energy Finance Solutions, EFS, which is an affiliate of Wisconsin Energy Conservation Core, in Wisconsin. If you are working with a lender or lenders in your state or locality, that are not a part of that list, and you wish them to be approved, we'd be happy to talk to you and see about doing that. Once the lender is approved, they then would sell loans directly to the Pennsylvania Treasurer, whom would aggregate them and sell to investors, and you would sign an agreement to fund your reserve accounts, either held by the Pennsylvania Treasurer or as Julie mentioned, Michigan Saves at the present time was just to hold a capitalized reserve fund. So, let's see. So, PA Treasurer has presently about $22 or $23 million dollars in this kind of, these loan assets, that are presently for sale, and we are advising them, we are, they are our client, and we're working with an investment bank they have selected, Bostonian, that is selling these loans to investors, and we've identified some socially responsible investors and some other more standard investors to purchase participations in this loan pool, so that it'll be the first, we believe, the first sale of secondary market assets of this type and introduce the capital markets to the whole notion of purchasing energy efficiency loans, conforming loans that are originated on a national basis. This first sale is extremely important, it's because rather than making models about whether the right rate is 7.99 or 8.99 percent, we'll identify what the actual rate is, and what the actual rate require Loan Loss Reserve component needs to look at. Is it closer to 5 percent or is it closer to 10 percent. Matthew discussed that the Loan Loss Reserve, which we're very happy DOE has agreed to the architecture of, can it self-contain loans. So that, if you are able and wish to provide funds to the Pennsylvania Treasurer to hold in trust for you, or your state, then that account can also be used to purchase loans. So, in effect, your Loan Loss Reserve account contains loans, which leverages the purchase, the rest of the purchase that the Pennsylvania Treasurer is doing, to a very great degree and returned interest income to you, so rather than have an account with cash in it, sitting in there making, you know, 5.5 percent, instead it's an account, some portion of which holds loans and it returns a much higher interest rate.
A participation of this sale is made to Calvert Foundation and Calvert is the bell-weather for a great many other foundations that are going to invest program related investments with the Pennsylvania Treasurer. Rockefeller Foundation has organized coalition of foundations, that together will invest PRI with the Pennsylvania Treasurer as an additional Loan Loss Reserves. So, again those amounts can be used by the purchase loans and the interest rate spread between their 1 percent money and the loan interest rate that the purchase loans provide can be used to cover operational costs of the warehouse line and potentially be used to themselves provide additional Loan Loss Reserve recovery. Let me quit being a ‘fast talking New Yorker', and say that last point I made is fairly critical for as the Pennsylvania Treasurer aggregates these loan sales, puts them into pools and sells them to investors. The Loan Loss Reserve then travels with that pool into the investor, so that the investor knows there's some coverage. So, a real simple obvious question is well then if we're delivering the Loan Loss Reserves with the secondary market sale, then the Loan Loss Reserve Account disappears, now what do we do? So, the interest spread between the low rates that the foundation investments in this are going to provide and the rate that the loans pay, that's actual money and that money then is used to re-capitalize Loan Loss Reserve Accounts, so that we don't need repeatedly invest 5 or 10 percent of these loans into new Loan Loss Reserve accounts. We will need continued public investment into Loan Loss Reserve until such time as the secondary market gets a handle about around that this is a legitimate product offered by legitimate providers and that it actually returns to promise rates. That will probably be 2 or 3 years out, so we see this approach as a way to use the money we have now, these federal dollars, ARRA and otherwise, to capitalize these accounts to provoke the secondary market, to become interested in buying scaled investments, of the kind we are talking about here, and then allow the interest that the borrowers pay on the loans to be used to recapitalize the Loan Loss Reserve Account.
I want to leave at least 2 minutes for questions, and so, let me just quickly say that, as you may or may not know, these loans perform extraordinarily well. The Pennsylvania Loan Portfolio, when we have the loan level data on that, it is less than 1 percent delinquency and less than 0.6 percent write-off. That's Iowa's experience, that's Nebraska's experience, different states that have supported residential energy efficiency lending find extraordinarily low fault rates. That's why it‘s that much more important to maintain the conforming standards to the loans we buy and have good lenders making these loans, they're going to make good loans. Before we heard the phrase, "skin in the game", and so, I've covered this last program goal slide, pretty much, one critical thing to say, is that , we have an agreement right now with the Department of Energy that the General Council is reviewing, which once approved we will provide to you, so if you wish to participate after reviewing the materials that we're happy to provide you, if you ask for them, you could then sign this agreement which is a loose commitment to provide loan reserve funds, either held in trust by the Pennsylvania Treasurer or held in trust in your state, either way it's a commitment to participate, unless of course you change your mind, so it's a very loose commitment but it counts as deployment. And so, we've structured this agreement carefully with that goal in mind, it allows you to commit to the use of your funds for reserve and so therefore then, that is fully deployed, and then later on, when you are extremely comfortable and ready, then you will sign a more structured agreement, with the Pennsylvania Treasurer to actually capitalize the loan loss reserve. There is a great many things I did not talk about here, because time was short, and I'm a little bit of a "blab", "blabber mouth" perhaps, but the last slide is contact information for myself, Howard Banker, at Energy Programs or Dave ______, also working with us. firstname.lastname@example.org, we very much look forward to your contacting us and saying "I'm interested, please send me your materials", and we'll be happy to follow up, so thank you.
