onvened early this fall by the KPMG Global Energy Institute and DLA Piper, a Webcast on the U.S. Department of Energy’s loan guarantee program offered guidance on the DOE’s own guidance concerning tax credits and loan guarantees.
      The panel featured John Gimigliano, a principal in KPMG's Washington National Tax practice; Jeremy Panacheril, who leads U.S. Commercial Due Diligence to the cleantech and renewable energy market at KPMG LLP; and Gary Klein, a Partner in the Federal Affairs and Legislative Practice of DLA Piper.
      First Klein, who helped form a good bit of energy industry infrastructure in the nation’s capital in the 1970s, briefed participants on the amendment to the Energy Policy Act of 2005 (EPACT) made by the American Recovery and Reinvestment Act of 2009 (ARRA), which added Section 1705 to provide “temporary” loan guarantee authority for the rapid deployment of (1) renewable energy projects that generate electricity and facilities that manufacture related components; (2) electric power transmission systems, and (3) cutting-edge biofuel projects. In addition, ARRA appropriated $6 billion to cover DOE’s credit subsidy cost and remove this cost from applicants’ responsibility, reported Klein.
      DOE’s first soicitations under ARRA came in late July 2009, with up to $2.5 billion in credit subsidy costs for renewable energy, advanced electric power transmission and leading-edge biofuels projects that employ a new or significantly improved technology that is not a commercial technology, and up to $750 million in credit subsidy costs for large transmission infrastructure projects that use commercial technologies and commence construction by September 30, 2011 (Part I applications were due September 16).
      Importantly, an additional $750-million solicitation for commercial renewable projects, with greater lender participation, came the day after the Webcast, on Oct. 7, 2009. DOE estimated its funding to cover the cost of loan guarantees, through its Financial Institution Partnership Program (FIPP), could support between $4 billion and $8 billion in lending to qualified projects, in such categories as wind, biomass, geothermal, landfill gas, trash-to-energy, hydropower and solar.
      “This was originally in the 2005 energy act, but remarkably no loans closed until Solyndra,” said Klein, referencing a large solar industry project in California that received the guarantee offer in March 2009 and saw it finalized and followed by a second fab plant announcement in fall 2009. “It’s worth noting that during the summer, as Cash for Clunkers had a run on it, they borrowed $2 billion not used in the ARRA program and put it in Cash for Clunkers, with assurances it would be replenished. It has not been replenished thus far.”
      Among the new stipulations brought on by the ARRA amendment is the requirement that construction begin by Sept. 30, 2011. Accordingly, cautioned Klein, one must “be confident construction may begin, because if it does not, and there’s no change of law, the loan guarantee would evaporate.”
      The review criteria are half technical and half financial. Klein reminded his audience why the Office of Management and Budget (OMB) was primarily interested in seeing loans repaid: “The only other time the energy administration had loan guarantee authority was with synfuels,” he said. “Several billion dollars was lost, and OMB does not want to repeat that experience.”
      Technological diversity is a non-weighted criterion, “so to the extent it’s unusual, that will be a non-weighted positive factor,” said Klein.
      Seven rounds of review will ensue through December 2010, with early filers getting priority review. Application fees are expensive, and thus a disadvantage for relatively small projects. For loans of up to $150 million, for example, total application fees come to $75,000. Origination fees for project loans between $150 million and $500 million total $375,000 plus 0.75 percent of the guaranteed amount. What’s more, a guarantee maintenance fee can range from $50,000 to $100,000 annually.       Klein offered some perspective on how the program has acquired some new momentum:
      “When Secretary [Steven] Chu came in, early on he banged some heads together and was appalled that no loan guarantees had been issued under EPACT during all that time,” he said. “Almost embarrassingly, DOE has still not issued a single solicitation for renewables, and the DOE has only concluded one loan guarantee generally, to Solyndra last month. They have expanded analyst staff, but don’t have much to show for it. DOE really wasn’t set up to do this kind of work. It was engaged in debate with OMB almost since enactment.”
      While efforts have been made to streamline the process and involve private lenders more actively, said Klein, those lenders have stayed on the sideline, primarily because DOE has first lien on all project assets.
      “That made it very difficult for private lenders to come in in a subordinate position,” he said. “There is a change in regulations — the draft came out in August — that will change this, and provide for a sharing of collateral among lenders.”
      Indeed, the changes received feedback from 2,100 parties, and were reflected in a final rule issued by DOE on December 7, 2009. “Under the rule change, the Loan Guarantee Program will be able to consider financing projects together with other lenders and will be able to provide loan guarantees to projects with multiple participants (who may hold undivided interests in a project),” said the DOE release. “As an example, export credit agencies and other financial institutions will now be able to provide financing to complement Title XVII loans and loan guarantees. This approach will result in lowered risk and potential costs to taxpayers.” Copies of the proposed rule are available from the Department’s Loan Guarantee Program.
      Klein pointed out that the “Buy American” provision of ARRA is limited to the construction, maintenance and repair of a public work or building. “We may have to seek waivers in certain contexts, but for the most part, private projects that are renewable energy, electric generation or component manufacturing should not trigger the ‘Buy American’ provisions.” However, the Davis-Bacon prevailing wage law will apply in the construction phase.
      Meanwhile, given that the guarantees are oriented toward cutting-edge innovation, some have expressed natural concern about disclosure of intellectual property details to the federal government.
