Loan Loss Reserves: Lessons from the Field (Text Version)
Merrian Fuller: Hi, and welcome to the Department of Energy's webinar on using loan-loss reserves report financing programs. My name is Marian Fuller, I work with Lawrence Berkeley National Laboratory, and I'm one of the technical system providers for the Department of Energy who serve recovery act recipients. We have a great team today to talk to you about real on the grounds loan-loss reserve applications. Both from the fields from someone who's actually doing this in their own community, and then also one of the technical system providers who works with grantee's on how to set-up loan-loss reserves.
First, a little bit about what is the technical systems program. The Department of Energy does offer support, both block grant recipients and SCP recipients and better building grant recipients. We connect these state local triable officials with tools and resources and real people that can actually help you get your programs off the ground if you need help. We offer, as I mentioned, one-on-one assistance. A bunch of webinars. We'll be giving you a link to future webinars and also you can access all our past webinars on our solution center web site. We have a blog, we have a huge resource of kind of a catalog of best practices and other recourses, and we also work with trying to facilitate exchange between peers between the recovery act recipients that are doing this work. On a range of topics which includes efficiency in renew water technologies program design implementation, financing for efficiency and renewable performance contracting, building capacity for this type of work at the state and the local levels.
The way you sign up for this is you go to the solution center and you can actually submit a tax request online using your user name and password and if you have any questions, you can call the number on your screen or e-mail us. You can also talk to your program officer if you have any questions about how this works. We'd be happy to help you. We have two presenters today and just so you know, at any time throughout this webinar, you can actually enter questions on that screen on the little side bar that you see. I'll be monitoring those as we go along, so feel free to ask any questions in there and kind of as appropriate either if it's an urgent question for that slide. I'll make sure that the presenter hears that, and then we'll have time for Q and A at the end of the session. Today we have Alex Ramel who's the policy and energy manager at Sustainable Connections, which is a nonprofit in Whatcom County, Washington. They work with local businesses, and they foster thriving local economy built on sustainable business practices. So Alex has been kind of one of the leads there implementing the community energy challenge which he'll talk to you about in a moment. And then John MacLean is the managing director of the Energy Efficiently Finance Corporation. They've been working on efficiency finance for years and are one of the technical assistance providers for the Department of Energy. John's helped a number of grantees already get loan-loss reserves and other financial mechanisms set up to be able to loan for efficiency and renewable projects. So without further adieu, I'm gonna pass is off to Alex who will talk to you about their program in Whatcom County, Washington.
Alex Ramel: Thanks, Marian. Are you able to hear me?
Merrian Fuller: Yep.
Alex Ramel: Great. This is Alex Ramel. I'm the energy and policy manager with Sustainable Connections, and I'm gonna be talking about an effort in Whatcom County that we're calling the community energy challenge. Essentially, the community energy challenge is an effort to help homes and businesses in Whatcom County achieve cost-effective energy efficiency through a mechanism of a one-stop shop. In other words, we're helping homeowners and business owners through the process of energy efficiency project implementation from start to finish. So for in general we tend to think about our loan program as one piece of that one-stop shop, one of the steps along the way. But you can also sort of think about it from the other direction, which is that our one-stop shop is a great mechanism for aggregating loan projects or eligible projects for an energy-efficiency loan program. And so I think that's kind of the angle I'm going to take in talking about it today, so how does a one-stop shop aggregate projects together and sort of take care of the other pieces so that a loan program can be effective?
If you want to jump onto the next slide. So our goal using recovery act funds through both the local Energy Efficiency Conservation Block Grants and the Washington State Energy Program, our goal over the next couple of years really about at this point is 18 more months is to work with 1800 homes to complete energy assessments, and we're anticipating that about half of those with implement energy efficiency projects. We're also working with 150 businesses in the community and again, anticipating in the range of about 5 and 30 percent energy savings in those projects. And all together that adds up to about a million dollars in energy savings every year. That's money that will be retained in our community and can be reinvested elsewhere by those businesses and homeowners. So for today's talk, I'm gonna focus predominantly on the residential and the program simply for ______ sake, but it's worth keeping in mind that there's a parallel program on the commercial side working with small businesses. So this is kind of an outline of what I anticipate talking about today.
A little bit about the partnerships that came together to form the Community Energy Challenge. I spend most of my time on this point of tackling multiple barriers because that's really, I think, the centerpiece of the idea of one-stop shop, and I think is crucial to the work that we're doing, and then I'll spend a little bit of time at the end talking about social change in market transformation. So, on the next slide talk about the sustainable connections and the opportunity counsel who are sort of the founding partners for this Community Energy Challenge. The Opportunity Counsel is a nonprofit Community Action Agency among the other things that they do is they implement the Department of the Energy's Weatherization Assistance Program, and have been doing so for about 25 years, which means they've weatherized something like 5,000 homes in a three-county area during that period and in the partnership that we've formed with them for the Community Challenge, we're offering similar services to middle income families where instead of the Department of Energy ultimately foots the bill for the project, we help reduce the cost, help expedite the project, and then provide loan program to cover the balance of the cost.
Sustainable connections is, as Marian mentioned, a business network of about 700, 650, 700 locally owned independent businesses in Whatcom County. Among the things that we've done in the past is we organized a Green-Power Community Challenge several years ago and as a result of that, something like the hundred businesses and close to a thousand homeowners signed up to buy green power through _________ Green-Power Energy Program. So we want to build on that success in implementing the marketing in outreach efforts of the community energy challenge. Folks are familiar with that brand, folks are familiar with the source of information, and so we're building on that, and we're also reaching out to our business members and other businesses in the community to help them implement energy efficiency projects. And then the last part of my job is sort of organizing and orchestrating some of these partnerships.
