USDA Loan Guarantees: A Viable Alternative for Renewable Energy Projects?
As the Department of Energy section 1705 loan guarantee program for renewable energy projects using commercially-proven technologies approaches its legislative sunset on September 30, 2011, developers are looking for alternative means to tap attractive, low-cost debt.
Possible alternatives include the section 1703 loan guarantee program for innovative energy projects run by the Department of Energy and a separate loan guarantee program run by the Rural Utilities Service in the Department of Agriculture.
Neither is a direct substitute for the section 1705 program; however, for the right project, either offers access to attractive borrowing rates through the Federal Financing Bank.
The “DOE Loan Guarantee Update” in the January 2011 NewsWire compared the advantages and disadvantages of the section 1703 program in relation to the section 1705 program. This note provides an overview of the legislative authority, program requirements and implementing regulations of the less-familiar RUS program available through the Department of Agriculture.
RUS in the News
The RUS program recently made the renewable energy industry news with the February 9 announcement by the Secretary of Agriculture of a $204 million loan guarantee for the PrairieWinds wind farm, a 151.5 megawatt, $340 million project in central South Dakota. The project, heralded in the February announcement as a “model of public and private investment partnership,” is being developed by PrairieWinds SD1, a for-profit subsidiary of Basin Electric Power Cooperative, a consumer-owned, regional cooperative. PrairieWinds has also been tapped to construct, operate and purchase (on behalf of the cooperative) the 10.5 megawatt output of seven additional, adjacent turbines financed through private investments by South Dakota residents.
This was not the cooperative’s first successful bid for a loan guarantee. In late 2010, it received two RUS program loan guarantees totaling $153 million for wind projects in North Dakota. Around the same time, the Central Virginia Electric Cooperative was awarded an $84 million loan guarantee to finance its partial ownership of two hydroelectric projects in Kentucky.
RUS Loan Guarantees
The RUS enabling legislation has been around for a while. Title I of the Rural Electrification Act, first enacted in 1936, authorizes the Agriculture Department to make loans for rural electrification and for the purpose of furnishing and improving electric service to persons in rural areas.
In 1973, the statute was amended to reestablish a revolving fund for insured and guaranteed loans; Title XIII of the Federal Credit Reform Act of 1990 superseded the revolving loan fund legislative provision and first established loan guarantee authority. Most recently, Subtitle B of the Food, Conservation, and Energy Act of 2008, (known as the “farm act”), further amended the statute by extending the Agriculture Department’s authority to make loans through RUS for electric generation from renewable energy resources, defining “renewable energy source” as “an energy conversion system fueled from a solar, wind, hydropower, biomass, or geothermal source of energy.”
In its current form, the Rural Electrification Act authorizes direct lending as well as a loan guarantee program, with the availability of either option subject to appropriations. The guarantee program provides 100% guarantees of loans made by the Federal Financing Bank, an arm of the US Treasury. Since 1990, most RUS appropriations have been directed to the guarantee program.
RUS guaranteed and insured loan programs, including those for renewable energy, were funded at $6.6 billion for fiscal year 2009 and at $7.1 billion for fiscal year 2010. The Obama administration requested $4.1 billion for the current fiscal year 2011 that ends on September 30 and $6.1 billion for 2012. Farm-related programs remain more popular at the moment in Congress than renewable energy. In fiscal year 2010, $313 million was awarded in loans and loan guarantees to renewable energy applicants.
A Program for the Times
The Rural Electrification Act’s preference for energy distributors and not-for-profits has, historically, shaped borrowers’ perceptions of the RUS program as geared solely to utilities and non-for-profit applicants. This perception is not entirely accurate today.
In 2009, RUS signaled its willingness to consider loans to entities other than utility systems and to include private developer limited liability companies, provided that there is adequate credit assurance such that the associated credit risk is a “constructive system loan” (meaning that the developer has signed a power supply agreement and the offtaker has agreed to provide RUS revenue assurances). Under these conditions, the risk of these LLC transactions is commensurate with the risk level traditionally associated with the RUS guarantee program and related subsidy (risk of loss) rate assigned by the Office of Management and Budget. Of note, the OMB subsidy rate for the RUS program applies to the full loan program level rather than to individual projects, as is the case with the DOE loan guarantee programs. The higher the subsidy rate, the less the program loan level authorization is for a given dollar of appropriated budget authority.
In addition, the RUS program does not construe the Rural Electrification Act’s not-for-profit preference as a prohibition against lending to for-profit entities. If the annual program level is undersubscribed, then the preference is not a problem in any event for for-profit LLC borrowers and, where a for-profit LLC is selling to a not-for-profit utility, the not-for-profit preference has been considered met as a policy matter.
