Establishing a Secondary Credit Market Crucial to Future Investment

By W. Bruce Crain | August 27, 2007
As the ethanol industry continues to grow, so does the need for additional financing. However, there is a lack of underwriting expertise with community banks and a perceived long-term risk associated with ethanol loans. If the number of renewable energy companies is to continue to grow, federal action must be taken to educate the lending community and provide banks with the tools needed to service the debt financing needs of the new companies.

Renewable energy financing has its roots in production agriculture and farmer cooperatives served by the Farm Credit System, which is a government-sponsored enterprise (GSE) created by Congress in 1916 to provide American agriculture with a dependable source of credit. However, more non-farmers are now involved in the development of renewable energy, and these entrepreneurs do not have access to the Farm Credit System member institutions. Instead, they rely on community bankers for financing. For the most part, "Main Street" lenders have yet to develop an understanding of the underwriting necessary for financing ethanol and biodiesel plants, anaerobic digester projects, wood pellets plants and other sources of renewable biomass energy. Little education has occurred to teach community bankers how to best determine the financial viability of a renewable energy project. Even with government guarantees provided by the USDA and the U.S. DOE, banks still perceive the risk to be too great and thus do not make funding available for these projects that in many cases could provide an important economic boost for their communities.

Some would argue that community banks "redline" these projects, much like banks were accused of doing with inner-city businesses and housing in the latter part of the 20th century. To overcome that obstacle, Congress and banking regulators established the Community Reinvestment Act (CRA). Enacted in 1977, the CRA is intended to encourage depository institutions to help meet the credit needs of the communities in which they operate. It also mandated lenders to demonstrate how they serve the underserved segments of their communities.

Banks argue that loans to renewable energy and other less conventional ventures have to stay on their books for years and lenders are thus subjected to market risks that many small banks are simply unable to absorb. Unlike mortgage and rural land loans, a "secondary market" that allows banks to sell these loans off to an entity like Fannie Mae or Farmer Mac does not exist. Banks argue that without a further way to mitigate risk, their participation in this new domestic industry will be limited. Creating a secondary market would "liquefy" these funds thereby freeing up bank capital that can be further invested in other renewable energy projects or commercial and residential ventures.

To overcome this obstacle to a steady flow of commercial credit for renewable energy, the following recommendations should receive serious consideration in Washington, D.C. First, Congress should work with federal and state financial institution regulators to expand the CRA requirements imposed on depository institutions to include loans made to entrepreneurs and companies commercializing renewable energy projects in their communities. This will entice and encourage lenders to learn how to make loans to these companies and produce much-needed debt financing for these projects.

Congress should also consider the creation of a secondary market for renewable energy loans that would mitigate some of the risk associated with long-term financing necessary for renewable energy projects such as ethanol, biodiesel and other ventures. This secondary market could be pursued in one of three ways:

› Expanding the charter of Farmer Mac or the Federal Home Loan Bank System to allow these GSEs to purchase renewable energy loans at a premium from lenders.
› Authorizing the establishment of the "Renewable Energy Government Loan Corporation (Reggie Mac)" that has a mission of purchasing renewable energy loans from lenders. As with other GSEs, these loans would be pooled, securitized and sold to investors who are interested in buying AAA-rated paper from other GSEs such as Fannie Mae and Freddie Mac. Pooling different types of renewable energy projects further helps mitigate risk and helps stabilize funding for future developments.
› Authorizing a study to be carried out jointly by the USDA and DOE to examine the feasibility of an in-house secondary market entity like Ginnie Mae that would be charged with purchasing renewable energy loans from lenders. Congress should require the departments to seek that advice and counsel of the Office of Housing Enterprise Oversight (Fannie Mae and Freddie Mac's Federal regulator) while conducting this study.

Finally, national renewable energy associations should work with federal banking regulators, USDA Rural Development, DOE, the American Bankers Association and other banking associations to offer underwriting education to teach lenders how to underwrite renewable energy loans.

Maintain Economic Development
If renewable energy continues to grow in this country, everything possible must be done to ensure that federally insured depository institutions such as banks, thrifts and credit unions are willing and able to provide the much-needed debt financing for renewable energy projects.
The banking community is essential to the economic development in our communities. To make sure mostly rural areas, where renewable energy plants are located, get access to debt and credit needed to run a business, we need to bring lenders into the renewable energy community as active participants. This must be done in a way that makes lenders understand the potential for this new and growing book of business. However, bankers must be provided with the underwriting education and lending tools necessary to serve renewable energy companies without damaging the stability of their own financial institutions. Doing so will make bankers become willing partners in this ever-growing segment of our economy that over the long term will be an important new customer base for the nation's depository lending institutions.
For this reason Congress and President George W. Bush's administration should act now to do the same for the renewable energy market that they did for other underserved segments of society. Banks should receive credit toward their CRA lending requirements for making renewable energy loans. Also, banks should be given access to a secondary market for renewable energy loans similar to the secondary markets that exist for housing and student loans. Mitigating risks is essential to any type of business, and providing the necessary incentives, education and financial support will allow banks to serve renewable energy companies without jeopardizing the viability of these local institutions that are essential to the economic stability and growth of our communities.

One would be hard pressed to argue that domestically produced renewable energy is any less important that a steady flow of credit for housing, student loans or farming operations. Therefore, necessary lending education needs to be offered, and legislation, policies and regulations need to be enacted to ensure that debt financing critical to successful commercialization of renewable energy companies is readily available from local lending institutions.

W. Bruce Crain is the president of Crain Consulting Inc., a renewable energy financial consulting firm based in Jackson, Miss. He has more than 25 years of experience in debt and equity finance, business development, management and government relations on the national and state levels. Reach Crain at [email protected] or (601) 957-3493.

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