Some US renewable energy projects — including generation, transmission, distribution and energy efficiency projects — may have greater access soon to attractively-priced debt through a loan guarantee program run by the Rural Utilities Service.

Debt through the program can price as low as 12.5 basis points above Treasury yields.  

The RUS

The Rural Utilities Service is part of the US Department of Agriculture. It is not an experienced project finance lender. Nor does it cater to investor-owned utilities or private sector project developers. Yet, it represents the largest federal direct investment in the electric sector, manages an active electric loan portfolio of more than $44.5 billion, and, in 2012, had $6.5 billion in loan guarantee authority for electric generation, distribution, transmission and efficiency projects, of which $4.3 billion was used to guarantee 120 loans.  

As its name implies, the RUS is focused on rural America. It has been financing rural electrification and improvements in electric services to rural areas under the authority of the Rural Electrification Act since 1936. What started as a pure loan program has evolved to encompass three authorized financing options, each available in appropriate circumstances to both on-grid and off-grid renewable energy systems. The options are insured loans at the corresponding municipal bond rate, direct loans at the direct Treasury loan rate, plus 12.5 basis points and 100% loan guarantees, most often funded by the Federal Financing Bank with rates at 12.5 basis points above Treasury yields.  

Guaranteed loans made through the Federal Financing Bank dominate RUS financing today. In fiscal year 2012, RUS approved more than $4.33 billion in loan guarantees in contrast to $4.24 million in insured loans. The direct Treasury lending program is dormant.  

RUS has managed its portfolio prudently and managed to stay out of Washington’s political crosshairs. The program boasts a default rate of less than 1% and requires little budget beyond staff salaries and expenses.  

Given the size of its electric loan portfolio, and a mandate under the Farm Act of 2008 to fund renewable energy generating facilities serving mixtures of rural and non-rural customers, the RUS program would seem to have the potential to be a popular source of low-cost debt for renewable energy projects. However, RUS eligibility requirements and financing structures are major deterrents to many prospective project borrowers. Of the $4.33 billion in loan guarantees issued in FY 2012, only $278 million (less than 6.5%) went to four renewable energy projects (out of 120 overall projects).  

The RUS is under the gun to attract more renewable energy projects into the program and intends to make some major changes in order to do so.  

It has asked for comments by August 5, 2013 on proposed changes in how the RUS determines rural eligibility for its loans and loan guarantees and limits on the percentage of total project costs the RUS will finance when a project supplies electricity to an area that is only partially rural.  

The proposed changes also include special provisions for forprofit renewable energy projects and designate renewable energy applications as a loan processing priority. The agency is also looking for comments on the design of a proposed RUS project financing program.

How Rural?

Under existing rules, RUS loan guarantees are available only to applicants that provide or improve electric facilities to persons, businesses or other entities in a rural area with a population less than 20,000 (unless the area is otherwise grandfathered — see below). There is an exception for entities and projects to serve non-rural customers in cases where such service is “necessary and incidental” to the primary purpose of meeting the rural customers’ needs.  

The RUS has proposed instead that a project would be eligible for financing if it serves, directly or indirectly, any person in a rural area. In most cases, the percentage of rural customers relative to the total population in the service area determines a “rural percentage,” which, in turn, affects the percentage of project costs that RUS will finance.  

Under the new rules, the prospective borrower would select one of four methods to calculate the rural percentage that RUS will assign to a “hybrid” project, meaning one that serves both rural and non-rural customers. Two methods — based on the ratio of either rural meters to total meters or rural sales to total energy sales — require existing geographic information software data on meter locations in the service area that is then compared with US Census Bureau maps. Absent geographic data, the borrower may use Census data alone to estimate the percentage of rural customers. A fourth method, where the data is lacking for one of the other three approaches, requires a load flow study in and around the proposed plant site to estimate the degree of rural utilization.  

Today, if a project with a hybrid service area is eligible under the “necessary and incidental” exception, the RUS may fund up to the percentage of eligible project costs that correspond to the portion of the service area considered rural. If the required equity is insufficient to cover the difference between permitted RUS debt and total project costs, then another lender must fill the gap. An exception occurs if the power purchaser is an existing RUS borrower operating within its 2008 “rural” footprint, in which case the rural eligibility requirement is considered met and RUS may fund up to 100% of project debt.  

Under the new rules, RUS would finance up to 100% of debt for all qualifying projects in a hybrid service area until total RUS financing allocated to that service area reaches a newly-defined “rural cap” (or in some instances, a “financing cap” derived from the rural cap). Once the rural cap has been reached, the power company (borrower or offtaker) would be ineligible for additional RUS financing.  

Methods for determining the rural cap differ, depending on whether the applicant is seeking to finance a generation, transmission, distribution or energy efficiency project. The service area’s rural percentage is a key factor in setting the rural cap.  

Other Changes

The RUS program lending authority, history and selection criteria are skewed today toward well-established utilities, mostly non-profit rural electric cooperatives that serve rural communities. The agency is required by law to give preferential treatment to public sector and non-profit borrowers. RUS lending to privately-owned, for-profit applicants, while occasionally feasible, is rare.  

The agency is proposing to maintain a non-profit preference, but also to bring for-profit renewable energy developers (and their municipal, coop or investor-owned utility offtakers) into the RUS camp.  

