Financing Home Energy Efficiency & Renewable Energy
Energy efficiency improvements can reduce utility bills while making homes healthier and more comfortable. Although that’s an attractive proposition to the vast majority of homeowners, many balk at the up-front cost. In fact, 86% of surveyed California homeowners expressed interest in a hypothetical loan product for clean energy or water conservation improvements (data from a private study conducted on behalf of our firm).
Because the up-front cost hurdle is one of the key barriers to residential energy efficiency investment, the home contracting industry, policy makers, and financial firms have spent many years working to improve financing options. While progress has been slower than hoped for, there are several promising new approaches being pioneered around the country that have the potential to unlock significant investment in residential efficiency. Property Assessed Clean Energy financing, on-bill financing, and unsecured consumer loans all appear to be important pieces of the puzzle. But let’s start with some lessons that were learned in the solar industry.
The Home Solar Market
Homeowners looking to invest in solar PV face the same sticker shock as those looking to make an efficiency improvement, but integrated financing options radically reshaped the solar market in just a few years. Despite the recession, demand for residential solar systems has grown steadily across the United States.
Solar leases and power purchase agreements (PPAs) are integrated financing options that allow consumers to receive the benefits of solar without the up-front cost. The introduction to the residential market of these new financing options a few years ago coincided with a remarkable increase in demand. Three years ago, these types of financed solar systems represented just 11% of the market in California. Today, leases and PPAs represent almost 60% of all residential solar systems installed in California—and the California residential solar market has grown by 150% in those three years (see Figure 1).
Third-party financing has succeeded in unlocking a large potential market by solving two related challenges—making rooftop solar affordable to many more homeowners and integrating the financing directly into the sales process value proposition. While leases and PPAs cannot today be used to finance residential efficiency improvements, a new generation of tailored financing products has the potential to similarly transform the home energy upgrade market.
The Development of Home Energy Efficiency Finance
The home energy improvement industry, governments, and utilities have been focused on creating new financing options for years. Those efforts have proceeded by fits and starts and often either have been expensive or have required unsustainable levels of subsidy. However, the experience and data from those programs have provided lessons that are being applied to develop a second generation of products that can meet the national need for residential efficiency financing.
Property Assessed Clean Energy
Property Assessed Clean Energy (PACE) financing allows property owners to pay for energy improvements as a tax or assessment on their property tax bill. This unique structure allows programs to offer competitive rates and long repayment terms. The up-front costs for an approved energy improvement are advanced to a property owner in the form of a loan. The property owner repays the loan as part of his or her property tax bill over a period of up to 20 years. Because the debt is attached to the property, the repayment obligation generally transfers to the new owner if the building is sold.
The PACE concept was developed and piloted by the city of Berkeley, California, in 2008 and quickly spread across the country, with over half of the states passing PACE legislation. Programs that had launched—in Palm Desert, California; Boulder County, Colorado; Sonoma County, California; Babylon, New York; and San Francisco, California—had seen strong demand.
This model was taking off like wildfire in 2010, but then residential PACE ran into regulatory opposition from the Federal Housing Finance Agency (FHFA)—the regulator of mortgage giants Fannie Mae and Freddie Mac. In the summer of 2010, the FHFA directed Fannie Mae and Freddie Mac to treat a property’s participation in a PACE program as cause to default the mortgage. Nearly overnight, programs around the country were frozen.
In response, local and state governments have joined PACE advocates to pursue legislation and litigation to restore residential PACE. The PACE Protection Act of 2012 was introduced in the House and currently has a bipartisan group of 53 cosponsors. However, it remains a victim of the dysfunction in Congress and has not moved forward.
Efforts have moved forward more aggressively on the legal front. Following an order from a federal judge, the FHFA was required to begin a formal rulemaking to develop new regulations for PACE. The agency completed two public comment periods and has received over 80,000 letters and substantive comments in support of PACE. Unfortunately, the agency has so far remained firmly in opposition. In June, the agency released a new proposed rule that was, if anything, more hostile than the last one. The rule states the FHFA’s intent to require “immediate” action by Fannie Mae and Freddie Mac to use their mortgage contracts to prevent homeowners from participating in PACE programs. Advocates are currently awaiting the final rule, which will be issued in May 2012.