This is a tough slide for me to do and the reason is because I could easily talk for a long time about how all of these important partners are crucial to the work that we're doing, but I need to keep it quick so I'm gonna -- just what I will say is both utilities are providing substantial support to the program. Both financially and in form of some program development assistance as well as the rebaits for energy efficiency projects. Both utilities are serving as marketing partners. All of the local governments in Whatcom County, the County Government itself, and all of the cities are participating as funders. Utilizing the EECBG funds and are also partnering in a varity of other ways including the city of Bellingham is helping administer some of the State Energy Program Funds, and they're all marketing partners with us as well, helping get the word out about the availability of the one-stop shop. Nonprofits in educational institutions there are all serving as examples in the Community Savings Energy at their facilities, and they're helping us tell the story of why energy efficiency makes sense and helping us get the word out again about the availability of the one-stop shop.
The Energy Efficiency Finance Corporation has helped us to develop our loan programs that you'll be hearing from John in a few minutes, and we're really grateful for the good help that they put into helping us come up with that program and then Banner Bank is the institution that is offering loans. They're our financial institution partner. If you want to jump to the next slide. Our program is apprenticed on the idea that there's multiple barriers to implementing energy efficiency projects that they're numerous cost effective opportunities to save money that are that make economic sense. We're not really generally looking at projects that have 60 year pay-back periods or even 20 year pay-back periods. We're looking at projects that really do have a financial pay out for our clients but for one reason or another are not being implemented, and we looked a lot to a report that came out last year from the same company a mocking energy efficiency potential in the U.S. economy that really drove home this point that there's multiple barriers.
In other words, if you give the average homeowner $5000, just hand them $5000 cash and say spend this on energy efficiency. In a lot of cases, I would mention the majority of cases, they would spend that money on something that's not the most cost effective. A lot of times they're gonna want to replace their windows. Even well, it's likely their duct system is venting heated air into the outside. So there's an informational barrier, and there's also just the fact that salting that informational challenge is not easy because all of the information isn't in one place. If you talk to an HBHC contractor about what should I do to improve my home, they're gonna tell you to replace your furnace. If you talk to a windows contractor, they're probably gonna tell you to replace your windows. So there's sort of just an awareness challenge. And then, of course affordability is a problem even where you've got a quick pay-back period capital can be a challenge. And then knowing that the work was done properly. Huge amount of insulation and HBHC equipment is installed suboptimally. Can you jump to the next slide? So --
Merrian Fuller: Can I just ask --
Alex Ramel: Yep.
Merrian Fuller: I just want to ask a question. There's a -- your conversion rate of assessment to improvements to the house was 50 percent is what you're hoping to get?
Alex Ramel: Yes.
Merrian Fuller: How did you come up with that number? There's a question basically saying a lot of folks are estimating a lot less than that. Maybe around 25 percent, so is there a -- how did you come to that number? Is that based on your experience or talking to others or how did you do that?
Alex Ramel: We looked at a couple of other programs that were similar, and one of them had achieved 30 percent and one of them had achieved 70 percent. And to split the difference. We didn't really know. We budgeted for 50 percent, and had some sort of contingency plan for if we didn't achieve that level. Presently, we're right on track within just a couple of percentage points of 50 percent.
Merrian Fuller: Great.
Alex Ramel: So it was a little bit of a best guess, but it seems to be about where we landed.
Merrian Fuller: Okay. Great. Thanks.
Alex Ramel: So in terms of how the one-stop shop works, we begin the process again with the homeowner and there's a parallel commercial program that will begin to work much the same way, but we begin the process with an assessment of the home. That assessment is conducted by a building analyst who does about four hours of work to come up with really personalized fuel neutral assessment of the house. We use the word assessment instead of the word audit and the reason for that is our focus group research found that people didn't like the idea of getting an audit, so we just changed the name. Once that assessment is complete, about two weeks later, the homeowner receives a sort of a report and that report is then delivered to them and gone over with them by the home energy advisor, and that's the image that's pictured there so we really sit down and take a look at photographs that were taken of problem areas in the home, talk about various measures that might make sense, and in addition to this sort of where your house is, we're able to talk to them about all of the measures that could make sense to doing that house listed out by cost effectiveness. In other words, because we're working with contractors who've agreed to set unit prices, we can tell them what it costs to do the insulation and attic to our 49, and then we can tell them on the same spread sheet in the next column, here's where the utility incentives would come into play, and this is the portion of this that would qualify for the federal tax credit etc., etc. So we're really able to give them a bottom-line cost without them having to do any of the math or homework.
Merrian Fuller: And Alex, who covers the cost of the initial assessment?
Alex Ramel: So the assessments cost the homeowner $95.00. It costs us about $600.00 to do it. The difference is made up from two sources. Todd Town Energy has a home-print assessment program that for qualifying households allows the utility to pay $350.00 of that cost. And those right now are about 20 percent of our total projects are able to take advantage of that program. And then the balance of the cost is paid for using Washington State Energy Program Funds through the Community Energy Efficiency Pilot Program. Sort of continuing through the details of how the one-stop shop works. The intention is to make sure that it's customer service oriented and absolutely simple for folks, so once the assess -- once the bill -- excuse me.
Once the home energy advisor has sat down with the client and talked to them about the range of possible projects, the homeowner then makes a decision about which their interested in moving forward with, and that's where we can send them over to the bank if they want to get a loan, they can go to Banner Bank and qualify for the program, and then a group of contractors who's been vetted and has agreed to set unit pricing through this program and so we can send those contractors directly so those projects but at the end of the projects, somebody from the opportunity counsel comes back and provides quality assurance in 100 percent of cases. So the same folks that are doing the quality assurance for the Weatherization Assistance Program are doing this quality assurance for these projects as well. Want to jump to the next?
Merrian Fuller: Actually, yeah. Just a couple quick questions.
Alex Ramel: Sure.
