This is Part III of a multi-part series on why we should get serious about launching a green bank in Georgia. If you missed Part I, you can find it here or Part II here.
Part III – Putting Capital to Work
As hard as it was to pass the Inflation Reduction Act (IRA), the most challenging part of any spending legislation is ensuring it achieves the desired goals. Despite the name, for the IRA, the goal is accelerating the transition to a low-carbon economy. As mentioned in Part I, the IRA’s targeted spending and tax credits will catalyze $11 trillion of infrastructure spending, but it won’t be evenly distributed. States are competing to lead a new and rapidly growing sector and Georgia is off to a killer start. However, long-term winners must build out the entire ecosystem and support existing businesses, start-ups, and relocating or expanding enterprises not just one or the other.
A majority of net job creation in the U.S. comes from growth-oriented small businesses. If you ask many of those business owners what they need to keep growing, they will tell you people and money. The people side of that is critical but will have to be the topic of another deep dive. The money side is where green banks can play a significant role.
Green banks, like CDFI and other non-banking financial intermediaries, exist to fill the gaps in our financial markets. As noted earlier, a sizable divide (or Valley) exists between venture capital and Wall Street. The same can be said about the gap between venture capital and project finance. As the 20+ year cleantech investing veteran Rob Day put it, “Venture capital races to be the first to do something, whereas project finance races to be the 10th”. Driving the divide is a dramatically different level of risk tolerance. A key to bridging that divide is understanding the needs of the businesses and the concerns of the investors. For the low carbon transition, a green bank can play the role of interlocutor and bring capital to catalyze more investment.
Another large gulf is the size of the projects requiring financing and the transaction costs of large investors. Let’s take electric vehicle (EV) charging equipment as an example. The “deployment of one 75-kilowatt DC fast charger could range between $100,000 and $150,000,” with much of that cost coming from site improvements, not the equipment itself. That means the collateral for a loan is insufficient (and not standardized enough yet) for most banks. Yet, the financial need is too low to cover transaction costs for many specialized investors. The need for public-private partnerships and intermediation to bridge the gap is well documented and broader than just EV charging. This is an important example for Georgia in particular. Despite our emergence as an EV manufacturing hub, transportation is now Georgia’s largest source of emissions. Green banks can intermediate public-private partnerships (PPP), and for EV transportation, there has never been a better time for them to serve in that capacity.
This is just an example of the benefits of having a green bank in Georgia. The actual tools that a green bank in Georgia would leverage will be based on the amount of capital available and the mandates associated with that capital. They will evolve as incentives, capital, and political priorities adjust. Nevertheless, the vast toolbox at a green bank’s disposal makes them versatile enough to respond to the needs in nearly any geography.
It is useful to generalize the market gaps that green banks seek to bridge and put them into broad categories. These are issues that nearly all markets face but are particularly painful where innovation or new markets are concerned. The innovations leading the low-carbon transition are no exception.
Low Liquidity
Liquidity, in this case, refers to the ability of an investor to quickly sell a financial asset (like a loan, security, or mortgage) for cash. In most cases, the faster and easier it is to sell a financial asset, the cheaper and more accessible it will be. Low liquidity means that new technologies and markets often face higher capital costs and fewer options. Intermediaries can play a significant role by offering to buy financial assets or by providing additional low-cost capital to investors.
High Costs
Risk premiums are the additional returns sought by investors for perceived risk. The result is higher capital costs for innovations and new markets where investors lack experience or track record. Intermediaries can provide credit enhancements that reduce the cost by absorbing initial losses or reducing the overall capital requirements.
Limited Capital
Where existing investors have not stepped in, intermediaries can create direct investing tools. These tools either underwrite risks that existing investors won’t or can’t do themselves or inject additional capital into a stagnating market. Intermediaries should be cautious not to compete with private investors and instead design direct investing products that clear a path for private investors to join.
Information Asymmetry
Information Asymmetry often refers to market conditions where both parties don’t have an equal understanding of the risks in a particular transaction. There is always asymmetry in investing, and risk premiums factor that in. However, with innovation, new policies, emerging marketplaces, or underinvested communities, the information asymmetry can lead to complete market failure. In these cases, non-financial intermediation tools or technical assistance can play a significant role. On the business side, intermediaries can help prepare management for requesting investment through standardizing documents, data collection, and reporting in advance. For investors, education through case studies, information sessions, and site visits can play a key role. The focus of the intermediary should be to illuminate the risks so premiums can adequately reflect the market.
