Looking Under the Hood: Some Perspective on the Loan Guarantee Program

Michael Mendelsohn's picture

Suddenly, Americans are familiar with the U.S. Department of Energy (DOE) loan guarantee program. And Solyndra.[1] But the comprehension of the program seems to be limited to what's seen in the rearview mirror. So, let's take a closer look under the hood.

A classic car with the hood propped open.

DOE's loan guarantee program supports the development of renewable electric manufacturing and generation facilities by making available low-cost debt, both public and private. The debt is guaranteed, meaning the borrower has the "full faith and credit of the U.S. government" behind it [2]. The majority of loan guarantees have been issued to relatively secure power generation projects, while less than 10% were issued to manufacturing projects, which are perceived to be more risky. The difference is important.

Federal loan guarantees require that a "credit subsidy"— essentially a payment that represents the probability of the loan not being repaid — be set aside at a U.S. Treasury account. Think of it as insurance. In bank parlance, it's referred to as a "loan loss reserve." When aggregated, the supported projects essentially insure each other, just like auto insurance pools drivers of different risk characteristics.

Amid the recent scrutiny of the loan guarantee program, some important considerations have been lost. First, direct loans and loan guarantees have been used by the government to stimulate private investment for more than 200 years, and have been used for everything from the financial rescue of New York City to economic development in Ghana [3][4]. For example, in 2010, the Export-Import Bank of the United States (Ex-Im Bank), the official export credit agency of the United States, issued $24.5 billion in loans, loan guarantees, and credit insurance—the highest in its 76-year history to support a wide array of international investments [5]. Second, loans and loan guarantees can be valuable not only for the entities receiving the loans but to taxpayers as well, because these loans are repaid with interest, sales and income tax revenues are boosted, and the loans often spur the competitiveness of the industry in which they are made (such as farm products, refined minerals, or renewable electricity).

Historically, borrowers under the DOE loan guarantee program were required to pay their own credit subsidy cost, which is uniquely calculated for each project based on the specific risks involved. Under the American Recovery and Reinvestment Act (ARRA), Congress appropriated $6 billion to pay the credit subsidy costs to support projects in a new DOE loan guarantee program referred to as 1705 after the section of the Energy Policy Act of 2005 under which it was enacted.  The $6 billion put aside for this credit subsidy was later reduced to $2.435 billion as monies were reallocated to the Cash-for-Clunkers program, education, and Medicaid.

The credit subsidy is specific to each loan, but was initially estimated by industry experts to average roughly 10% .[6]  This means that every dollar spent in credit subsidy would leverage $10 in loans.  In the end, the DOE required a credit subsidy cost of 11.7% or $1.88 billion on a total of $16.16 billion in loans made under the 1705 program (see Table 1).[7]

Table 1. 1705 Loan Guarantee Information
Program Loan Amount ($B) Estimated Credit Subsidy at 11.7% Rate ($B)
Photovoltaic Electric Generation 6.14 0.72
CSP Electric Generation 5.86 0.69
Solar Manufacturing 1.28 0.15
Wind Generation 1.70 0.20
Other Technologies 1.19 0.14
Total 16.16 1.88
Electric-generating only 14.23 1.67

 *Other Technologies includes a mix of electric and non-electric generation.

The actual credit subsidy cost — by project — is not publicly available. The required credit subsidy payments are calculated by the DOE using complex models of potential default scenarios.  According to Ken Hansen, a partner with the law firm of Chadbourne & Parke, LLC, and a former General Counsel of the Ex-Im Bank, DOE's default models are extremely conservative, particularly for the power generation projects, which represent over $14 billion of the roughly $16 billion in total loans guaranteed under the 1705 program[8].

The loans supporting power generation projects represent a very different risk profile than those supporting manufacturing facilities, such as Solyndra, or storage technologies, such as Beacon Power Corporation[9]. According to Hansen, the risk of default for loans supporting generation projects is extremely low given that they (i) hold long-term contracts with credit-worthy utilities, (ii) often have production guarantees from the equipment manufacturer, and (iii) often have construction-cost guarantees from international construction firms. In the case of the projects that embody some form of innovative technology, the functionality of that technology is thoroughly reviewed by DOE and its independent engineers before DOE agrees to finance the project.