Merrian Fuller: We have one comment that two -- you mentioned needing to wait two weeks to get the report back. One of our viewers is vaguely saying they've lost a lot of customers that way. Actually, I talked to a few contractors who said if I don't get it back within 24, 48 hours, there's a pretty steep decline in terms of response rates. Have you seen anything like that, you know, in terms of the need too get information to people quickly while it's on their mind?
Alex Ramel: No, but that may be a program structure question because we schedule both appointments at the same time.
Merrian Fuller: Okay. Then no.
Alex Ramel: We schedule the advisor visit for two weeks later, and so it's already on your calendar when you get your assessment. There's just so much information that goes into those reports that it'd be, it would be really difficult to get it down -- we could push it and make a week in some cases, but even that's kind of difficult to do.
Merrian Fuller: Okay. And one more question about contractors. What's the contractor betting process, and is there any issues so far with contractor quality?
Alex Ramel: The betting process was request for proposals. It was sent out last year. We looked at a whole range of different things and experience doing these kinds of projects, certifications, trainings that the contractors had been to, and then we looked at a handfull of projects, and we asked them to give us a list of projects, and the top ones we actually went out and -- I didn't do it, but folks from the building performance center did go out and look at the quality of work that the contractors had done.
Merrian Fuller: Great.
Alex Ramel: And then that was sort of the initial selection process and then subsequently they've been required to attend a number of trainings through the building performance center to sort of bring them up to speed. There, of course, have been points in that quality assurance where we've had to say yes, this needs to be fixed, this needs to be fixed. That's the intention of that assurance check. Its building or performance contracting is new to several of these contractors. They were doing general remodels before and are just starting to specialize in performance contracting, and so there's some learning opportunities as they're doing the projects and that was anticipated. We certainly haven't run into any situations where homeowners are upset.
Merrian Fuller: Great. And just one more question about your energy advisors. Do you know how many energy advisors you're planning to need to serve those 900 homes in the pilot?
Alex Ramel: We have two right now. We just hired the second one about six weeks ago.
Merrian Fuller: Okay. Great.
Alex Ramel: They're doing an average of two advisor visits a day.
Merrian Fuller: Okay. Great. Thanks.
Alex Ramel: So in terms of that question of affordability, we're addressing it a couple of ways. One, we have a low-end-three barrier, that's the assessment I mentioned that's $95.00. We wanted to set that high enough that people who are just curious but didn't really have any intention probably wouldn't take us up on it, but anybody who was serious about moving forward with the project, it wouldn't be a challenge for them. It's where $95.00 came from. Then again through that State Energy Program, we're able to provide an additional $1,500.00 in added cash and incentives and that aims towards the most cost-effective energy efficiency measures in a project. And then we're able to provide guidance on the tax credits and the utility rebates, as well. So again, the fact is that a lot of work isn't even done properly, and we're not realizing the full energy efficiency benefit of work that's being done, and so we're very conscious of that and working closely with the Building Performance Center to make sure that projects that are completed in that program to achieve their full-energy efficiency potential. If you want to jump to the next slide.
So we talked just a moment about how we're letting the community know about this program, and what we hope that will do beyond just sort of these 900 homes, we're hopeful that this is creating social change and beginning to transform the market. Jump onto the next slide.
Of course, we're building on an existing brand sustainable connections logos are well known in the community for a variety of different sustainable practices survey done a couple of years ago showed something like 70 percent brand recognition of ______ ________ first campaign, and so we're building on that brand recognition. And we're working with all of the businesses participating in the program to help spread that message. One of the other things that a lot of social change theorists talk a lot about is community goal setting. And so we're doing exactly that. We set this goal of saving a million dollars worth of energy and keeping that retained in Whatcom County and recirculating in Whatcom County's economy. And we're tracking progress towards that goal as each home and will each business is sort of kicked off the list, the number on this Sabo meter moves up. We're posting these banners around town and updating them periodically with stickers, and we're also tracking carbon reduction and job creation in much smaller fonts. The other thing we're trying to do to sort of give folks a little bit more consciousness about the energy consumption habits is providing information, sort of comparative benchmark information, through energy performance scores, through the Earth Advantage Institute, and we're also using utility millers through -- called OPOWER. To provide people information about how their home or how their energy use sort of stacks up to -- not any individual neighbor but any homes like theirs on average. And if you jump to the next one.
The main thing our experience with marketing this program so far has told us is that most people who end up calling the phone number or going to the web site do so because a friend told them about it, and so that's really kind of bottom line. That's where we're gonna invest our marketing average dollars in the future. And then in terms of just sort of transforming the market, our goal here is ultimately to bring down the cost of doing these projects, so it's beyond the Recovery Act Funding period we can continue doing this work. 900 homes and a 150 businesses is a great start, but it's certainly not all the buildings that need it in Whatcom County and certainly not beyond so we're utilizing these incentive available right now through the Recovery Act, but we're also building on existing utility rebates and other appliance rebates that are available, and building on the tax credits, and we would add to this list and be available to everybody on the phone if and when the Senate passes it, we'll certainly continue to build on home star which will make this even easier.
Innovative financing, this is really the talk that John's going to give in just a moment here, but the -- we're utilizing both Loan Loss Reserve Fund and direct interest rate buy downs and working with our partner Banner Bank. Again, they can let their customers know about the program, and its availability, and so in the long term or even the medium term, our expectation is that we'll start to achieve economies of scale by aggregating projects either geographically or by project type. In other words, insulate all the homes on this block or do these six furnace replacements at the same time. A contractor is able to make bulk purchases, is able to reduce the number of trips that they make, is able to hire an electrician to come in and look at three projects at the same time. That sort of thing. And can bring down the cost of doing these projects. Savings that ends up getting passed onto these clients. I think that's -- oh. So this slide is a little bit out of date, but our current status right now, we've completed more than a hundred assessments with more than a hundred more scheduled booked into December at this point, and I know we're over 60 home energy advisor appointments. I'm not sure what the actual number is, but it's greater than 60. And I believe there's about nine projects completed and more than 30 that are in progress, enter between reviewing options, and contractors working on the house. And of those three projects have completed loans and 12 to 15 more are in -- have indicated interest in taking a loan. Taking out a loan through the loan program. We've created 11 jobs and on the commercial side, we've got about 33 businesses that are participating.