A few jurisdictions are providing PACE financing to residential properties, though they must disclose that participants face the risk of being found in default of their mortgage.
In the meantime, PACE financing for commercial buildings is expanding rapidly across the state of California. Building on the leadership of Sonoma and Placer counties, many large new programs have launched. For example, PACE programs serving Los Angeles County, San Francisco, a group of cities in southeast Florida, and CaliforniaFIRST—covering over 100 local governments—formed the Commercial Clean Energy Financing Alliance to support commercial PACE programs and set standards to make PACE more widely available and accessible.
PACE has proven to be popular with consumers and can readily attract large-scale low-cost capital. However, for residential PACE programs to get under way at any scale, the regulatory issues must be resolved.
Perhaps the single most elegant way to pay for energy efficiency improvements is directly on the utility bill. Utilities have been experimenting with various types of on-bill financing programs for decades, with varying degrees of success. A new round of on-bill efforts—including several large pilots and statewide initiatives in Oregon, Illinois, and New York—have raised hopes that residential on-bill financing may finally break through. However, key policy and finance issues must be resolved for large-scale private capital to become available.
The defining characteristic of an on-bill financing program is that the loan is repaid on the utility bill. Most of the capital to fund these loans has come from utilities, ratepayers, or grant funds. As the focus of policy shifts toward creating larger programs that use private capital, fundamental policy and political issues regarding the utility service shutoff, and the security capital providers’ need for repayment, need to be addressed.
Following is a snapshot of on-bill programs across the country.
Oregon. In 2009, the city of Portland launched an on-bill financing program called Clean Energy Works. The program concluded its pilot phase in February 2011, when it completed its 500th loan. The pilot’s high audit conversion rate demonstrates the efficacy of the program in driving demand for energy efficiency. Of the homes that received an audit through the program, 66% installed at least one energy efficiency measure, compared with 25% under existing residential audit programs.
Last year, the Clean Energy Works program was approved to expand to other areas of the state. While the Portland metropolitan area is still the only region that offers an on-bill payment option, other counties offer energy efficiency consumer loans that are repaid on a separate bill. The Portland on-bill loans start at 5.99% and can be repaid over periods as long as 20 years. Although these loans are repaid on the utility bill, the program will not shut off utility services for failure to pay. This has complicated efforts to expand the sources of capital for this product after grant funds and other initial sources are exhausted.
New York. The New York State Energy Research and Development Authority launched an on-bill program in early 2012 serving homeowners throughout the state of New York. The program offers a low 2.99% fixed-interest rate and is available with 5-, 10-, and 15-year repayment terms. Participants can finance up to $25,000 if projects meet cost-effectiveness standards, and the bill can be transferred upon sale of the home.
Illinois.The Illinois Energy Efficiency Loan program, a residential on-bill financing program, began operation in 2011. Administered by AFC First Financial Corporation, the program is currently available to customers of four utilities, with another utility planned. Over $1.5 million in loans has been funded, with another $1 million in the pipeline and volume growing monthly as the individual utilities roll out their respective programs. Illinois utilities are required to guarantee the repayment of the loans to the capital providers.
Over the past several years, the California Public Utilities Commission (CPUC) has required utilities to provide a pilot commercial on-bill financing option funded with ratepayer dollars. In May 2012, the CPUC directed that the commercial on-bill program be expanded over the next two years. Although the CPUC initially planned to roll out a residential program that would be financed by private capital, it postponed that effort when it ran into several regulatory and policy concerns.