Hansen has been involved in exactly half of the closed transactions under the 1705 program. He argued that the nearly 12% credit subsidy is above and beyond levels used for far riskier ventures supported by other U.S. agencies. Recalling his experience working with the Ex-Im Bank, Hansen noted that loan guarantees to support projects in developing countries routinely required credit subsidy payments in the 5%-7% range. Plus, many of those projects were in places with political or economic instability.

In contrast to the generation-based loans, the loans supporting manufacturing facilities represent far higher risk. These facilities have no long-term contract or guaranteed market. Instead, they compete in the global marketplace against foreign manufacturers, such as those in China, who not only have access to similar low-cost capital as well as a low-cost labor pool and regulatory environment, but can access the financial capital and complete the regulatory hurdles in a fraction of the time required of U.S. companies [10].

Importantly, no loan guarantee money is actually spent unless a project defaults. The money is only transferred into a Treasury Department account where it is pooled with the credit subsidy costs from other projects in the program. So, using the credit subsidy costs referenced above, if 11.7% of the loans default, they are fully covered and repaid from the credit subsidy account. If fewer default, the money is retained by the government. If more default, the Treasury funds the difference from supplemental funding available to it.

But let's assume the credit subsidy accurately represents the defaults we can expect from the projects supported by the LG program. Considering Solyndra's recent bankruptcy announcement, as much as 22% of the total $2.435 billion credit subsidy available may already have been consumed, assuming the government does not get money back from the liquidation of assets. To put things in perspective, if all of the manufacturing facilities fail—and nothing is recovered—$1.28 billion, or 53% of the total credit subsidy, will be expended, representing—seemingly—a moderate risk to the program's overall financial stability.

The questions of taxpayer support of U.S. manufacturing are clearly important and will certainly get a lot of attention over the coming months. However, let's focus on a separate, somewhat overlooked question. That is, when looking at the portfolio of generation projects supported through the 1705 program, were the loan guarantees a reasonable investment from the taxpayer's perspective? To help assess the question, the analysis represented in Table 2 was developed.

The loan guarantees associated only with electric generation facilities totaled $14.23 billion. On a very simplistic basis, the government credit subsidy should lead to roughly 12 terawatt per hour (TWh) of energy per year according to DOE estimates, or 212.5 TWh over the next 20 years, assuming 11.7% of the capacity is lost to bankruptcy and ignoring any productivity declines. If all of the credit-subsidy put aside for those loans is consumed, taxpayers will have paid $7.84 for every megawatt per hour (MWh) of expected electricity production over the next 20 years, not including any discounting.

Table 2. Credit Subsidy per MWh of Production [4]
Program LG Amount ($B) Assumed Credit Subsidy ($B) MW(ac) Annual Generation per DOE (GWh) Assumed 20 years of Generation less 11.7% (GWh) Calculated Credit Subsidy per MWh over 20 years
Photovoltaic Electric Generation 6.14 0.72 2,272 4,730 83,528 $8.60
CSP Electric Generation 5.86 0.69 1,243 3,623 63,982 $10.72
Solar Manufacturing 1.28 0.15     0  
Wind Generation 1.70 0.20 1,025 2,188 38,640 $5.11
Other Technologies* 1.19 0.14 180 1,492 26,349 $5.27
Total 16.16 1.88        
Electric-generating only 14.23 1.67 4,720 12,033 212,499 $7.84

 *Other Technologies includes a mix of electric and non-electric generation.