For power plants, for-profit borrowers would still be subject to a more restrictive version of the financing cap, couched in state renewable portfolio standard terms, than are their nonprofit counterparts. A for-profit borrower’s financing cap will be the lesser of the rural cap and the state’s renewable portfolio standard (or 20% as a default cap for states that have not set an RPS), measured in terms of the offtaker utility’s peak demand or total energy sold.

The RUS could fully finance the project debt, with 20% to 25% of project costs being covered by equity.  

For example, a rural cooperative with an 80% rural service area and a coincident peak demand recorded at 1,000 megawatts would have a rural cap, measured in megawatts, of 800 megawatts. Accordingly, RUS would be able to provide 100% of debt for a given project or fleet of projects owned by the coop until the cumulative nameplate capacity financed by RUS in the service area reached 800 megawatts (the rural percentage times 1,000 megawatts). In contrast, an investor-owned utility with the same 80% rural service area, same coincident peak demand, and in a state without an RPS would have a financing cap of 20% times 1,000 megawatts or 200 megawatts. RUS would be able to provide 100% of debt for qualifying projects until the cumulative nameplate capacity financed by RUS reaches 200 megawatts.  

The same would hold true at the project level. For example, a 50-megawatt wind project applying for a loan guarantee secured in part by a long-term PPA with the coop described earlier would be subject to the coop’s service area cap of 800 megawatts. As long as the cumulative nameplate capacity financed by RUS in the service area was less than or equal to 750 megawatts, the project could borrow up to 100% debt. However, if the offtaker were the investor-owned utility described earlier, then the project could borrow up to 100% debt only to the extent that the cumulative nameplate capacity financed by RUS in the IOU’s service area was less than or equal to 150 megawatts.  

In contrast to power plants, RUS proposes no differences in financing caps for nonprofit and for-profit developers of distribution, energy efficiency and transmission projects.  

Renewable energy projects receive no special accommodations today in the applicant review process.  

Under the proposal, the RUS may give top priority to processing loan applications for generating facilities that use renewable fuel and to transmission facilities that deliver electricity from a renewable energy supplier.  

The agency has also proposed to revamp the basic program structure.  

Loans under the RUS loan guarantee program are generally made today at the power company level and are secured on a “system” basis. That is, RUS requires a first lien with full recourse to the borrower’s entire electrical system (not just the assets being financed) as well as its revenue streams and afteracquired property. For example, the RUS $14.6 million loan guarantee issued for the SMECO solar project was supported by a general repayment obligation of SMECO, the cooperative that owns the project. Similarly, RUS’s FY 2012 $151 million loan guarantee for the Woodville biomass project was made to the East Texas Electric Cooperative, the project’s owner and developer, which pledged all its assets to repayment of the RUS-guaranteed loan.  

In the case of a non-utility borrower, current policy provides for a “constructive system” loan where the developer signs a power purchase agreement with a utility and the utility offtaker guarantees loan payments as a partner-in-risk with RUS.  

Where a utility system is the borrower, construction financing is available from the RUS. For project-level commercial borrowers, the RUS generally disburses term financing only on commencement of commercial operation. Thus, the program is designed to refinance construction lenders following COD. However, because the Rural Electrification Act has been interpreted not to allow refinancing as a general matter, RUS can reimburse general funds or replace interim financing used for construction only if the project’s RUS-approved construction work plan anticipated an RUS takeout. Both Eagle Valley Clean Energy, LLC (the recipient of an RUS FY 2012 $40 million loan guarantee for an 11.5-megawatt woody biomass facility in Colorado) and Green Energy Team, LLC (the recipient of an RUS FY 2012 $72.8 million loan guarantee for a 7.5-megawatt woody biomass facility in Hawaii) had to line up commercial lenders to provide interim financing for (and to assume the construction risk of) their respective projects.

In the future, the RUS is considering a move to a “focused project financing program” for investments in electric generation, transmission and distribution facilities, “including plants necessary for generating electricity from renewable energy resources.” This means moving away from lending secured on a system-wide basis to lending secured by the assets of individual projects.  

Based on the topics the notice identifies for public comment, the RUS is looking at debt issued at the project level and secured by the project assets, with FFB loans for up to 75% of eligible project costs and a required minimum of 25% equity investment. The agency still does not intend to take on construction risk under the proposed program.  

Practical Considerations

The RUS program will by law continue to include a number of provisions not typically found in private sector financing, such as a review of each project pursuant to the National Environmental Policy Act.  

Although these reviews can vary in complexity, all are time consuming and involve additional cost. At best, project activities “categorically excluded” by RUS can get by without a formal review or with completion of an “environmental review,” the lowest level of RUS scrutiny. Projects not categorically excluded require a more detailed “environmental assessment” or a full-blown “environmental impact assessment.” The federal environmental review must be completed before the project starts any meaningful construction and, importantly, before RUS will process the loan application.  

Comments on the rural eligibility, financing cap and accommodations for project-level and for-profit borrowers were due August 5. The timing for issuing a final rule is unclear and depends on clearance from the Office of Management and Budget. Approval for the establishment of the project financing program, if it happens, will probably take considerably longer.