SOURCE: Center for American Progress
Download this testimony (pdf)
Chairmen Whitfield and Stearns, Ranking Members Rush and DeGette, and members of the committees, thank you for accepting my written testimony.
I am Richard W. Caperton, the Director of Clean Energy Investment at the Center for American Progress Action Fund, a tax-exempt organization dedicated to improving the lives of Americans by transforming progressive values and ideas into policy.
The focus of this hearing is the “No More Solyndras Act.” In this testimony, I share my thoughts on the Title XVII Loan Guarantee Program and the “No More Solyndras Act.”
For more than a year, the House of Representatives has conducted an investigation into the Solyndra loan guarantee. In that time, you have received some 187,000 documents, held at least 10 hearings, and heard from dozens of witnesses, yet you have found no inappropriate or illegal behavior in the loan guarantee program. This hearing likely represents the culmination of your investigation and has informed the “No More Solyndras Act.”
My testimony explains why the loan guarantee program exists and describes the program’s history. I then show evidence that the program has moved innovative technologies forward while exposing taxpayers to minimal risk. Finally, I propose ways to improve the program by allowing it to fund many more projects with a full portfolio of financial tools and explain why the changes proposed in the “No More Solyndras Act” would be misguided.
Why does the loan guarantee program exist?
Right now, innovative companies—the key to our future competitiveness and economic prosperity—risk getting caught in the “Valley of Death,” where emerging and promising companies languish as they strive to accumulate the necessary funds. The loan guarantee program exists to bring companies across this valley by providing businesses with guarantees that will make it possible for companies to raise the necessary capital and to jumpstart the economy.
Bringing new clean energy technologies to commercial score can require hundreds of millions, even billions, of dollars and private investors are either unable to fund projects that require this much capital, as is the case with many venture capitalists, or are unwilling to lend money to projects that use first-of-a-kind technology not fully proven at commercial scale, as it the case with most banks.
This is why Congress created the loan guarantee program. Then, Congress expanded the program to deal with another pressing issue: the financial crisis. In 2009, there was no debt capital available for any projects, notwithstanding the “valley of death.” The loan guarantee program helped ease the credit crunch for clean energy and kept this important industrial sector alive during very challenging times.
Notably, when Congress created this program, they recognized that it’s important for this type of financing vehicle to exist at the federal level. While state governments have significant roles to play in advancing clean energy—and in many cases are leading the way—the federal government has unique strengths that make it the appropriate leader in helping technologies cross the Valley of Death. In particular, the federal government has the budgetary strength to support projects that cost hundreds of millions of dollars, which would overwhelm state capacities. The federal government also has technical expertise in energy technology and a long history of innovative financing tools that don’t exist in many states.
The loan guarantee program helped America compete in the global economy. In 2011 the United States invested more in renewable energy than any other country in the world, helping us capture our share of this trillion-dollar opportunity.
History of program
The Department of Energy Loan Program began in July 2005. President George W. Bush signed the Energy Policy Act of 2005 creating the Title XVII loan guarantee program. Even though the program was created and signed into law in 2005, implementation delays under the Bush administration forced the program to be operational in 2009 under President Barack Obama.
The Solyndra loan guarantee was a multiyear process beginning in 2006 when the company applied for a loan guarantee under the original loan guarantee program (also known as Section 1703), and in late 2007 the Bush administration DOE moved forward to develop a conditional commitment.
In an effort to show it had done something to support renewable energy, the Bush administration tried to take Solyndra in front of a DOE credit review committee before President Obama took office. The committee, consisting of career civil servants with financial expertise, remanded the loan back to DOE “without prejudice” because it wasn’t ready for conditional commitment.
The same credit committee approved the strengthened loan guarantee application. The deal passed onto DOE’s credit review board. Career staff (not political appointees) within the DOE then issued a conditional commitment setting out terms for a guarantee.