      “The DOE has made it clear that as long as you require proprietary treatment, they will not provide it to the public,” said Klein. “Every applicant, particularly those with important IP, should apply with clear indications in the application that either the entirety of the application or specific components is confidential business property and should not be disclosed. It’s extremely unlikely DOE would be forced to disclose this under a FOI [Freedom of Information Act] request or lawsuit. Applicants can feel quite comfortable that while this information will be disclosed to DOE and its consultants, it will not be disclosed publicly.”       Also central to the nature of innovation is relatively unproven technology. But to get a loan guarantee, and to satisfy the OMB’s cardinal requirement of loan repayment, it had better be proven enough.
      “DOE has set a minimum of 1,000 to 2,000 hours of operating data,” said Jeremy Panacheril, noting that the hours should pertain to the specific technology in the application. “From a strategic point of view, the level of commercialization will be driven in part by its peer group” and there is likely going to be a preference for technologies with proven history. “It’s a challenge for any applicant to balance these two,” he said. Another balancing challenge is off-take provisions: DOE has said those that do not have off-take provisions will be considered disfavorably. And applicants are grappling with needing to show need for financing vs. needing to show that customers are lined up and ready to go.
      “If you’re a manufacturing applicant, it’s a whole different set of possibilities,” said Panacheril. “If you’re funding a project, it’s difficult to secure an off-take arrangement. If you’re in manufacturing though, look at the lithium-ion industry in automotive. It’s new, but they have a place in the electric hybrid vehicle, so it was easier to prove it had viability. Also, though we’re talking here about loan guarantees, there is a variety of funding opportunities, and aligning your business strategy to the various funding options available is ultimately what any application ought to do.”
      Klein reminded listeners that such things as off-take agreements and equity commitments will determinee whether applicants apply in Round 1 or later. “It’s a balance that has to be struck by applicants, in terms of not filing too early before you have those agreements lined up,” he said.
      “The other lever the applicant needs to pull is the public benefit lever,” said Panacheril, noting that a DOE inspector concluded a recent report with a note on the lack of specific metrics around job creation.
      “They would prefer projects that have a greater equity,” he said. “They’re looking for some sort of revenue stream over the life of the loan. Applicants will really need to have a strong showing of how they’re going to get their equity — letters of credit from sponsors, or some evidence of credit quality. Not only availability, but that it will be there at the required time. The guaranteed portion of debt should not exceed 80 percent of project costs.”
      Klein added that contingent letters of support are not preferred, but will be accepted, as long as the equity is irrevocably committed.
      “I’m given to understand DOE will only guarantee one loan for a specific technology,” Panacheril said. “Private markets will have to kick in. And if the project investment is greater than $25 million, they will will need a rating.”
      “True,” said Klein, “and let me add you need a project credit rating or a credit rating for a company, and that’s an expensive proposition also. It’s at least $100,000 from one of the three national credit rating agencies that are being pressed right now. The regulations actually said a project less than $25 million did not need to have a credit rating, but it’s become apparent that the costs of the entire process are such that it becomes extremely expensive to finance a loan of $25 million or less. DOE is in discussions with OMB to come up with a small business lending program. I’ve been in some of these discussions. It’s not going to come out in the immediate future, but hopefully by 2010, so that lenders can make most determinations on a much quicker basis than DOE could on smaller loans.”
      Regarding loan size, asked Gimigliano, “Is there a scale at which it’s hardly worth it? A number?”
      “$25 million is probably a level at which the costs become too high for the scale of the project,” answered Klein. “I don’t think there’s another number at which it becomes magic and the costs become reasonable.” That said, “it’s so difficult to get debt today and certainly you can’t get debt for the rates of these loans, which may be 50 basis points over Treasuries. Even with private lenders taking a piece of it, the rates are far lower than those available to most of these projects. At a $50-million level, it becomes worth reviewing your possibility of doing this.”       Technical talk is worth heeding whether it applies to these applications or to definitions in other federal programs.
      Loan guarantee applicants will also need to discuss how the technology constitutes a significant improvement over existing technologies, including such matters as cost or greenhouse gas emission avoidance, etc. “Another factor that a lot of applicants don’t consider is that the DOE said applicants will have to discuss mitigation of technology risk,” said Panacheril. “DOE is also very keen that applicants provide clarity on the roles of key staff and employees. You have to have a very detailed financial model with a thorough explanation, allowing analysts to understand the model and test it. The same applies on technical factors — show how the technology is going to play out and work. You need to show how the technology fits on a commercial basis relative to its competitors. Many applicants will need to commission a variety of tests.”
      Meanwhile, there are other opportunities for applicants, such as tax breaks in clause 48C of the stimulus bill. Some projects may qualify for both. And Panacheril reminded listeners of the panoply of state incentives also available for their projects.
      “Look at the advanced [energy] storage applications last fall,” he said. “Many lithium-ion manufacturers [come from] traditional manufacturing in Japan, Korea or China, where the DNA of that industry exists. Many of those early-stage companies looked at their opportunities, looked at the lever to pull by applying for grants from the State of Michigan, and on top of that allowing knowledge transfer into the U.S. You can have incentives at a variety of different levels.”
      “This has nothing to do with foreign ownership, which is not in any way a disqualification,” added Klein. “State and local benefits can be used to a major advantage, and indeed it makes good sense to develop state, local, union or other forms of support for your project, political or technical. It will be very useful when DOE evaluates it relative to others.”