Thank you Howard, we've gone a little bit over on the total time and but I've felt it was very useful to have the full presentations from everybody, hopefully everybody has benefited from these. We've, I've been collecting questions and I thought what I would do is, there are a number of questions that I will just go through quickly myself and answer and there are a set of questions that I will kind of send out to the panelists, who were here, and by the way, there have been a couple of query's about where they can, where people can get the presentation, and I would actually ask if Ellen Embry, whose on the call would mind posting the web address for the, both the location where the presentations will be and also the router web address for the Solution Center. That would be very helpful and so if everybody should be able to see that on their screen. So, I'm just going to run through a couple of questions, first off and just kind of blast through a few of these.
One question, early on was, can funds be used to guarantee private dollars, in other words, can you use Loan Loss Reserve to attract and to leverage private funds?
And the answer there is, an unequiviqual yes, there is a lot of discussion back and forth with the Department of Energy General Council on this very issue, and it is an allowable usage of funds to reserve against private lending, so third-party lending, it doesn't just have to be reserving against the lending that you might make through your own EECBG funds, for instance. So, you can leverage private funds.
Second question was, why has DOE blocked loan guarantees?, and I'm paraphrasing here, and the biggest reason again coming from DOE General Council, is that they wanted to essentially provide a protection mechanism to short circuit the eventualality that some local governments or states might actually end up over committing funds and so they didn't want to get, they felt that they didn't want to get states into a difficult situation of having overcommitted with a guarantee, they like to see, they wanted to see a reserve that was put in place. Second of all, and this relates to another question, indeed DOE also, for the same reason, put in place a 50 percent cap on the use of EECBG or SEP funds in a credit enhancement, or Loan Loss Reserve kind of mechanism, and again, the concern there is that this a relatively new mechanism, I think both for General Council at DOE and also for the states, and some concern there was limiting any potential problems that might arise with perhaps over commitment of those funds, but there is that 50 percent upper limit.
There was a question also on who bears the cost of a Loan Loss Reserve and where those funds come from?, and in general for the Grantees on the telephone, it's EECBG and SEP funds are very good, subjects to limitations described earlier, very good source of funds for a Loan Loss Reserve.
Somebody had mentioned other types of funds, government funding and so on, community development block grant and the like. Other types of funds like that can also be used either as loan capital and may be able to be used as Loan Loss Reserves, I'm not aware and Howard might be aware of situations where community development block grant or home funds might have been used as a loss reserve, I'm not aware of that having happened, I know they have been used as loan capital.
So, that's running through quickly a number of questions, I guess, let me throw out a couple of questions to Brett, and one is in relationship to CHFA acting as essentially as an agent for the Governors Energy Office, did you, and as judiciary for those funds, did you encounter any, well I guess the first question is what's the outstanding relationship between CHFA and GEO, as far as management of those funds, maybe you might describe the proposed structure of a loan committee that GEO has for use of the funds and approval of loans.
Yeah, I can respond to both the, in terms of the guidelines, I guess there is a two tiered answer and that for the purpose of our Loan Loss Reserve, ultimately the broadscaping guidelines of both of these, the direct and the Loan Loss Reserve Program is that, it has to ultimately promote energy efficiency or renewable energy or a combination of both in one way, shape, or form and that fits within the parameters of how these funds are supposed to be used, in general. From that answer, for the Loan Loss Reserve, the Colorado Credit Reserve, Loan Loss Reserve, that, a lot of those lending and underwriting guidelines will be determined based on most small CDFI's who will be participating in that program. Ultimately, we're holding the Loan Loss Reserve to incent them to make these loans, but ultimately they'll be the loan originator for those. For the Direct Lending Program, we've constructed a Loan Committee that will be constructed within the parameters of the Governor's Energy Office, there will be 5 people that will consist on certain folks including myself, the finance manager, in this office as well as a few non state agency folks to provide some experience and understanding what these loans, those direct loans will generally be on a case-by-case basis, there may be some great loans that we would be the first position and there maybe some that we will, we maybe in third or fourth position on the loan and that will be determined based on how important we feel the project is, the impacts and how comfortable we feel with making that loan. In terms of CHFA acting as the agent, ultimately these are funds that we are giving CHFA to manage and they will be servicing the loans, but if a loan does end up in the default situation, especially on the direct lending side, they, you know, it's generally a loss of the fund that we have constructed and at some point we will the option within the agreement to either use CHFA to go through a foreclosure process or we will have the option to turn that loan over to the state and the Attorney General's Office to remedy that situation, and so we have flexibility to do both.
Thank you Brett, this is a question for Julie, can you talk a little bit about some of the security issues and what, there's a residential program which is unsecured, but maybe talk a little bit about, what security is provided and some of the discussions regarding security in the commercial sector and some of the difficulties and challenges there and getting the lender happy with the level of security or lack thereof.