Merrian Fuller: Great. Thanks, Alex. So now we're gonna go to John MacLean who I mentioned earlier is one of the technical assistance providers for the Department of Energy, and one of the founders of efficiency -- Energy Efficiency Finance Corp. He's been working with a number of programs including Whatcom County Program to set up loan loss reserves so John, I will turn it over to you.
John MacLean: Thank you, Marian, and thank you, Alex. It's been a real privilege to work with Sustainable Connections and learn from their operating experience in the field and Alex, question for you to start off, what portion of the folks that are implementing projects are taking loans at this stage?
Alex Ramel: On the residential side, it's about 50 percent.
John MacLean: Uh-huh. I think that's an important number to track, and I would say as an opening remark that financing is important, you could say it's necessary, but it's not sufficient. A lot of folks will implement projects even without loans, and I think we are still in a market test period here to see not only how to deliver attractive financial products, which I think we've figured out a good way to do, but what the uptake's gonna be and what the response from the customer's gonna be. So to engage financial institutions in this market and that's the goal of the use of grant funds is to combine the grant financing, the ___ financing that all your programs have available in a structure with the financial institution partner, commercial financial institution partner could also be a community development financial institution or a credit union for example, but the goal is to leverage up the grant money with the commercial financial institution partner not only to deliver more capital to fund more projects, but also to create a program that will be commercially sustainable over time and has the ability to grow as the market transforms the way Alex is mapping out through their experience in Bellingham, there'll be an ongoing demand for loans.
What do financial institutions need to engage in this market? They want to see a steady and substantial demand for their financial products, that's gonna be a credit worthy and address their security and credit needs as well as have reasonably managed transaction costs and therefore be a profitable and scaleable business and the loan loss reserve are credit enhancement more generically addresses that credit structuring need and the programs that Alex is running are generating demand and also helping manage transaction cost, and that's one of the ways to make this type of financial product attractive to partners. So we're gonna talk mainly about the residential and mainly just in the family residential marketplace a little bit about the commercial but more broadly credit enhancement can be used to support a range of different financing models and instruments and address multiple sectors of loan loss reserves very suitable for the residential sector and the goal of the credit enhancement from the public standpoint is to deliver financing at affordable cost to broaden access to finance, which means getting at the details of the underwriting guidelines that the lenders use to make their loans.
Extending the loan tenors so that the loan payments match as close as possible the energy cost savings and then to get the interest rates down so Whatcom program combines the grant moneys with a commercial bank partner, but just want to note that credit enhancements can be used to support bond issues, utility on bill financing, and other types of structures, and there's other ways to use the moneys for credit enhancement as well. Not only loan loss reserves but at that service reserve or subordinated cofinance describe a little bit further those options as we go forward so next slide, please.
So the loan loss reserve can be funded with ARRA monies. There is no guarantor, so the limit of liability over the local government is providing the ARRA monies is strictly limited to the amount of cash that's put up from the grant. The goal is in using the loan loss reserve is to give the financial institution partner a way to be made whole to recover their principle in the event of loan losses up to a portion of the total portfolio. One of the concerns that's raised in any type of credit enhancement program is what's called moral hazard meaning if you give a 100 percent guarantee, are the loans gonna be made without respective prudent underwriting? Well, the program is designed to strike a proper balance of risk sharing between the government providing the concessional funds and the financial institution partner so with the loan loss reserve, we define a portion of first losses would be 5 percent, 10 percent in Bellingham starting with 10 percent of the total original loan portfolio. That's a very high number. It's a comfortable margin above what we expect any losses to be. But the virtue here is we've got a large number of very small loans that can take a portfolio approach to the credit structure so a reserve of, you know, 2 to 5 to 10 percent of the principle amount of the original principle is significant to mitigate the credit risk that the lender takes, and in the process help them not only deploy their own funds to get leverage of the public funds, but also to broaden access to finance in the way the underwriting guidelines are put together so next slide, please.
Compass Underwriting and this is a key question. We don't want to support loans who can't repay them, so we're always looking to what's the relationship of the energy cost savings to the loan payment? What's the ability of the borrower to pay? One of the core marketing theses, and I'd be interested to get your market test on this is that the loan payments are offset by the energy cost savings at least to a significant extent. So that broadens ability to pay so if we can expand acess to finance, we can get more deals done, so we've seen in the application of loan loss reserve the response of the banks have often been to modify their underwriting criteria respect to the credit score, debt to income ratio, longer loan tenors, and I think it's especially important to allow a larger unsecured loans. So by having the loan unsecure, an appraisal's not needed.
There maybe some component of the market for the bigger whole house retro fits where they're willing to provide a second mortgage and have lendable equity but in general, the core underwriting criterion here is in effect an unsecure loan. Many lenders will take a UCC1 to fix your filing which can also help in certain events to recover losses, so that'a what we're looking for in of the negotiation with the financial institution partner. How the use of the loan loss reserve serves these programs and public goals as reflected in the underwriting. In the Whatcom case, it's important to note as Alex said, both loan loss reserves and interest rate buy downs, two sectors, both single family residential and small commercial and certain small multifamily houses can qualify in the small commercial. There's been three government entities involved, and it's important to note that we had to work through that process in the implementing agreements to have and receive and be able to report properly on funds from three government entities, and in the process of arranging the financial institution partner, the city of Bellingham on behalf of all the government entities conducted competitive request for proposal process so that was part of our work scope that Dan Clarkson and myself to write the financial institution RFP, and then help in the evaluation of proposal is and then proceed to the implementing agreements. Next slide, please.