Intermediaries like green banks are innovating the tools they use at a break neck base, especially when it comes to the low-carbon transition. New financial tools like carbon credits and offsets have created new opportunities that many traditional investors have yet to grasp. The table below illustrates some of the more common tools used to today, and is intended to be a living document that evolves as the industry continues to innovate. The real advantages of green banks are the dedicated teams they employ and the flexibility they are given to meet the market needs. Innovation is expected.
| ISSUE | PRODUCT | DESCRIPTION | PURPOSE | ||
|---|---|---|---|---|---|
| Low Liquidity | Loan Acquisition (hold until term) | Acquiring loans originated by other lenders with the intent of holding until term. | Smaller lenders can lack the capital or loss reserve coverage to continue lending, in particular lenders extending longer-term loans. In areas where there aren't many lenders this can hamper business growth. | ||
| Aggregation (loans/leases) | Acquiring loans and leases originated by other lenders with the intent of reselling them or repackaging them as a security. | Lenders, in particular non-depository financial institutions, provide vital credit to consumers and businesses but often can't continue to provide capital without selling existing loans and leases at a margin. | |||
| Warehousing | Loan or Line-of-Credit for lenders with long-term lending products. Intended to bridge the gap between loan origination and securitization. | Enables lenders to use loans as collateral for new capital while they are being packaged into securities and resold. | |||
| Securitization Guarantees | Providing a partial guarantee against loss in value associated with a collateralized debt obligation or similar security whose value is based on a group of loans, leases, or similar payment obligations. | Enables investment banks or other licensed security brokers to create and market securities backed by payments from credit obligations associated with innovations that are not universally understood. | |||
| High Cost | Loan Guarantee | Guarantees against default or loss for all or a portion of a loan in return for a premium. | Allows commercial lenders to make loans with lower interest rates/fees for innovations or markets where they haven't fully established a viable risk premium. | ||
| Subordination | Loan or Line of Credit that is paid after, or subordinate to, financing from another provider. | Reduces risk for lenders with concerns that the value or marketability of collateral will prevent them from recovering sufficient capital in case of default. | |||
| Interest Rate Buy-Down | Payment to a lender in exchange for lower interest rate for the borrower. Rate may adjust over time. | Ensures that loan payments and overall cost are affordable to borrowers. In particular those who may not otherwise be able to afford them. | |||
| Tax Credit Financing | Payment to borrower in exchange for assignment of tax rebate or credit. | Provides upfront capital to borrower, reducing the amount of loan capital needed, in exchange for tax credits or rebates that can be aggregated and resold. | |||
| Carbon Offsets | Payment to borrower in exchange for assignment of carbon offsets generated by the purchase or project. | Provides upfront capital to borrower, reducing the amount of loan capital needed, in exchange for carbon credits or offsets that can be aggregated and resold. | |||
| Limited Capital | Refinancing | Providing borrower with capital to pay-off existing high-interest financing. | Improves lender liquidity and, more importantly, the balance sheet of borrowers allowing them to continue to grow. | ||
| Revolving Credit | Short-term, revolving credit or loans for requiring expenses. | Enables businesses to grow more rapidly by providing capital for inventory or expenses that traditional lenders are unwilling to cover. | |||
| Bridge Loans | Short-term financing offered in advance of, and paid off by, an anticipated loan or investment. | Enables borrowers to continue growth despite a delay from lenders that is expected to be resolved with time. | |||
| Term Loan | Loan either with or without collateral offered to a businesses with need for growth capital. | Offered in cases where existing lenders have not found a commercially viable way to extend credit for an innovation or underserved market. | |||
| Green Bond Guarantee | Guarantee for payments or principal of a Bond offering that supports low carbon innovation or activities. | Helps overcome the lack of marketability of innovative "green" or "blue" bonds by reducing risk for investors who purchase the bonds. | |||
| Fund of Fund | Investment in emerging private equity or venture capital funds. Investment can be in the Fund Manager (GP) or the fund vehicle. | Catalyze investment in pre-commercial innovations in sectors or markets where more traditional institutional investors are nor comfortable yet. | |||
| Information Asymmetry | Standardization & Data Collection | Standardization of lending practices, performance metrics and reporting. | Reduce perceived risk by commercial lenders through performance comparisons over time and simple, standard benchmarks. | ||
| Solution Validation | Working with partners, and experts to pilot, test, collect and analyze data in hopes of validating promising innovations. | Provide validation, benchmark data and case studies for promising innovations to improve adoption and availability of capital. | |||
| Capacity Development/Technical Assistance | Provide grant support to borrowers to improve growth and impact. | Improve management and performance of businesses through free or low cost advisory services. | |||
| Consumer Education | Community education and advocacy. | Serve as a credible, centralized source of information for promising innovations and underserved markets. | |||
| Advocacy and Policy | Elected official and regulator education. | Ensure that legislators and government administrators have sufficient knowledge of the benefits of key innovations and the opportunities in underserved markets. |