This is usually the part of the call I turn it back over to you Matthew, so, I'll do my best. Yeah, so, in our residential program, this is an unsecured product so we aren't running into those barriers, but with the commercial sector typically, there is already a lender there involved in the deal and they really have the lien on the property and so when we're trying to layer on a second loan on to that deal, there's not anything for them to associate the loan with any security for them, to associate the loan with, and so, you know we talked ways to get around that, in terms of having a, you know, the borrower being a good guarantor of the loan. We've talked about, well I think that is a lot of the reason why the loss reserve that we've settled on in the Detroit area is so high, is because of that fear from the lenders perspective of the risk involved and essentially, you know, having a $50,000 basically unsecured loan, because there is really, they don't have a property lien or anything associated with the loan. And then there is also a way to get around that and Matthew, you know, I think you've been working with the Colorado program on the agreement, but you would have with the primary mortgage holder where you would amend that mortgage in order to have access to those improvements that were made with the energy efficiency loan, and I don't know if you want to talk about that?
I think there are various types of filings that can be put in, there's an UCC filing essentially a fixture filing to get a lien on the fixtures as opposed to a lien on the full property and so it's possible to set those up, those are relatively weak as compared to a lien on a first priority lien and yes it is possible to get, as part of that as possible to attempt to negotiate anyway with the lender a waiver on the lien, that they might have not only on the property, but also on the attached fixtures. But that's all a matter of negotiation as a challenge to get that and it's a matter of negotiation with the existing lien holder, so it's certainly a challenge that you run into in commercial lending absolutely.
There were a couple of number of questions that had come to Julie on the relationship to the underwriting criteria for the Michigan Saves loan program, I'm, those get so detailed, it's a little tough to handle those, but Julie has also offered to provide some of that information in a, through email. I think that the basic underwriting criteria looked at credit scores and as Julie was saying 680 and above is in most cases, 640 and above, in some cases, looked at debt to income ratios and a number of other criteria, but those of, it's very much of a consumer loan, fast approval kind of basis for that underwriting criteria.
There was one question and it came in the chats, I am not sure that you saw it, about the FICO score 680 and higher were allowing lenders to claim 80 percent of the loan loss, but lower FICO's are getting less of a claim, and there was a question about that, because it does seem counter- intuitive as you're trying to offer these loans to folks with lower credit scores, you know, it almost seems like a penalty but, and the discussions we have with lenders and working with the loss reserve, they're very protective of the loss reserve, even though it's not something that is theirs, unless there is a loss, they still want, there's still a vested in sustaining that, and so, if they want to offer loans to less credit worthy people, they don't think that the burden of the extra risk is solved on the loss reserve, so it is actually their idea to put less of our loss reserve at risk when lending to people with lower credit scores.
Great. Ok, the, another question had come out and I am going to send this to Brett, again talking about the negotiations with that Housing Financial Authority and some of the questions that may arise because some housing authorities can only deal with people of, in a certain income bracket. Did you, maybe talk a little bit about some of the issues that arose, and I can help out if you want me to Brett, on this one?
Yeah, well first of all, the Colorado Housing Finance Authority is in a unique position in which their not just participating on the residential side in terms of residential loan solutions, but they're also on the commercial side and so, in terms of the commercial side, that's really what this program is focusing on and so we don't quite have those restrictions on that, but I can speak with regard to CHFA does have a certain mission aside from the program I'm trying to construct. That may be a limitation, for example, you know, if you're to do a residential loan program, it would have to be constrained within certain parameters of AMI and they're often starts to be a discussion within CHFA as to whether they want to have more leniency for a certain programs, for certain exceptions, but right now, based on statute, that's the universe in which they're working with, that kind of first home buyer, or a qualified income component for residential loans, and so why this doesn't necessarily affect my non-residential program, it certainly does, you know, for other solutions and other finance mechanisms that we've been really trying to hone in on. Aside from this program, whether it is PACE or whether it's other programs that are always a component that we need to be aware of.
One item here is, I think is important is that every housing finance agency is different and there are going to be different requirements and different restrictions at every housing agency will have. I think I'm going to shut this down at this point, we've gone overtime, but I wanted to spend some additional time to begin to enter some questions. You will find that there is a, the presentations are available on the new and expanded DOE Solutions Center Website, I'm going to read that to you, which is; http://wip.energy.gov/solutioncenter , and then check out the webcasts, so again that's http://wip.energy.gov/solutioncenter, and then check out the webcasts, that will get you to the presentations here, there was one query and this relates to a broader question, one query about whether we would be available, some of us on the call who serve with the Department of Energy on the Technical Assistance Team would be willing to review RFP's, and the answer is that yes, we would, please contact, you can contact us directly and my email address is mailto:email@example.com and we can connect with the right people. I wanted to finally send a note from Chris Lowman, who started out the call, that he and the Department of Energy are also very happy that everybody was able to join this call, please contact your Project Officer, if you have further questions, and do check out the solution center website that I had mentioned before and thank you very much everybody for participating in this call.
Thank you! And thank you again for all the presenters, Bye. Bye.