However, time has yet to erode the primary purpose of the RUS program—the provision and improvement of electric service to persons in rural areas—or change its policy against non-recourse financing. While the farm act added a new section 317 to the Rural Electrification Act that authorized loans for the resale of renewable electricity to urban as well as rural residents, that section has not yet received any appropriations. However, for renewable projects that serve rural load, the absence of such appropriations is not an impediment to obtaining RUS financing. As a matter of policy, RUS does not make or guarantee non-recourse loans.
RUS Program Overview
The general contours and terms of RUS loan guarantees are found in section 306 and surrounding sections of the Rural Electrification Act. NewsWire readers familiar with the section 1703 and section 1705 programs will see numerous parallels between the DOE and RUS loan guarantee provisions.
The Rural Electrification Act provides that guarantees may be issued for the full amount (100%) of the loan and that, at the request of the borrower with such a guarantee, FFB shall make the loan at an interest rate not more than that applicable to other similar loans. The borrower has the option to repay the FFB loan at any time, in whole or in part. Make-whole premiums as required by the FFB will be assessed if the loan is repaid earlier than expected.
As the administrator of the loan guarantees, guided by private lender practices, is charged with relieving borrowers whose net worth exceeds 100% of the outstanding principal balance of the guaranteed loan of unnecessary and burdensome requirements. In addition, the RUS may give highest funding priority to designated projects in substantially underserved trust areas (for example, land held in trust by the United States for Native Americans) provided they are financially feasible. Such loans or loan guarantees may bear interest rates as low as 2%.
Unlike the DOE section 1703 and section 1705 programs, which prompted issuance of a federal regulation tailored, initially, to innovative energy investments, the RUS program continues to operate under its existing regulations found in 7 CFR Part 1710 and 1714. There is an informal guide, available to prospective LLC applicants, that adapts these regulations to LLC developers who meet the constructive loan system requirement described earlier.
Terms of guarantee:
RUS will provide 100% loan guarantees. The guarantees are not to exceed the useful life of the facilities being financed, with a maximum term of 35 years. For generation and transmission power supply borrowers, the loan term is limited by the term of their wholesale power contracts. The interest rate is as agreed to by the borrower and lender, with RUS concurrence. The guarantee applies to the repayment of both principal and interest.
Purpose of financing:
Loans guaranteed by the RUS may be used to finance a range of projects, including energy conservation and efficiency programs and on-grid and off-grid renewable energy systems. Where a utility system is the borrower, construction financing is available from the RUS. For LLC borrowers, RUS provides only term financing upon commencement of commercial operation, and only where the interim construction financing contemplated an RUS takeout. (The Rural Electrification Act has been interpreted not to allow refinancing as a general matter.) Eligible costs include direct costs of procurement and construction and related costs of engineering, architectural, environmental and other studies and of plans needed to support the project, provided the costs are capitalized as part of the cost of the facilities and were included in a RUS-approved plan.
Both distribution and power supply borrowers are eligible for a section 306 loan guarantee. While preference is given to states, territories, municipalities and cooperative, nonprofit, limited-dividend or mutual associations that provide retail electric service in rural areas or the power supply needs of distribution borrowers, a private developer can qualify for a guarantee if it signs a power supply agreement satisfactory to RUS.
To the greatest extent practical, loan guarantees are limited to projects that provide and improve electric facilities to consumers who are Rural Electrification Act beneficiaries—that is, persons, businesses or other entities located in a rural area with a population of less than 20,000. The guaranteed loan may be used for facilities to serve non-Rural Electrification Act beneficiaries only if that service is necessary and incidental to the primary purpose of meeting rural area needs.
If a project LLC sells to a power purchaser that is an existing RUS borrower, the rural eligibility requirement is considered to be met, even if a portion of the service territory is no longer rural. If the power purchaser is not an RUS borrower, the percentage of the project that can be financed using RUS guaranteed financing may not exceed the proportion of the service territory that is considered rural.
In contrast to the DOE programs where applications are invited through formal solicitations, the RUS application process is consultative with the program office actively involved in assisting the prospective borrower in preparing the application. Once complete, applications are assigned an “application received date” and considered in order of the assigned date. If there are insufficient program resources to meet demand, the application rolls over to the following fiscal year.