In contrast, energy cost savings from the program may far exceed the expected costs. According to an upcoming analysis using NREL's System Advisor Model (SAM) on the impact of various financing scenarios, the low-cost debt available under the loan guarantee program can reduce the levelized cost of the generated electricity about $20/MWh for photovoltaic projects and $29 - $37/MWh for projects using CSP technologies. The analysis is based on generic 2011 installed prices and capacity factors, and is not specific to the actual projects approved under the 1705 program Nevertheless, it demonstrates that access to low-cost financing can have a significant impact on the cost of energy, and that public investment in credit subsidy costs to support loan guarantees could have a direct positive impact. Given the long-term contracts for the power output, the equipment manufacturer production guarantees, and the insurance products surrounding project construction and operation, the risk of default of the generation projects — representing the large majority of loan guarantees — should be minimal.

Importantly, the DOE Loan Guarantee program was never expected to be risk-free, but rather was designed to support a portfolio of promising energy technologies that, when combined, represent a manageable level of risk. Chadbourne's Hansen argues that, "if the Loan Guarantee program has no defaults, it's simply not taking on the risk it was designed to. The overall risk of the portfolio is the critical metric, and for that, given the DOE's conservative assessment of the projects, the credit subsidy costs provided under ARRA should provide the taxpayer plenty of insurance."

Overall, the loan guarantees should provide significant benefits. First, the program is supporting unprecedented levels of renewable energy deployment, including 3,500 MW of solar generation, a level more than two times the total installed U.S. capacity prior to 2011. The economies of scale and scope embodied in that level of deployment should provide manufacturing, development, and operating cost-reduction benefits. Second, the projects supported under the program will provide construction and operation job creation, and make the United States a clear leader in the development of concentrating solar power. Lastly, as calculated thru NREL's SAM model, enabling projects to access low-cost debt provides direct benefits to U.S. utility customers through lower cost power.

References:

[1] Solyndra is a California-based solar power manufacturing firm that received loan guarantees totaling $535 million loan guarantee from DOE in September 2009. On September 6, 2011, Solyndra filed for bankruptcy, after having drawn down $527 million of its DOE loan guarantee facility. According to the Congressional Research Service, the marketability of Solyndra's technology decreased significantly along with prices for polysilicon, a primary ingredient in the majority of competing solar panels, and the general commoditization of the industry. See "Market Dynamics That May Have Contributed to Solyndra's Bankruptcy," Phillip Brown, Congressional Research Service, October 25, 2011.

[2] "DOE Proposes Regulations for Loan Guarantee Program," DOE Loan Programs Office, May 10, 2007

[3] Bowsher (1983). "The Federal Government and Loan Guarantee Programs." Address by Charles A. Bowsher, Comptroller General of the United States before the Economic Club of Detroit, January 1983, See General Accounting Office

[4] Leahy, 2009. "U.S. Loan Guarantee Helps Ghana Port Company Acquire Forklifts." U.S. Agency for International Development, accessed November 2, 2011

[5] Export Import Bank of the United States (2011). "Management's Discussion and Results of Operations and Financial Condition." accessed October 31, 2011

[6] Bracewell & Giuliani (2009). "Federal Stimulus Funding Fuels Further DOE Loan Guarantee Program Opportunities," accessed November 3, 2011

[7] DOE Loan Programs Office. Webpage entitled "Our Projects," accessed October 25, 2011. All data in tables 1 and 2 that were either "assumed" or "calculated" by the author are referenced and italicized in the header. All other data are from the Loan Programs Office.

[8] Hansen (2011). Conference call with Keith Hansen, Chadbourne & Parke, LLC, October 2011

[9] On October 31, 2011, Beacon Power Corp., an energy-storage company that received a $43 million DOE Loan Guarantee sought bankruptcy protection from creditors. The Stephentown facility supported by the loan guarantee is very unique from other 1705 projects in that it primarily sells "ancillary services" to the competitive power market, and has no long-term contract for its output.   See "Flying Under the Radar: Is there Profit in Grid Stability and Improved Renewable System Integration?". On November 18, 2011, Beacon Power settled with the Department of Energy's Loan Programs Office to sell the Stephentown facility by January 31, 2012.  See "Beacon Power Settles with Department of Energy Loan Programs Office."  Beacon Power is included under "Other Technologies" within Tables 1 & 2.

[10] Bradsher, Keith (2010). "On Clean Energy, China Skirts the Rules," New York Times, September 8, 2010