DOE Moves on Loan Guarantees
Although progress has at times seemed painfully slow, the US Department of Energy is making progress toward issuing federal loan guarantees for renewable energy, transmission and other projects.
The department has had authority since August 2005 to guarantee loans to projects that use innovative technologies. A technology is considered innovative if it is has not seen at least three commercial applications in the United States lasting at least five years.
Congress gave the department additional authority in the economic stimulus bill last year to guarantee loans to finance new electric transmission lines and grid upgrades and renewable energy projects that use commercially-proven technologies.
There are currently two active solicitations under which developers can apply for guarantees for projects.
The first is a July 29, 2009 solicitation for assorted projects that involve innovative technologies (generation, manufacturing, energy efficiency, transmission and alternative fuel vehicle projects) under both section 1703 of the Energy Policy Act of 2005 and section 1705 (also under the Energy Policy Act but created by the economic stimulus bill last February). Absent early termination of the application period, part I applications can be filed through August 24, with part II submissions due by December 31, 2010.
The second is the October 7, 2009 solicitation establishing a “financial institutions partnership program,” known as “FIPP,” for energy projects that use commercially-proven technologies also under section 1705. Both part I and part II applications are expected to remain welcome through January 6, 2011.
A third solicitation, also issued July 29, recently closed and is a solicitation for major transmission projects under section 1705 only (thus requiring no innovation). The deadline for part II submissions was January 25, 2010.
More tracks, under further solicitations, are planned, but these three are where all the action is for the moment, at least pending Congressional restoration of $2 billion in cash that Congress moved from the section 1705 loan guarantee program last year to fund the cash payments by auto dealers for “clunkers.” Congressional staff predict that restoration will happen in February.
So far, the projects approaching financial closure are all under the section 1703 program for innovative technologies, though most also qualify under section 1705. The advantage of qualifying under both is that the project can be financed by borrowing at a low interest rate directly from a window at the US Treasury called the Federal Financing Bank. This type of borrowing is available only for innovative technology projects, whether receiving loan guarantees under section 1703 or section 1705. However, the projects that qualify under section 1705 do not have to pay “credit subsidy” charges for the guarantees.
The first, and so far only, loan guarantee to reach financial closure is that of Solyndra, Inc., a manufacturer of cylindrical solar photovoltaic panels. (Solyndra applied under a December 31, 2006 solicitation, announced it had signed a term sheet on March 20, 2009, and reached financial closure on September 4.)
Three other term sheets have been concluded, one with Nordic Windpower, USA, a maker of two-blade, one-megawatt wind turbines, one with Beacon Power, an energy storage company (both announced July 2), and one with Red River, an activated carbon manufacturing plant, announced in December. Each of these three subsequent projects had applied pursuant to the section 1703 solicitation that closed February 26, 2009.
A key question is whether the timing required for processing applications and closing loans can be expected to accelerate.
The Department of Energy has been criticized for the slowness with which opportunities to apply have been doled out and with which applications, once submitted, have been processed. More than two years elapsed following Solyndra’s application before a term sheet was issued. In contrast, two of the more recent applicants in the February 26 round completed term sheets less than six moths later, though the third’s term sheet took 10 months, and several other projects from the February 2009 round have term sheets at various stages of negotiation.
Nonetheless, the loan guarantee staff have indicated their expectation that, as the program gains experience, the pace of processing applications, finalizing term sheets and closing financings should accelerate. Given that projects to date have been delayed, at least in part by DOE sorting out resolutions to various threshold issues, later projects will benefit from those precedents and should indeed be able to move more quickly through the underwriting, negotiating and documentation processes.
Status of the FIPP
The FIPP continues as a repository of more potential than achievement.
Several part I applications have been received that are expected to yield part II applications and a good likelihood of closed financings. But experience to date is far from the flood of commercial technology projects under the stimulus that was expected.
One can speculate whether the early post-stimulus projections over-estimated prospective demand. Has resolution of the financial crisis sufficiently restored alternative financing sources? Did the specific hurdles in the solicitation (for example, simple financing structures and a BB credit rating) drastically limit the applicant pool? Did structural requirements imposed by the solicitation that were not required under the relevant statutes or the final program guidelines (for example, a prohibition against stripping the guaranteed and unguaranteed portions of the DOE-supported loans and precluding access to the Federal Financing Bank) impair the value of seeking the federal guarantee? Might the unexpectedly limited volume of financing made available under the solicitation have discouraged commercial lenders from investing time and effort in making the program work?
Whatever the reason, and no doubt the dismal pace of applications reflects a combination of these factors, the FIPP, for which there were great hopes for over-subscription (which would have bolstered the argument to restore the cash-for-clunkers money), may not need the relatively paltry $750 million in credit subsidy appropriation that was allocated to it.