So the way the funds flow is that the financial institution partner, which is Banner Bank, it's a regional bank in Washington and Oregon. It's entered into an agreement with several government entities pursuant to which then the grant funds for the loan loss reserve are deposited in the deposit account. There's also a separate account for the interest rate buy downs as well. And then as loans are made, funds are shifted in the appropriate formula based on the risk sharing to the reserve account. Once they're in the reserve account, they stay there through the term of the loans to provide necessary protection. We only have the lost reserve fund covering the unsecured not residential loans. Not the commercial loans. We felt that the underwriting of the commercial loans are to customize business by business, but the residential lending can be fairly standardized, and that's where the risk protection was applied. Next slide, please.
So to implement the program, there's been a loan loss reserve agreement. It's actually goes by a slightly different title but that's the function that main functions that it covers between various government entities and financial institution. There's also a program agreement between sustainable connections and opportunity counsel who are implementing the program and the bank that covers all of the steps in loan origination and the distribution of roles and function and that's really a living agreement that's being adapted with program experience. Next slide, please.
Several of these next slides, what I'd like to do is just allude to the detail. As part of the U.S. Deal, we -- the financial advisory team, the whole team has prepared a playbook on, you can think of it as a guide book, and the single family residential loan loss reserve structures has been one of the first topics treated in detail. So that's available for followup and further information as we get into the operating details here. Just note that the loan loss reserve agreement itself does include a definition and a form term sheet for the financial product itself that's being offered so that's part of the negotiation. Crafted so it's attractive and work through the full steps of the process, of who's eligible, what projects are eligible, the application, the credit screening, and Alex, you said you had a ratio so far of applications to approvals of 100 percent; is that right? Are you available there?
Alex Ramel: That's correct. In at least one case we worked with the - financial institution worked with the opportunity counsel to sort of scale back the project.
John MacLean: Got ya.
Alex Ramel: The original application would have been denied, but we sort of structured the program so it could work that way. They were able to implement a less ambitious program with a smaller loan that they did qualify for.
John MacLean: I think that's very interesting. That shows the importance of the partnership with the bank to roll up their sleeves and figure out how to get to you, and that's one of the things you're looking for with your financial institution partner. The payment schedules are just level monthly payments in rears and the loan is typically dispersed in one payment to the contractor following completion of the project installation. There maybe some modifications on that and one thing I forgot to note is from a marketing standpoint, these programs are driven by a number of marketing channels including the community based approach that Sustainable Connections using the vendors and contractors are often the first touch point with the customer and help drive the market, especially with the equipment. When the equipment needs to be replaced, so you've got to serve your contractor's a complimentary financial product could be helping the contractors get construction line to credit or work in capital lines with the bank partner as well. So next slide then.
The typical loss reserve formula has both the first loss component and a second loss component. The definition of first losses might be, say 2 to 10 percent, and the loss reserve would pay for a large portion, say 80, 90 percent plus of those first losses. Any of the second losses meaning, after that loss reserve is exhausted would be fully to the account of the lending bank so in general, their incentives are aligned for both good loaner origination and administration, and we've seen some first loss percentages go up for example, with communities that are interested in targeting low-income citizens for the program. Again, you don't want to support a loan when it can't be repaid, but if they can apply good underwriting criteria, then maybe that part of the market can be treated but with a higher first loss percentage, so there's trade offs in crafting that formula. Next slide, please.
The loss reserve agreement itself is discussed in principle in the playbook. It covers this list of items. It includes program targets and program deadlines, so it's important to note that as donors in the local government you have control points in -- even after these agreements are signed including a claw back provisions, I use that term colloquially meaning, you can get some of the funds back, but that has -- if the lending targets are not met. But that has to be crafted in a way that doesn't undermind the confidence of the financial institution in the availability of the loss reserve to achieve its development lanes. It's important to note, too, that the loss reserve funds are made assignable so they can support the development of a secondary market, and at the end of the term, the funds would remit back to the local government that remain and that's actually expected and then those funds can be available for further ARRA eligible uses. The goal here too is to see after the financial institution gains experience, are they willing to provide a greater amount of loans for a given amount of loss reserve funds, so what we've developed in Bellingham is a way to reset the resharing formula based on payment performance, collections experience, how the loan portfolio is performing so that's a important feature to build in to that agreement as well as the reporting and monitoring. Next slide, please.
So lessons learned. Lots of programs being set up, loss reserve funds are best applied where you can take a portfolio approach if you've got a commercial sector like nonprofit, or multifamily-housing-type of program. Maybe you want to use a debt service reserve where the funds are drawn onto keep loans current rather than only drawn on in the event of default or loss. We're also seeing a need to modify and accelerate the transfer of funds to the reserve account to meet new guidance from the DOE on the definition of spending, the ARRA Funds. Once funds are in the reserve account, now they're considered spent. That's the latest version, so we're looking at amending actually the agreement in the Bellingham case to accommodate that new guidance, but also maintain control points for sustainable connections in the city. And also, if folks are looking at how to set up reserves with multiple financial institutions, a Michigan State program has done that with a whole series of credit unions that can work statewide. Next slide, and we'll move to wrap up here.
So just to wrap up, I wanted to just outline a typical process. It's not the process everyone will have to go through, but very typically in designing a finance program, once you know your target market and you have an estimate of your lending targets, how much lending you want to do, and you know your aquantum of your available ARRA Funds in potential financial institution partners can be identified in the Whatcom, Bellingham case, we really focused on local financial institutions that was a very strong preference as opposed to -- we weren't against national institutions, but we're looking at how to work with the local financial institutions, credits, and banks. So you can identify those just through your general networking, through your associations, through, you know, exchange of information with other practitioners. There are a number of folks who are working nationwide in this field. And then develop a structure of the financial product and how the ARRA Funds are gonna be used. So, at that point then, you're ready to precure your financial institution partner, and you may need to go through a competitive proposal process or perhaps not even if you're not, the financial institution RFP process still provides a useful frame work for outlining the information you need to get to an implementing agreement with the financial institution partner. And the USDOE Financial Advisory Team can provide assistance through that cycle of developing programs. Next slide, please.