The American Recovery and Reinvestment Act, or ARRA, made a noteworthy commitment to deploying U.S. commercial clean energy technology in 2009 by appropriating $6 billion—which was eventually reduced to approximately $2.5 billion through several rescissions—to cover the credit subsidy cost for loan guarantees for renewable energy, advanced biofuels, and upgrades to our nation’s transmission system.
This new part of the loan guarantee program is known as Section 1705. It offers the program the ability to guarantee loans for anywhere from $40 billion to $120 billion depending on the types of projects in the portfolio. That’s because while each project is unique, an average project has a credit subsidy cost in the range of 5 percent to 15 percent of the total value of the loan guarantee.
A robust pipeline of projects closed at the end of September 2011.
DOE loan guarantee program results
Loan guarantee program moving clean energy forward
The loan guarantee program alone financed 32 projects in more than 20 states, ultimately creating 22,000 jobs directly. Best of all, the government only spent $2.5 billion to mobilize more than $20 billion in private capital.
Over the past three years, the loan programs have invested in some of the world’s biggest, most innovative, and most ambitious clean energy projects to date, supporting a balanced portfolio of American clean energy projects that are creating tens of thousands of jobs nationwide and are expected to provide power to nearly three million U.S. households.
Some examples of innovative projects that received loan guarantees include
- First Solar’s Antelope Valley, California, project will be the first utility-scale solar plant in the United States to incorporate thin-film technology on a system that tracks the movement of the sun. This technology will increase solar efficiencies and help make solar power more cost competitive. Antelope Valley, which will create 350 jobs and generate 230 MW of energy, received a $680 million loan guarantee.
- 1366 Technologies will reduce silicon waste in the solar manufacturing process, which will dramatically lower the price of solar panels. The company received a $150 million loan guarantee for a manufacturing facility in Massachusetts, which will create 50 construction jobs and 70 permanent jobs.
- Ormat Nevada is building three facilities—in McGinness Hills, Jersey Valley, and Tuscarora—which will produce clean and base load power through 20-year purchase agreements with Nevada Power Company. The $350 million project will produce 121 MW of power from the three facilities and increase geothermal production in Nevada by nearly 25 percent. The number of construction jobs created is estimated to be 332 with 64 permanent jobs upon completion of the projects.
- Record Hill Wind received a $102 million loan guarantee in August 2011 in conjunction with an investment by the Yale University Endowment after five years of planning. The wind project consists of not only a 50.6 MW wind power plant, but also an eight-mile transmission line and associated interconnection equipment near the town of Roxbury, Maine. The project is unlike the previous two wind projects for which the DOE guaranteed loans since the wind turbines are equipped with advanced monitoring software that improves performance. The project has been completed and the company made its first quarterly loan repayment.
Even projects without guarantees have benefitted from the process. For example, the due diligence process helped bring in a $1 billion investment from Bank of America for the largest residential solar project in U.S. history. The chief executive officer of the solar company deploying the project said that without the due diligence process that helped attract private lenders, “We would not have been able to make the economics of this project work.”
The same goes for the 550-MW Topaz project, a thin-film solar field being built in central California. The company originally building the project, First Solar, couldn’t secure a loan guarantee after moving through the approval process. But just two months later, the company was able to entice Warren Buffett’s MidAmerican Energy Company to invest in the $2.4 billion project.
Loan guarantee program protects taxpayers
Under ARRA, the DOE received appropriated funds to pay for credit subsidy costs associated with Section 1705 loan guarantees, which, after rescissions and transfers, was $2.435 billion.
As the Congressional Research Service puts it, “Section 1705 loan guarantees were very attractive as they provided an opportunity to obtain low-cost capital with the required credit subsidy costs paid for by appropriated government funds.”
This money covers any losses on loan guarantees. So, when a company like Solyndra goes bankrupt, there is money set aside to cover that loss. Fortunately, there is more than enough money set aside to cover losses we’ve already seen.
A chart created by Media Matters for America illustrates the amount Congress has budgeted for the 1705 program versus the current losses:
The current losses in this chart are from the $9 million for Beacon Hill, $535 million for Solyndra, and $60 million for Abound Solar.