Applications for non-utility system borrowers are screened on a preliminary basis at the national level to determine whether the rural eligibility requirement is satisfied, the purchasing utility has provided adequate sponsorship and credit assurance, and the timing allows for completion of the environmental review required pursuant to the RUS environmental regulations found at 7 CFR 1794. Approval authority for renewable energy loan guarantees is reserved solely to the RUS. Members of Congress are notified directly, and the public is notified through normal media communications. Loan guarantees are approved or rejected generally within an average of three to nine months following the assignment of an application received date.
The regulations do not set borrower contribution rates for non-municipality borrowers. The Rural Electrification Act affirmatively requires the RUS to make a finding of security and feasibility for each loan that is made. According to the informal guide available to prospective LLC applicants, LLC borrowers are expected to maintain a minimum equity requirement of 25%.
Virtually all of the loans guaranteed by RUS are made by the FFB, although, historically, borrowers have obtained the RUS guarantee for loans from other sources. FFB determines the interest rate at the time of each advance, based on rates established daily by the US Treasury plus 12.5 basis points versus the DOE loan guarantee programs’ norm of a spread of 37.5 basis points. FFB can set a different interest rate and has done so at the request of a borrower who was seeking an IRS private letter ruling that RUS guaranteed financing is not considered subsidized energy financing for purposes of production tax credits.
In most cases (Indian tribes, public utility districts and municipalities being the exceptions), all current and future assets of the borrowing entity are pledged as security for the loan.
As previously noted, the OMB subsidy rate for the RUS program applies to the full loan program level rather than to individual projects, as is the case with the DOE loan guarantee programs. The higher the subsidy rate, the less the program’s loan authorization is for a given dollar of appropriated budget authority. While borrowers as a group may feel the effect of a lower cap on the amount of loans RUS can guarantee, the individual borrower is not affected in terms of direct cost.
While the PrairieWind wind farm loan guarantee showcased the RUS program as an alternative source of financing for renewable energy projects, it is not a straight shot for a loan guarantee in general or FFB financing in particular.
Just as the section 1703 program excludes candidates that cannot meet its “innovative technology” criteria, the RUS program excludes several renewable energy activities that conceivably would meet the broader section 1705 program requirements. For example, the “Rural Electrification Act-beneficiary” (rural) requirement weighs against, or would significantly reduce the amount of the loan guarantee available to, projects that benefit more populated regions. As a practical matter, the service territory needs to be at least 75% rural, or RUS cannot fund the entirety of the debt needed in excess of the equity requirement.
In addition, the RUS program could consider a project focused on installing and servicing renewable energy systems on consumers’ premises (such as the distributed generation projects seeking DOE support) where the LLC is implementing the program on behalf of a utility within its rural service territory and the utility provides credit support for the RUS loan to the LLC. However, a project for manufacturing renewable energy system components (such as Abound Solar Manufacturing, which received a $400 million DOE loan guarantee) would not qualify under the Rural Electrification Act because it is not sufficiently directly related to the “purpose of furnishing and improving electric . . . service in rural areas.”
Nuclear power is an eligible purpose under the Rural Electrification Act and, historically, the Rural Electrification Administration financed fractional ownership shares in nuclear plants owned by rural electric cooperatives. It is expected, as a practical matter, that DOE will provide financing for the nuclear plants now under consideration.
RUS support to privately-owned, for-profit applicants, while feasible under the Rural Electrification Act and the relevant regulations as a constructive system loan, is of untested and unproven potential. Despite the claim in the USDA February 9, 2011 news release that the PrairieWind project is a “model of public and private investment partnership,” the recipient of the loan guarantee in fact is the consumer-owned cooperative, not its for-profit subsidiary charged with developing and operating the project, and private investor participation is limited to the seven turbines adjacent to the project, the financing of which falls outside of the RUS loan guarantee. Opportunities remain, however, for the private developer in a mutually-beneficial partnership with a utility offtaker to take advantage of the RUS program offerings.
Finally, the stability of funding for the RUS program is vulnerable to both the short-term effects of the ongoing fiscal year 2011 budget debate in Congress as well as the longer-term fiscal pressures and funding constraints on government spending in fiscal year 2012 and beyond. The extremely low, and at times, negative subsidy rate that the RUS program enjoys should, however, mitigate this vulnerability; nothing much is achieved toward the targeted budget cuts by cutting the RUS program because so little budget authority is needed to fund it in the first place.
Despite its limits and uncertainty, the RUS program may offer an attractive funding option for renewable energy projects, particularly where the developer has partnered with a utility with a rural service territory and the utility is willing to step up to the RUS revenue assurance requirement in order to realize lower costs. If it fits, it could work well—for both the renewable energy developer and the rural population the RUS is designed to serve.