So the financial institution RFP gives the perspective financial institution partner the information they need to come up with a good proposal on the financial product, the pricing, the distribution of roles in administration, the risk sharing formula and so forth. All those are subject to negotiation with the financial institution partner so you want to give them in order to prepare an affective proposal thorough background information on your partners, your target market, your lending goals, the economics of the project, the business case to the borrower for implementing the project, the marketing, so forth, and a estimate of the types of loan terms that you think you need. It's important in the process to have a balance between being descriptive and providing a lot of information versus being open to creative responses.
We learned a lot in the precurement process, and there definitely were some surprises in what we learned from financial institutions, so it's good to give them latitude to make creative proposals even while your prescribing the format of the proposal so you can think of an RFP in a way as drawing a target and the better and more clearly you draw the target the more easily the proposers will hit the target and give you what you need and again, even if you're not going through a competitive process, the same flow of thought and the same outline of detail can be useful in all sorts of negotiations, which we're helping with in some cases. Next slide, please.
So this outlines the topics that a financial institution would address in their proposal. The same topics are treated, I think, in the program design process, but then you're asking for confirmation and alternatives and options based on the way the financial institution does business. The service aspect of this and the relationship aspect are very important. Bellingham considered multiple financial institutions and thought quite a bit about it, but made a decision to go with one in part to strengthen that service relationship between the program and the bank partner. Next slide.
That's about it. Yeah. So thank you. I look forward to your questions. Again, I hope that's useful and for further information follow-up, we're available as part of the advisory team, but there's also the playbook which we can help you to get hooked up with or Marian, I believe likewise.
Merrian Fuller: Yep. Thanks, John. Really great presentation. We do have a bunch of questions, and folks on the line can continue to add some to the cue. Just so you guys know, there's a bunch of webinars coming up and this link at the bottom of this screen, the one that goes to the webcast, that's where you'll be able to find this presentation and the audio to this presentation as well, a whole bunch of past webinars that have gone on, and we have a number of them on financing on a whole branch of issues, but just before we get to questions, upcoming webinars include on Wednesday, one on qualified energy conservation bonds, on September 23, on Thursday, one on energy savings performance contracting. On the 24th, green codes and programs. On the 28th, designing affectable renewable programs, and on the 20th -- sorry the 29th, driving demand for home energy improvements. So we have a ton of webinars, we're also open to advice to what webinars we should be offering so please let us know.
Let's go straight to questions. This is for Alex and for John really, can you just give us a run down, Alex, can you just tell us the stats in terms of just remind us the percent of coverage of loan loss reserve that you set up currently provides? The interest rate versus the homes and businesses and if there's a buy down involved? And then John, I'd like to have you talk about those three kind of statistics in terms of what you're seeing elsewhere in the country.
Alex Ramel: Sure. So on the residential side, the loans range from 5 to 15 years, fixed rate. And the interest rate ranges, it's dependent on a couple things, the credit score of the applicant being the biggest driver, ranges from 3.5 to 6 percent. Those are unsecured loans that are being treated because of the loss reserve as though they are secured loans. On the commercial side, there is similarly five-year-term loans, fixed interest rate and the 3.5 to 5.5 percent is the range over there.
Merrian Fuller: Is there any buy downs involved in that or is that simply from the loan loss reserve?
Alex Ramel: On both of those that includes a 3 percent interest rate buy down. Some of the longer term residential loans we only did a 2 percent interest rate buy down because it costs more to buy down an interest rate over longer periods, and we couldn't put more money into those.
Merrian Fuller: And for your buying down the loans, what's your thinking in terms of long term sustainability of that, you know, in a few years that won't be available. Is that -- are you concerned about how that might affect the market? What's the thinking behind buying a down?
Alex Ramel: The thinking behind buy down is essentially that we want this program to get a really strong start, we want to demonstrate the market. We want to get people in the community thinking about it and eager for energy efficiency improvements in their home and businesses, and so an interest rate buy down is essentially relatively inexpensive way to get the -- to get those rates down even further than a loss reserve alone. And given the fact that as the question demonstrates, the first thing everybody wants to know about your loan is, what's the interest rate gonna be? We wanted to have a really strong answer for that, so being able to say the answer to that is as low as 3.5 percent was something that was important to us. And our expectation is that over the course of several years of this will generate enough proof of concept that the interest rate will be a little bit less important in the long term. The Loss Reserve Funds, of course, can be reused through that mechanism of the repo accounts.
Merrian Fuller: What was the percentage of the Loss Reserve? What was it, 5 percent of total?
Alex Ramel: 10 percent.
Merrian Fuller: 10 percent. Okay so 10 percent loss reserve?
John MacLean: It starts at 10 percent, then it can be reset down to 7.5 and perhaps lower following the couple year's experience.
Merrian Fuller: Okay.
John MacLean: And the amount of the loss that's shared it's 90 percent. Alex, refresh me if I'm wrong on that, it's been awhile since I looked at that number. I think it's 90 percent?
Alex Ramel: It's been awhile for me as well.
John MacLean: Yeah.
Alex Ramel: Not 100, but it's one of those two.