Most of the remaining guarantees are extremely low risk, since they are for power generation projects that have long-term contracts with creditworthy utilities to buy the electricity. More than 87 percent of the DOE funds for the 1705 program went to low risk generation projects.
This finding that the program has made low-risk investments and is performing better than expected is confirmed by three outside analyses.
Congressional Research Service
Phillip Brown, author of the Congressional Research Service report Solar Projects: DOE Section 1705 Loan Guarantees concluded:
Each solar project supported by Section 1705 has a unique set of project, technology, and risk characteristics that require constant management. It is important to recognize, however, that Section 1705 solar projects fall into one of two categories: (1) solar manufacturing, or (2) solar generation. Risk characteristics for each category are distinctly different and solar manufacturing projects are generally considered higher risk than solar generation projects because the latter can use contractual mechanisms to reduce market, project, and financial risks. Whether or not Section 1705 solar projects will succeed is beyond the scope of this report. However, each Section 1705 solar manufacturing project will have to address the same market dynamics that may have contributed to Solyndra’s bankruptcy. Ultimately, the success or failure of all Section 1705 solar projects will likely be determined by the ability of each project’s management team to adapt to market dynamics and manage project risks.
Herb Allison
Herb Allison, former national finance chairman for Sen. John McCain (R-AZ), led a team of accountants and auditors in conducting an independent analysis of the loan guarantee program. Allison and his team found that, despite the hysteria around the now-bankrupt solar-panel maker Solyndra LLC, this program will cost $2 billion less than initially expected.
When the DOE first issued these guarantees starting in 2009, it expected that they would cost the government more than $5 billion. At its most recent internal analysis in 2011, the DOE concluded that the loans were performing better than expected, and that they would not cost less than $3 billion. Then in January of 2012, Allison and his team of independent consultants found that even the DOE’s most recent projections were too high, and that the guarantees would only cost $2.7 billion.
Bloomberg Government
The Bloomberg Government analysis of the Department of Energy’s 1705 loan guarantee program found that 87 percent of the portfolio is low-risk and that even if all 10 of the higher risk projects defaulted, we would still have nearly half a billion dollars left in the fund set aside by Congress to cover losses. Alison Williams, who previously served as a DOE analyst under both the Bush and Obama administrations, authored the report.
These independent reviews tell us everything we need to know about the DOE Loan Guarantee Program: It’s a good deal for taxpayers, and DOE staff has avoided exposing taxpayers to unacceptable risks.
There are ways to improve the program
The loan guarantee program is clearly an effective tool at moving the clean energy economy forward while protecting taxpayers. But, there are ways to improve the program. Rather than artificially constrain, Congress should recognize that this is a success story and improve the Loan Guarantee Program by allowing it to fund many more projects with a full portfolio of financial tools.
There are three important ways to improve the program:
- An improved loan guarantee program needs to apply a portfolio approach and have access to a range of financial instruments covering debt, equity, and insurance investments.
- The improved loan guarantee program’s portfolio of investments should be scored by the Office of Management and Budget on a product basis or using a pre-determined model, rather than deal by deal, thereby ensuring appropriate oversight while streamlining financial management.
- The improved loan guarantee program should be capitalized over five years on the scale of $10 billion to $20 billion, and the administration should actively work with congressional champions to assure an appropriate way to pay for it.
A suite of tools are necessary to improve the program
Different energy technologies and different companies have different types of risk and different return profiles. An improved loan guarantee program would have a suite of tools at its disposal, including debt, equity, and insurance tools.
Debt
Debt investors require a stable, fixed rate of return. Some clean energy projects will generate returns like this, particularly if they have some type of an off-take agreement—for example, an agreement from a utility to buy all of the power from a renewable electricity generation facility—for their energy. The government should provide debt instruments for these projects such as direct loans or loan guarantees.
The existing loan guarantee program is a useful example of the type of tool that’s required in this space. The Rural Utilities Service and Export-Import Bank both also provide debt financing.