For a number of the projects that have applied to date, the sponsors, rather than the banks, have led the way. These developers each have large projects costing more than $1 billion that caught the attention of banks anxious to win mandates to lead those financings. A condition of the mandate was to include a proposal to tap the DOE program. These mega-projects, which can accommodate the transaction costs necessitated by the terms of the solicitation if the capital markets are to be tapped, will likely break the ice for the FIPP.
One question is whether, with those precedents established, funding arrangements will be designed that can accommodate projects in the mere $50 to $500 million range that were the original target of the FIPP. A couple applications in that range have been filed, but without aspirations of capital market funding. Notwithstanding the handful of applications filed, it appears that the expected flood of such applications has been more discouraged than motivated by the terms of the FIPP.
Revised Final Rule
Other news is better. Proposed helpful changes to guidelines for the loan guarantee program as a whole — that were in the works, in one guise or another, for nearly a year — became effective on December 7. Each change addresses an important impediment to DOE co-financing with other lenders.
DOE is now prepared to share collateral with co-lenders.
Previously, DOE would only share collateral in one narrow context. If it were to provide a partially-guaranteed obligation, meaning if it were to guarantee payment of some cents on each dollar of financing, then it was prepared to share collateral with a guaranteed lender in proportion to the non-guaranteed portion of the loan. However, if DOE were to fully guarantee a loan, as applicants overwhelmingly preferred, but the project were to require complementary co-financing from another lender, then the co-lender would have to be unsecured because DOE insisted on a lien on all project assets and it was not permitted to share that lien. Co-financing required from export credit agencies to support nuclear power projects was the case most used to demonstrate the problem.
With the latest rule change, DOE is now free to share collateral with co-lenders on whatever terms are deemed appropriate from an underwriting perspective to assure compliance with the continuing statutory obligation to achieve “a reasonable prospect of repayment.”
In another change, DOE relaxed the requirement that it must have a lien on all project assets.
This change permits the scope of the collateral package to be driven by underwriting considerations rather than rigid legal requirements. Although that facilitates co-financing, since co-lenders will be driven by similar underwriting concerns, the motivation for this was primarily to accommodate financing of contractual joint ventures where the collateral might consist of an assignment of contractual rights rather than a lien on the physical assets of a project in which multiple owners (including owners not benefiting from DOE financing) hold undivided interests.
A third key rule change is that DOE is now prepared to share decision-making after a borrower default.
The loan guarantee program rules originally provided that DOE could decide, in its sole discretion, how to respond to defaults. Whether construction should be completed or abandoned, whether security interests in collateral should be enforced, and whether a project should be liquidated or continue to operate were all to be solely DOE’s call, regardless of the role, or the magnitude of the roles, played by co-lenders. Prospective lenders were concerned that DOE might be — indeed was bound to be — motivated by non-commercial considerations in exercising that discretion.
Not surprisingly, the DOE loan guarantee program, at least until roll-out of the FIPP, was bereft of co-financing. With these changes, not only has financing for the nuclear projects become more likely to succeed, but also any project interested in coupling DOE support with other financing — such as a tranche of tax-exempt bond debt — just became feasible with these changes. For the FIPP, which requires co-financing, the prospects of conventional inter-creditor terms prevailing have improved immensely.
Davis Bacon and New Director
The stimulus required Davis Bacon-compliant “prevailing wages” to be paid to all on-site construction workers and mechanics for projects supported by loan guarantees issued under section 1705. Section 310 of the Energy and Water Development and Related Agencies Appropriations Act, enacted at the end of 2009, expanded the scope of the Davis Bacon compliance requirement to include all DOE loan guarantees, including those issued under section 1703.
The DOE loan guarantee program had been housed, since its inception, in the office of the department’s chief financial officer. In a demonstration of the importance that the Obama administration, through the Secretary of Energy, places on the program, it has been put under the control of a new recruit, Jonathan Silver, titled executive director, who reports directly to the Secretary of Energy. In a series of meetings with program applicants, prospective applicants and trade associations, Mr. Silver has indicated his commitment to accelerate loan processing and closing and his sympathy with the sorts of concerns listed later this article on the to-be-done list.
Among the continuing challenges Mr. Silver faces, as do program applicants, are the following.
Don’t Ask, Don’t Tell: Communicating with the loan guarantee program office can be challenging. DOE takes a quasi-government procurement approach to processing applications, such that each applicant under a solicitation for a loan guarantee is deemed to be in direct competition with each other applicant. The concern is that any question raised by an applicant could, if answered by DOE, give that applicant an unfair advantage in that competition.