John MacLean: Yeah, I think it's 90 percent of the first loss is paid out of the loss reserve fund, so there's a little bit of sharing in the beginning with the financial institution partner. And that's what we're seeing around the country typically is between 5 and 10 percent. Again, some cases it's being considered higher that we're aware of in order to provide credit support for more difficult to reach markets like low income. With the loss share of those first losses being somewhere between 80 and a 100 percent typically and interest rates before interest rate buy downs, we're seeing the lowest rates with credit union partners like with another group that has reserved grant funds through Washington State which is sustainable where it's working in ________ pearston. ____________ and those rates from credit unions have been again, for the better quality credits and there's often risk waited pricing at 5 percent up to say 7 percent before any interest rate buy downs, and other programs too the interest rate buy downs are sometimes focused on folks who do deeper efficiency retrofit so that would support larger loans, and another case we know the rate buy downs are being used to help the risk waited pricing for the lower quality credits become more attractive.
I would comment too about the commercial sustainability of vest rate buy downs, it's really -- we're in a market test here and it's really important to get the uptake focused psychologically on the interest rates so it may be a useful and important use of incentives and there may in terms of scale up and sustainability be other sources of funds potential for rate buy downs or to top off lost reserve funds. Maybe utilities would be willing to consider that if they see is that these financing solutions are helping drive the market they might reprogram a small portion of their rebait incentive moneys to support financing programs through either loss reserve funds or rate buy downs. It's also common commercial finance practice for vendors to provide some of their margin to that purpose and the customer ends up paying for it one way or the other so what's the difference? Well, it's really just the psychology of the sale, and that's what we'd be looking at.
Merrian Fuller: So we have a question here. One of our audience members is being told by lenders that unsecure loans will be, you know, 15 percent or more interest rate, and I know I've seen programs that are even offering more than that. What is -- especially John, since you've been working nationally, what have you seen programs that have been using interest rates like that and can you buy down to under 10 percent cost effectively? What are your thoughts on that?
John MacLean: Well, Fannie Mae is offering loan products for this purpose, and they purchase loans from several qualified loan originators and servicers, and they've been doing that for quite some years. Their interest rate on purchasing the loans is in that 11 percent range and when the originator and servicer adds their fees for their functions, then the rate can go higher. They, I think, are also looking for ways to lower that so I am aware that some pricing for these loans is -- reaches that high, but I think for most of the other programs even with commercial bank partners, there maybe a size 9 percent, but typically not much higher than that, and before interest rate buy downs and this is a point of negotiation, how is the lender gonna view this from security standpoint? Are they viewing it purely like an unsecured loan in which case their market comparable interest might be credit cards on the high end of the rate spectrum? Even though the operating experience today indicates that the payment track record of borrowers is much improved for the energy system loans. That's one of the purposes nationally of the USDOEs to be collecting this type of information on payment performance track record and the like. I hope I'm answering the question.
Merrian Fuller: Yeah, that makes sense. We've another question about looking, you know, for folks out there who are going to be going to local financial institutions, can they get some of the details of the contracts and things you've worked out with Bellingham and with others to take to their local financial institutions so that they're using real numbers and real examples about their programs? Is that something you do as a technical system provider?
John MacLean: Yes, and that is a topic for the next version of the playbook too is to add to the playbook more information on the working examples. We and other team members as well because there's a number of folks on the team can work individually with grantees to help adapt a program design, but when you're approaching the financial institutions it's good to just have a two or three pager to lay out the basics in particularly the type of lending you want to do, the target borrowers, the typical amounts of the loans, the total lending target, the budget available for the credit enhancement or grant funds so that initial set of information about the partners, I think, help start the conversation.
Merrian Fuller: And that playbook, John, I don't think we've actually put that online yet; is that right? Mostly been giving it directly from a text ______ system provider to a grantee?
John MacLean: That's -- yes.
Merrian Fuller: Is that right?
John MacLean: Yes.
Merrian Fuller: So eventually we'll probably put that online, but it's been going through a number of versions, I believe. So the best thing you can do is -- yeah. Go ahead.
John MacLean: It's a work in progress. Pardon me.
Merrian Fuller: Yeah. So one thing you can do if you're a grantee is just you can submit a tack request and ask that one of the technical system providers walk through one of the key sections that are relevant to you. You can also e-mail John or myself and we can just, I think we can just forward the document; is that right, John?
John MacLean: Yeah, I would be pleased to do that.
Merrian Fuller: So that's another option. Okay. Couple -- we've a bunch of questions. I'm just gonna try to go through them. This can be for both Alex or John. When you made the agreement with Banner Bank, was there a loan origination production target kind of baked into that agreement, and what if the program doesn't actually meet that target and you said, oh we're gonna do about 800 loans or 500 loans whatever it was, is there some consequence in not having met those numbers? Let's say everybody decides to get a home equity line or do something else, pay in cash or whatnot, is there some consequence in not meeting numbers and is there any numbers agreed upon?
Alex Ramel: Yes.
John MacLean: Alex, you want me to take that first or you want to go first with the numbers?
Alex Ramel: Well, I don't have the numbers of the targets in my head but essentially the answer to the question is yes, and we built a whole table of what those loan origination targets would be with estimates of both total dollar amounts and number of loans and we had six month check-in points along the way. And we did not build in any sort of hard consequences but at each of these check-in points, if we're well below our targets, then the expectation is that we review the program and say is this working as well as we need it to in order to be able to meet the goals we've established, and if it's not, then we have sort of a menu of options. First is, well it didn't last time, but we think we solved the problem and we're gonna go another six months and see if it works. Or we can revise the program. We can reprioritize funds from the loss reserve towards even greater interest rate buy down and is in the case of some of the EDCBT Funds, we can reprioritize those from loss reserve to direct cash incentives to encourage projects so our plan is to see if we can reach the targets, check in periodically, and if not, repurpose funds to encourage projects in other ways. That probably -- those later options lead us to less total projects in the program, but if we're not gonna hit our numbers, we can at least increase them somewhat.