On-bill programs provide consumers with a straightforward financing option that places the repayment obligation on the same bill that is seeing the benefits of the energy savings. However, program designers must make difficult policy decisions about program structure if they wish to use private rather than public or utility funds. Specifically, programs must decide how to secure repayment if a property owner fails to repay the loan. Some programs utilize ratepayer funds as a backstop, others use the utility’s balance sheet, and others are requiring that utility service be disconnected if the loan goes unpaid. These core issues must be addressed if on-bill programs are to succeed on a broad scale.
The development of targeted financing products has been a key priority of Recovery Through Retrofit, an initiative to promote residential energy efficiency launched by Vice President Joe Biden’s Middle Class Task Force. As part of this initiative, HUD and the Federal Housing Administration (FHA) developed the PowerSaver loan program.
PowerSaver provides consumer energy efficiency loans that come with partial federal insurance against loss. Creditworthy borrowers who meet program requirements will be able to borrow up to $25,000, to be repaid over terms as long as 20 years. Loans over $7,500 will be secured by a second mortgage on the participating property.
In 2011, the FHA selected 18 national lenders to provide PowerSaver loans and launched the pilot phase of the program. Because loan origination is limited to those lenders, loans are not currently available in all regions, and volume has been limited to roughly 30,000 homeowners. The pilot is slated to last two years, at which point it will be evaluated, and will be expanded if it has proven successful.
Consumer Credit Financing
Consumer energy efficiency loans—often referred to as unsecured loans—are a familiar option for homeowners. This is a common type of financing, one that is based on the credit of the individual borrower.
The loan application and approval process for consumer credit loans is relatively quick and simple, making this product attractive to contractors, who can help a customer close a loan in just a few minutes. The biggest challenges have been the relatively high interest rates, and the geographic restrictions required by local financial institutions.
Some local and state governments have worked with credit unions or regional banks to develop lower-rate unsecured options for homeowners in their communities. These programs fund the principal of the loan with private capital and use government funds to make the financing more affordable.
Two examples of federal grant-supported programs that have worked with local credit unions are the Los Angeles County Energy Upgrade California program and Michigan Saves. These programs work with local and regional financial institutions to originate loans and deliver below-market rates and longer repayment terms, with support from grant-funded loan loss reserves.
However, the potential market for energy efficiency is estimated to be at least $40 billion per year. California alone needs $60 billion in investments over the next decade to reach its residential energy efficiency goals. In order to provide sufficient capital to fund this potential demand, financing products will need to be deployed at a larger scale than they are at present, and will need to make use of the capital markets in order to do so.
A new initiative called the Warehouse for Energy Efficiency Loans promises to build on the earlier successes of smaller programs to meet that need. This program was developed by the Energy Programs Consortium and Pennsylvania Treasury, in partnership with Renewable Funding and Citigroup. It is designed to be the first program to create a secondary market for energy efficiency loans by bundling a large number of loans from different programs together for sale in the investment grade securities market. If it is successful, it will provide a long-term source of low-cost capital for energy efficiency loans.
At the time of writing, this program was expected to launch in the winter of 2012. Participating lenders will be able to offer five-, seven-, and ten-year loans at fixed rates under 10% to qualifying borrowers.
To learn more about Property Assessed Clean Energy (PACE), visit www.pacenow.org.
For more information about on-bill financing, visit the Environmental Defense Fund web site at www.edf.org/energy/obr.
To learn more about DOE’s PowerSaver program in your area, visit www.energy.gov/energysaver/articles/watch-new-powersaver-pilot-loan-program-your-area.
Find more information on the Warehouse for Energy Efficiency Loans program, visit the National Association of State Energy Officers web site at www.naseo.org/committees/financing.
The Future of Financing
After years of financing pilots, the United States is finally on the brink of driving energy efficiency upgrades in homes at a scale that will meaningfully reduce national energy consumption and will put thousands to work. New financial structures have the ability to deliver the billions needed for retrofits at affordable rates and can serve homeowners across the country.
This second generation of financing programs offers the necessary scale and accessibility while learning from the experience of smaller programs. Equipped with affordable, scalable, and attractive financing tools, the residential efficiency industry is now poised to follow in the footprint of residential solar.
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