11.09.2010

Recovery Act Funds-Low-Interest Revolving Loan Funds

You Spin Me Right Round Baby: A Look at Low-Interest Revolving Loan Funds

Some state and local governments are getting creative by recycling funds and spinning them off into multiple clean energy projects. How are they getting this groove on? Through low-interest revolving loan funds: as the loans are repaid, additional loans can be made over time. A picture of a record player. While it may require a lot of up-front capital, the money can come from a variety of resources (e.g., state coffers and bonds). And, a revolving loan fund can provide a particularly good alternative for using Recovery Act funds (perhaps to replace stalled PACE programs) since they are not subject to the law's expiration and there are limited program administration and staffing requirements.

Detailed below are the major advantages, challenges, and design considerations of low-interest revolving loan funds, based on recent research about this funding mechanism.

Revolving Loan Fund Advantages

• Encourages clean energy investment. Additional energy efficiency and renewable energy projects can be encouraged using low-interest loan funds, which can reduce energy consumption and provide environmental benefits.
• Addresses the biggest major barrier to renewable energy deployment: up-front costs. Many consumers lack enough disposable income to pay for clean energy equipment up front-this is true even if the cost is totally recovered over time and/or the initial price is reduced by a tax credit or rebate. Through the revolving loan, the consumer is provided with a large amount of money in the first year to pay for the system and its installation. This consideration is important and can encourage widespread use of the program.
• Provides access to capital at low interest rates. Consumer's access to capital can be severely limited during tough economic times, especially for smaller borrowers. Providing access to capital, in addition to offering interest rates typically lower than those that can be secured in the market could help motivate consumers to purchase clean energy technologies.
• Limits impact on taxpayers and/or ratepayers. The total cost of these programs is lower than that of rebate or tax credit programs, as it allows for leveraging of private capital. However, if the program is not well structured and other barriers are not addressed (i.e., there is low effectiveness), there may not be a demand for this low-cost capital.

Revolving Loan Fund Challenges

• Requires substantial up-front capitalization. Funding is needed up front to provide capital to entities seeking loans. The wider the eligibility, the more capital is needed. This may be less of an issue for states and local governments with access to Recovery Act funds.
• Needs additional project support. A May 2010 NREL report reveals "that technology installed under loan programs rarely supports clean energy production at levels that have a significant impact on the broader energy sector. As a result, loan programs are having only a marginal impact on the broad clean energy goals noted above. However, these findings should not be interpreted to suggest that loan programs are ineffective or unnecessary. Rather, they suggest that, while high initial costs are a barrier to clean energy technology, additional market barriers likely require attention."
• May not reach folks with need for capital. If an end-user already has access to capital, then a revolving loan fund may not be the best option to effect change (it is only one of many sources of capital available). In other words, participants might take advantage of this program, even if they would have done the project anyway (e.g., free riders). This depends on the rate offered- many revolving loan funds do have rates that are below market (which provides some benefit over other options available to end-users). Therefore, it is important to make sure borrowers are aware of other funding sources for which they are eligible.
• May not be self-sustaining. The subsidy provided through the loan will likely not be returned through repayment of the loan's principal and interest. In other words, the fund could be depleted because it will earn lower returns than other market investments, and it may not keep up with inflation (which increases the future cost of capital for new projects). Depending on where the interest rate is set, the fund may be fully replenished (if at a higher interest rate), or it could erode the capital base of the fund (if at a lower interest rate). If the capital base decreases, the capital base can either be replenished (i.e., through new appropriations) or additional fees and rates can be included (but that defeats the purpose of a low-interest loan).

Revolving Loan Policy Design Considerations

My research has shown that successful programs:

• Address risk of default. A process must be established for loan default: how will the risks be allocated and who will bear them? Borrower education through in-house technical assistance (for development groups) and homebuyer education and counseling (for individuals) can help prevent delinquencies.
• Provide information to increase participation. A targeted marketing program will be required to encourage participation in the program (including knowledge that the program exists and the relative advantages to participation). Education efforts should include information about the cost-effectiveness of the eligible technologies as well as information about the contractors that register for program implementation. The program may need to subsidize whole home audits so that the best combination of clean energy technologies can be identified (particularly important for implementing higher cost technologies like solar).
• Minimize overall cost of program. Revolving loan funds tend to have low administrative costs as long as the program size is relatively large. Smaller programs have high overhead costs because there is a base cost to setting up a program that does not vary with program size. Standardization (i.e., borrowing good ideas from other programs) helps to simplify loan tracking and reduce transaction costs.

If you are looking for more detail about how to design or set up a revolving loan fund, be sure to listen to a Webinar presented from DOE's Technical Assistance Project's Webinar series. PowerPoint presentations from the Webinars are available from Sam Booth of NREL, and state-specific presentations are available on Texas and Montana.

In summary, state and local governments that have a chunk of money from the Recovery Act can develop revolving loan funds to target clean energy deployment well beyond 2010. While these programs address critical renewable energy development barriers and allow for recycling funds, there are important design considerations that are critical for program success. NREL would love to hear about examples of revolving loan funds- both successful ones and ones that face challenges- so that we can facilitate communication of lessons learned throughout the policymaker community.