There are important reasons for an improved loan guarantee program to offer both direct loans and loan guarantees. Direct loans require more up-front capital—to actually lend the cash, whereas a third-party lends the cash with a guarantee—which is a disincentive to their use. Direct loans also reduce the ability to rely on outside investors to analyze investments, which is a key part of the existing loan guarantee program through the Financial Institution Partnership Program, in which DOE only guarantees 80 percent of the debt and outsources much of the analysis to an outside bank. The Small Business Administration also uses this model.
Some government agencies, however, find that direct loans are preferable because they eliminate a profit-oriented middleman and allow for more control over the program. The Department of Education’s student loan program recently moved from guarantees to direct loans, for example.
Equity
Some clean energy technologies have returns that are less certain but potentially much higher. In these cases, investors are able to bear more risk in the hopes of earning higher returns. Clean energy companies that operate outside of a regulated rate environment, such as manufacturing facilities or advanced biofuels companies, are more likely to require equity investments, which provide a less certain but potentially richer return to the investor.
There are two significant challenges for the government in making equity investments. First, there is a high degree of risk in any equity investment, so the government will need to diversify across multiple technologies and projects. Second, there are very real concerns that government should not play a management role in companies and that government could potentially skew the playing field toward certain companies if the government benefits from certain companies’ profits.
There are several ways to protect against these concerns while capturing equity-like returns:
- Government equity investments can flow not to individual companies but toward funds that will allow the government to see equity-like returns but maintain an arm’s-length distance from individual companies. The Overseas Private Investment Corporation, the U.S. development bank, currently invests money in private equity funds along this model, as does the Small Business Investment Company program. The Clinton administration also adopted this same equity investment approach in its New Market Venture Capital program (that the Bush administration terminated). Legislation in the House in 2010 (HR 5297) created a Small Business Early-Stage Investment Program that would function in the same way.
- The government can take warrants in a company as part of a debt issuance. A warrant allows the investor to buy stock in a company at a predetermined price. Some deals in the Section 1705 program were structured with warrants as a risk mitigation technique: As the borrower hits certain milestones—and becomes less risky—the warrants are converted to straight debt. That way, the government’s return is always linked to the riskiness of the investment.
Insurance and warranty
Beyond the typical debt and equity investments, a clean energy financing entity could also drive investment by offering insurance products, such as performance guarantees for new technologies. A performance guarantee would protect against product failure over the life of an investment, which is a real risk when using relatively new technologies with expected lifetimes of up to 30 years. Generally, these insurance products would likely be low cost and could be targeted at specific risks that investors in certain technologies are unwilling to bear.
The financing entity could also offer insurance wraps, which make bonds sold through capital markets more attractive to investors by guaranteeing a certain return on the investment.
Use $10 billion to $20 billion to leverage more than $100 billion
An improved loan guarantee program should be capitalized over a period of five years to a level of $10 billion to $20 billion. This money can be used to cover the costs of $100 billion to $200 billion in commitments, meaning that every $1 in public spending will drive $10 in private capital investment. Public policy that leverages private capital investment is fiscally responsible, increases public benefit, and helps grow domestic jobs in American industries.
While it will be very inexpensive for the government, the improved loan guarantee program will likely not be a self-sustaining entity. Federal credit programs that operate at zero cost to the government are essentially just offering the right to borrow money at Treasury rates, while requiring that borrowers compensate the government for any risk involved in the loan. The improved loan guarantee program will bear a higher risk than these zero-cost programs, because companies that are commercializing technologies for the first time are unable to cover the costs of the risk. This means that the bank will expect to lose a small amount of money on each investment.
Based on experience with other energy credit programs, we estimate that it will take the improved loan guarantee program about five years to use the initial $10 billion to $20 billion in capitalization to make investments fully. At that point, policymakers may want to provide more funding.
Effective financing requires a portfolio or product approach to budgeting
The government will make some investments that perform worse than expected and others that perform better given the breadth of technologies and investment types a clean energy financing entity would support. The exact performance of any one investment in any one technology is unknowable in advance and is also unimportant. It is common practice in capital markets to manage such risk through diversifying investments across a portfolio. The same practice applies in establishing a green bank or other public finance mechanism.
