So Why Aren’t Commercial Banks Lending on Energy Efficiency?
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With all the talk about the strong business case of energy efficiency retrofits, why aren’t we seeing private sector commercial banks committing significant capital to the energy efficiency retrofits of buildings?
UNEP-FI thinks that they know the reasons why. Energy efficiency (EE) has been widely documented as the ultimate low-hanging fruit — yet commercial banks are leaving it dying on the vine. The famous McKinsey report, for example, indicates that energy efficiency should generate returns close to 17 percent. In the US, McKinsey calculated that EE could deliver close to 60% of all cost-effective emissions reductions in a scenario aiming for a 60-80% cut in emissions by 2050. The size of the untapped US energy service market is estimated at $160 billion. UNEP-FI has just published a report of its findings on this and related questions, based upon a survey conducted last year with its financial institution (FI) members. So you’ll get a more global view of bank perspectives on the topic, as opposed to just domestic US. Download report –>energy_efficiency-unep-fi (9) The responding FI’s attributed their lack of action on EE to problems with capital efficiency — how much it costs internally to lend on the often many small projects which typify energy efficiency measures. That’s typically a very expensive business process for large institutions, making them shy away from such business strategies. Then there are the knotty, interrelated problems of adequately identifying, mitigating and pricing the credit risks associated with the energy efficiency savings, which are more serious problems, in my view — and definitely worthy of a fuller discussion on a different blog post in the future. Here are explanatory excerpts from the report:
- Scale – individual projects are considered to be too small to be commercially ‘interesting’ for mainstream private-sector FIs…
- The “asset” problem – energy savings, which underpin the usual ESCO business proposition, are not a conventional ‘asset’ against which a bank will lend. In other words, cash-flow from energy savings is not a familiar form of revenue or collateral to back lending (although clearly any additional equipment provided would be an asset). This means that FIs, particularly local FIs, need to become familiar with the nature, as well as the performance and credit risks of energy savings financed projects in order to be comfortable with providing debt. Despite not being uniformly available, partial-risk loan guarantees aimed at reducing these risks and facilitating finance, particularly in developing countries, represent an effective approach.
- Lack of loan/credit guarantee mechanisms – linked to the above, loan/credit guarantee mechanisms can play a key role in facilitating finance, particularly for smaller scale ESCOs. Experience from some actors, however, indicates that the guarantee schemes that exist today are for larger amounts and involve a “tedious and long process for approval”. Developing lean credit guarantee mechanisms tailored to smaller-scale projects would help address this deterrent to energy efficiency lending activities.
At the end of the day, this report calls for more product development and sponsor education: banks should work to resolve the technical EE credit quandries along with raising EE to a board level action item. Board member education about the untapped market for energy efficiency for FI’s was strongly urged. That said, my view is that the issues regarding reliably assessing credit risk of EE savings and the development of adequate credit guarantee mechanisms for EE retrofit projects are two significant, hard-boiled issues that can’t be whisked away.
Take a look at the report and let us know here if you see it differently.
Talkback on Transwestern’s Energy Efficiency Program
I didn’t want this week to end without acknowledging a couple of comments from Green Journey readers on last week’s post about Transwestern’s energy efficiency retrofit program.
Turns out that there were some who had differing opinions than I on whether Transwestern’s efforts were worthy of the industry pacesetter designation that we’re so fond of around here. They backed up their opinions with some fair points worth noting. I like authentic exchange, so I’m printing their comments here.
Alex Brennan, Cannon Equities wrote:
I did want to point out one objection, and that is your equation of low first cost to short payback.
The issue Transwestern (and most other building owners) have right now is that they have to operate within a pre-established budget. Right now owners are seeing falling revenue as tenants vacate, downsize, or demand rent concessions, which leaves less money for capital improvements. Because of this lack of liquid capital, they are targeting the low cost points. Often times these low cost points do not provide ANY tangible increase to NOI, and therefor have the longest payback possible.
Often times the “dogs” that need the most work done (and thus the most upfront capital) will realize savings that far exceed the better run buildings, giving these improvements a shorter payback. The problem is, the first costs (I know most LEED consultants hate to consider first costs, but it is a real and very valid concern for those of us having to come up with the cash within tightening budgets) are prohibitive in these scenarios. One of the better options if this is the situation is to go to Pay on Performance type contracts and let the savings pay for the improvements over time (thus eliminating or reducing the first cost concern). I wonder if Transwestern considered this type of contracting before deciding to forgo the dogs?
Paul Maenner, JMW Development wrote:
You are slightly (but not by much) unfair to the guys at Transwestern. At the end of the day, if sustainability initiatives don’t pencil, most developer/investors aren’t likely to adopt. Keep in mind, when we attend conferences like this, the crowd is mostly self-selecting, all usually singing from the same hymnal. We all think/believe that we ‘get it’…
With all of this said, the Transwestern guys are hard-boiled, old-school real estate types who are seeing the value (MAI speak) of sustainability. That they have come this far is admirable and impressive. I think you could classify them as Pacesetters in that they have come to their conclusions based on solid, no-nonsense, practical analysis and implementation.
So Now It’s My Turn
Ok, guys, I see your points — and they are fair. My comments about Transwestern were driven by them explicitly telling the ULI audience that they didn’t want to be leaders [at energy efficiency retrofitting], which was frankly disappointing — commercial real estate, particularly value-add investing with its famous short-term horizon, needs lots of leadership around energy efficiency right now. Add to that the impression I got, that they seemed intensely focused on fulfilling the LEED-Silver checklist, but not particularly able to talk about sustainability efforts in any dimensions beyond that.
That said, they are in fact still ahead of the overwhelming majority of commercial real estate landlords when it comes to successfully applying portfolio wide energy efficiency programming, and that we would all be in a better place on energy efficiency if most landlords would just take the good advice they were dishing out at ULI last week.
Alex and Paul are right to bring up the realities of today’s value-added landlord and manager. And I think Green Journey readers like you should keep writing us to present that pragmatic perspective as they see fit.
Thanks to both of you for contributing.