John MacLean: This is John. I'd add the reprogramming of the funds I think is key. Again, this is a market test now to see what the loan uptake will be if the definition have spent for the USDOE Grants are satisfied then given amount of reserve funds that are seeded with the grant can support expanded lending over time, so I see that as a possible scale of opportunities so even if the reserve account is overfunded, it creates the basis for an expanded lending facility, and I think most of these programs have visions of operating even beyond the original grant period so this could be a good legacy is the continued availability of funds through that financial institution partner. Also, in the reporting and monitoring we asked for comments without revealing confidential information on the ratio of applications to approvals so if the uptake isn't happening because of a lack of demand or if the uptake is not happening because of concerns about the underwriting criteria we should be able to make that distinction and also make corrections and operations.
Merrian Fuller: Great. A question here about the -- how do you handle the interest earned on the deposit account, and I assume this is the loan loss reserve account that's held by the bank? Especially in terms of the DOE Guidelines around how, you know, ARRA Funds are used?
John MacLean: We originally had understood that the -- and there was guidance on this that interest had to go back to the federal government and so when we did our RFP and our pricing, we counted that as one of the benefits to the financial institution partner that the true story now though, is we're incorrect before the guidance has changed that interest can accrue to the local government, the original grant recipient, that has to be used for our eligible purposes. So we just track that and account for it. It's not huge, but it was one of the benefits of the program. It received the deposit for the participating bank so we try to factor that into the negotiations on pricing and such.
Merrian Fuller: Great. And then - oh, go ahead.
John MacLean: I'd also like to add one more point about interest rate buy downs is we negotiated that price based on some assumption on loan prepayment rates, so there's a raw calculation of how much it costs to buy down the interest rate for a given term for a given percentage, but then we negotiated a price down from that based on certain prepayment assumptions.
Merrian Fuller: Okay. Great. Question about serving the multifamily market. Alex, it sounds like your program doesn't serve the multifamily larger apartment building market. Why is that and John -- if that's the case. And then John, have you seen programs that do serve that market and use a loan loss reserve facility?
Alex Ramel: This is Alex. We can work with buildings up to four units, and I can't recall off the top of my head where that - why the cut off is at four, but essentially the question for us was what's the expertise of the partners involved and opportunity counsel has a lot of experience with mobile homes and single-family homes, and we have experience with commercial buildings, and we didn't have a partner with a ton of experience doing multifamily buildings, so we didn't bite that piece off.
Merrian Fuller: Yep. It's often good to start with the chunk that you understand and can experiment with before moving beyond. Alex, can you talk a little bit about any key challenges that you're having or surprises that have come up as you've launched this program? Anything that you want other folks who are about to launch this to know before they go for it.
Alex Ramel: Sure. I think probably folks who are familiar with recovery act funding are paying attention already to the recording requirement is in particular, things like Davis Bacon, and in Washington State, we're also required to pay Washington State Prevailing Wage and that's then a complicating factor in these projects. I don't think it's insurmountable, but it's something that's taken some time to sort of think through how we're going to approach. And in particular on the commercial side, that's been difficulty because the prevailing wage rate for commercial trade is substantially higher than on the residential side. So that's been probably the largest complicating factor for us.
Merrian Fuller: Interesting. So I think we're all done with our questions. If there are any final questions, you guys can type that in now.
John MacLean: Merrian, I can add a little more on the multifamily housing.
Merrian Fuller: Excellent. Great.
Alex Ramel: John, if I could just wrap up my -- one other thing I would like to add on the prevailing wage question. Well, it's a complicating factor. I do ultimately think it's a good idea because to have -- to ensure that folks doing these projects are getting paid a fair wage, I'm absolutely in alignment with the principle of the thing. I don't want to come off sounding like I'm opposed to acquiring the revailing wage. I think it's a good idea.
John MacLean: And adding on the multifamily housing topic. Multifamily housing is a different type of credit. There's so many institutional factors depending on how it's owned and where its operating budgets is coming from, there are two multifamily housing programs that we work on. One with our Washington State Housing Finance Commission, which is the state charter bond authority that can issue tax except bonds for qualified low-income multifamily housing as well as other types of borrowers like nonprofits, so we are working with them where the ARRA Funds are being used as a Debt Service Reserve not a Loan Loss Reserve. The types of lending that will come out of this program will have a minimum size of probably in the $2,000.00 range and up to a million to a million and a half. So the portfolio is what you might say is lumpy. It's much fewer numbers of larger deals so rather than have the trigger for the use of grant funds being a loss, we're seeing habit as a debt service reserve pooled across a portfolio, so we're setting up our program with a single bond purchaser to buy the bonds issued by the housing finance commission.
It's not a commitment to buy the bonds, it's more like a first writer refusal to look at each of the deals and they will do the low-income housing as well so. We can also use those funds as subordinated cofinance. There's a place - the Chicago area. Chicago Metropolitan Agency for planning is also targeting the multifamily housing market. They're looking to work with local government to originating renovation loans for low income housing with community development block grant funds so they're piggy backing off that deal flow and that deal pipeline and then providing grant funds for cofinancing potentially on a subordinated basis for the overall loan that would now include not only renovation but energy efficiency measure so a number of other grantees around the country are also targeting multifamily housing, and I put that in a category similar to other large commercial so ES cofinance, tech service reserve, backing loan facilities, utility based arrangements we're doing in one case and then the tax except bonds, so I think there are housing finance agency throughout the country both chartered statewide as well as locally and for folks interested in the multifamily housing market, those housing finance agencies or authorities would be good people to talk to explore how their capacities can be used for your target market.
Merrian Fuller: Great. Well, thank you. We're out of time now. I want to thank both Alex and John for sharing your wisdom with us today. And really encourage folks on the line to tap into the technical systems available from Dewey if you're a recovery act recipient, it's free and available to you and we have amazing people like John, you know, available to help set up the projects that are going on right now. So thank you so much, and I hope folks tune in again for future webinars. Thanks.
Alex Ramel: Thank you, Merrian.
John MacLean: Thank you, Merrian. Thank you all.