Each investment should be analyzed independently, but the rules governing a financing entity should not be so stringent that they preclude investments in risky technologies.
Instead, these investments should be appropriately managed using proven portfolio strategies for risk mitigation so the overall risk and returns are in alignment.
Recent experiences with the DOE loan guarantee program show that the speed and velocity of lending suffered from complex OMB oversight at the transaction level. Because oversight is involved in every deal, guarantees move slowly through the DOE program.
OMB has strong and important authorities and must always have the right to exercise its oversight functions. But many other federal credit programs manage these risks differently and do not require deal-by-deal calculation of credit subsidy rates, which have been proven to paralyze these transactions—in some cases fatally.
One way to provide high standards of quality in underwriting without micromanaging transactions is to develop credit subsidy rates for similar transactions or loan and guarantee products rather than individual transactions. It is also possible to develop a pre-approved model jointly for evaluating credit subsidy that allows agency officials to determine the rate using approved methodology.
In this way, a portfolio or product approach can lead to improved government efficiency, consistent with common government credit practices and sound financial practice.
The “No More Solyndras Act” is misguided
Despite the fact that the Title XVII loan guarantee program has been a success and should be expanded, this committee is considering legislation that would effectively end the program, mandate unnecessary and duplicative consultations, and tie the government’s hands behind its back when it’s representing taxpayers.
This bill, the “No More Solyndras Act,” does three main things:
It sets a retrospective deadline by which applications have to have been received in order to be considered for loan guarantees. No application that was submitted after December 31, 2011, is eligible for a new guarantee.
It creates a new process for the Secretary of the Treasury to influence the outcome of a decision on a guarantee, and requires the Secretary of Energy to explain why he or she did or did not follow Treasury’s recommendation.
It says that taxpayers must always be the senior debt holder, even after a restructuring of a guarantee for a troubled company.
Each of these is a mistake.
First, not only is the deadline arbitrary, but it excludes any new technologies from receiving valuable financing assistance in the future. For example, small modular reactors, or SMRs, are one of the most promising nuclear technologies. Tidal and wave power are other rapidly developing technologies. Yet, when these technologies are ready for commercialization and need to cross the Valley of Death, they will be stranded because they didn’t apply to the loan guarantee program by December 31, 2011.
This makes no sense.
The government should provide equal opportunities to all technologies and companies, not just those that happened to have sent in paperwork by a certain date.
Second, the increased role for the Treasury Department is, at best, an unnecessary solution looking for a problem. The Treasury Department already weighs in on all federal credit programs. Further, this Committee has uncovered no evidence that the DOE has mismanaged this program, so it is not clear how more influence from Treasury would improve management. It is also important to remember that the Title XVII Loan Guarantee Program is fundamentally about investing in critical low-carbon energy sources.
The goal of this program is to make investments, but Treasury’s ultimate goal is to minimize risk to taxpayers. There is always some tension between making investments and minimizing risk. The rules governing federal credit, as laid out by Congress in the Federal Credit Reform Act of 1990, provide the right balance to this tension.
Changing Treasury’s role in this program would throw off that balance and set a negative precedent.
Third, the restructuring terms mandated by this bill do not provide the best outcome for taxpayers. The goal of a restructuring should be to minimize the amount of money that the government is likely to lose. While in many cases this can be accomplished by making the government the senior lender, this is not always the case. The government needs to be able to operate in sophisticated financial markets and in many cases subordination of federal debt is the only way to bring new investors into a troubled company.
Instead of requiring the government to adhere to certain terms in a restructuring process, Congress would be better off by requiring the government to pursue terms that provide the greatest likelihood that taxpayers won’t lose money.
None of the key provisions of this bill is a good idea.
I highly recommend that the committee take steps that will actually improve the loan guarantee program by allowing it to fund many more projects with a full portfolio of financial tools.
Download this testimony (pdf)
Richard W. Caperton is the Director of Clean Energy Investment at American Progress.