A number of ways out of the dilemma seem evident. One would be to conclude that an applicant may achieve some advantage by asking a good question, but that there is nothing unfair about that advantage so long as other applicants can also ask their questions (which is the approach taken by the US Treasury with the cash grant program for renewable energy projects that was also part of the stimulus). Another would be to make the questions asked and the answers given publicly available. An applicant would have to decide, given raising a question, whether the answer is worth knowing if competitors will also get the benefit of it. DOE has taken steps in the latter direction by posting answers to “frequently asked questions” on the loan guarantee office webpage.
Unfortunately, DOE imposes a “quiet period” for applicants between the part I and part II submissions. Given the relative simplicity of the part I submission and the relative depth and complexity of the part II submission, important questions necessarily arise when preparing that second round submission. DOE’s position to date is that it cannot, at that stage, provide any guidance.
For a still new financing program, with minimal track record and with its programs and policies still evolving, the inability to respond to questions is a problem. The good news is that program staff understand the problem and are working on a solution.
Refinancing Construction Debt: It has been clear from day one that DOE-guaranteed debt would not be available to re-finance loans in place for a finished project. It has also become clear that a project under construction with a term debt commitment in place would not qualify for DOE support for lack of “additionality,” meaning the project is going to happen anyway, with or without DOE support.
However, DOE staff have provided mixed signals — with different officials taking different public positions — with respect to whether DOE will be prepared to guarantee term loans that will refinance construction debt, if the availability of that term debt depends upon the availability of the DOE guarantee.
Some prospective projects that are excellent candidates for DOE support and that fit the popular image of “shovel-ready” can arrange construction financing (perhaps with an equity back-stop), but are concerned that DOE will take a view that “once financed, always financed” and that the availability of such construction financing itself will block access to a federal loan guarantee.
The consequence is that such projects are delaying construction while awaiting DOE processing of their applications. This effect is ironically anti-stimulative and unnecessary. DOE needs to resolve the doubt publicly — preferably by confirming that forward progress into construction will not, absent a term loan commitment being in place, disqualify a project for a loan guarantee.
Commencing Construction Ahead of NEPA Clearance: Many DOE loan guarantee applicants (though not all) have been advised that a project cannot commence construction in advance of DOE’s completion of its environmental review under the National Environmental Policy Act.
Even if a project proceeds along a path ultimately determined to be environmentally acceptable, or even environmentally optimal, the fact that some alternatives, albeit environmentally inferior, will have been foregone violates the DOE’s NEPA process and may disqualify a project from a loan guarantee.
This is another anti-stimulative element of the program. Obviously a developer that proceeds in advance of receiving NEPA clearance would be doing so at its own risk and running the risk that the project ultimately will not be deemed NEPA compliant. Many developers who are confident that they are on the right track environmentally would accept this risk in order to move forward with the project.
Whether this can be addressed administratively or requires legislative action is a point of some contention. We understand DOE is exploring a way forward.
Other Things That Haven’t Happened
The $6 billion loss reserve that Congress provided originally in the stimulus to support loan guarantees under the section 1705 program was reduced to $4 billion; $2 billion was taken away to fund the cash-for-clunkers program.
The money is expected by some close watchers of energy matters on Capitol Hill to be restored in February. If it is, the loan guarantee program will have the resources to roll out financing opportunities that avoid or otherwise address some of the issues that have, at least to date, limited demand for the FIPP program. Other variations on the loan guarantee program, such as an indirect investment program in which DOE supports investment funds that, in turn, invest in downstream projects, could then also be expected.
When the cash-for-clunkers transfer occurred, there was speculation within DOE as well in the market that the inadvertent exclusion of renewable energy projects that use commercially-proven technologies from 81% of the loan guarantee program’s resources under the stimulus would have to be addressed. (DOE has put most of the remaining loss reserve off limits to mainstream renewable energy projects by setting aside the reserve largely to support guarantees to projects that use innovative technologies and transmission projects.) The only clear solution, absent restoration of the transferred funds, appeared to be to re-allocate some of the funds allocated under the July 29 solicitation for innovative projects (and perhaps also under the simultaneous solicitation for large transmission projects) over to the FIPP. The unpopularity of the FIPP may ironically have resolved this issue.
DOE has indicated that other federal agencies that have already reviewed a project for compliance with the National Environmental Policy Act need not repeat the process for DOE. Similar deference is not accorded to state environmental clearances since, after all, they are not pursuant to NEPA. Still, some states, in particular California, have environmental requirements no less stringent than NEPA. Applicants have argued that they should be given credit by DOE for activities undertaken for purposes of state compliance and that, for those states with environmental clearance requirements substantially as stringent as NEPA, state compliance should be sufficient for purposes of NEPA.
DOE reports extensive and continuing discussions with the Council on Environmental Quality at the White House in search of a way forward that gives projects appropriate credit for state-level compliance activity. This is another work in progress.