BILL ANALYSIS Ó SENATE GOVERNANCE & FINANCE COMMITTEE Senator Lois Wolk, Chair BILL NO: SB 1121 HEARING: 4/24/14 AUTHOR: De Leon FISCAL: Yes VERSION: 4/10/14 TAX LEVY: No CONSULTANT: Grinnell CALIFORNIA GREEN BANK ACT Enacts the California Green Bank Act, which creates the California Green Bank. Background and Existing Law When public agencies issue bonds, they essentially borrow money from investors, who provide cash in exchange for the agencies' commitment to repay the principal amount of the bond plus interest in the future. Bonds are usually either revenue bonds, which repay investors out of revenue generated from the project the agency finances with bond proceeds, like a parking garage, or general-obligation bonds, which the public agency pays out of general revenues and is guaranteed by its full faith and credit. State law authorizes several authorities within the State Treasurer's Office to issue conduit bonds, whereby a public agency sells a bond, then loans the proceeds to a nongovernmental borrower, such as a hospital or factory. Only the nongovernmental borrower's loan repayments secure the bond. In addition to the above, the state authorizes the California Infrastructure and Economic Development Bank (I-Bank) to support economic development and public and private infrastructure investments through its authority to issue bonds, make loans and, provide credit enhancements. The I-Bank manages several programs, including: The Infrastructure State Revolving Fund Program (ISRF) provides low-cost financing to local agencies for public infrastructure projects. The Industrial Development Bond Program (IDB) provides tax-exempt revenue bond financing for eligible manufacturing and processing companies. The 501(c) (3) Revenue Bond Program offers SB 1121 (De Leon) - 2/19/14 -- Page 2 tax-exempt revenue bond financing for certain nonprofit, public benefit corporations. The Exempt Facility Bond Program provides tax-exempt financing for projects that are government-owned or consist of private improvements within publicly-owned facilities, such as private airline improvements at publicly owned airports. The Public Agency Revenue Bond Program provides tax-exempt and taxable bond financing to specified programs for state and local governmental agencies. Housed in the office of the State Treasurer, the California Alternative Energy and Advanced Transportation Financing Authority (CAEATFA) provides financing through conduit or revenue bonds, loan guarantees, loan loss reserves and a sales and use tax exemption for facilities that use alternative energy sources and technologies. While the Legislature created CAEATFA in 1980, it didn't do much until 2008, when Governor Arnold Schwarzenegger and State Treasurer Bill Lockyer announced that CAEATFA would use its existing authority to grant sales and use tax exemption for normally taxable manufacturing equipment purchased by Tesla Motors under a sale-leaseback agreement. Subsequently, the Legislature directed CAEATFA to administer three new programs, in addition to its conduit bond authority: A $10 million loan loss reserve program that directs the state to reimburse the original mortgage lender for the costs associated with the Property Assessed Clean Energy program assessments during a foreclosure (SB 96, Committee on Budget and Fiscal Review, 2013). A $25 million loan loss reserve program to backstop loans made by participating financial institutions for energy efficiency improvements and distributed generation technology (ABx1 14, Skinner, 2011). Sales and use tax exemptions for manufacturers of renewable technology (SB 71, Padilla, 2010), and advanced manufacturing (SB 1128, Padilla, 2012). Also housed in the office of the State Treasurer, the California Pollution Control Financing Authority deploys federal funds for commercial PACE projects, and a collateral support program for business loans. Proposed Law SB 1121 (De Leon) - 2/19/14 -- Page 3 Senate Bill 1121 enacts the Green Bank Act, to provide financial assistance to: Otherwise commercially viable projects, which are not currently able to obtain financing in capital markets at reasonable cost with a reasonable rate of return to a clean energy project developer, and Evaluate and coordinate support for innovative energy technology projects not currently able to obtain financing to achieve commercialization. The bill creates two divisions within the California Green Bank: The clean energy division which oversees all clean energy projects, and The innovative energy technology division, which oversees the innovative energy technology project. I. Financial Instruments. The Green Bank can issue bonds, including structured, subordinated bonds or other securities, loans, notes (including revenue, grant, and tax anticipation notes), commercial paper, floating rate and variable maturity securities, and any other evidences of indebtedness or ownership, such as asset backed certificates, lease-purchase or installment purchase agreements, or certificates of participation, for clean agriculture projects, clean energy infrastructure projects, clean energy projects, demand response projects, energy efficiency projects, innovative energy technology projects, low-carbon transportation projects, renewable energy projects, and system efficiency projects, as defined. Bonds can be in any form, denomination, or interest rate the Bank determines, but cannot have a maturity of more than 50 years. Bond repayment is solely the responsibility of the bank, and is not backed by the full faith and credit of the state. Each bond must have on its face a notice to that effect, in addition to the aggregate face amount. The Bank must issue bonds according to a competitive bidding process that encourages aggressive bidding. The Bank must establish a competitive program for loans, loan guarantees, securitization, insurance, portfolio insurance, and other financial assistance, for clean energy projects. As part of the process, the Board may set lending guidelines such as maturities and interest rates. Any public or private entity can apply, and the Board shall SB 1121 (De Leon) - 2/19/14 -- Page 4 establish guidelines and criteria to choose projects for financial support that comply with the following criteria: Maximizing economic, environmental, and public health benefits to the state, Fostering job creation by promoting the reduction of greenhouse gas emissions by California workers and businesses, Complementing efforts to improve air quality, Directing investment toward the most disadvantaged communities and households in the state, Providing opportunities for business, public agencies, nonprofits, and other community institutions to participate in and benefit from statewide efforts to reduce greenhouse gas emissions, Lessening the impacts and effects of climate change on the state's communities, economy, and environment, Funding to reduce greenhouse gas emissions through energy efficiency, clean and renewable energy generation, clean and renewable energy generation, distributed renewable energy generation, energy transmission and storage, Funding to reduce greenhouse gas emissions through the development of state-of-the-art systems to move goods and freight, advanced technology vehicles and vehicle infrastructure, advanced biofuels, and low-carbon and efficient public transportation, Funding to reduce greenhouse gas emissions associated with water use and supply, land, and natural resource conservation and management, forestry, and sustainable agriculture, Funding to reduce greenhouse gas emissions through strategic planning and development of sustainable infrastructure projects, including, but not limited to, transportation and housing, Funding to reduce greenhouse gas emissions through increased diversion of municipal solid waste from disposal through waste reduction, diversion, and reuse, Funding to reduce greenhouse gas emissions through investments in programs implemented by local and regional agencies, local and regional collaboratives, and nonprofit organizations coordinating with local governments, Funding in research, development, and deployment of innovative technologies, measures, and practices related to programs and projects funded pursuant to SB 1121 (De Leon) - 2/19/14 -- Page 5 this part, Creating robust private markets for low-carbon technologies. The Bank shall only provide financial assistance if the project is: Located inside the state, Can support a commercial rate of debt adjusted for the bank's lower costs (except in the case of an innovative energy technology project), The requested financing support is secured as the chief executive officer of the bank determines appropriate for the sector and the project, The project satisfied the terms of the Greenhouse Gas Reduction Fund Investment Plan and Communities Revitalization Act, and The project is consistent with any criteria, priorities, and guidelines issued by the bank. The Bank also must determine one or more of the following to fund a project: The bank's participation enables otherwise creditworthy and commercially viable entities to deploy clean energy projects at a reasonable cost with a reasonable rate of return to the project developer. The financing will facilitate deployment of a clean energy project at an accelerated rate. The financing support will stimulate, aid, or otherwise support manufacturing of finished products or component parts used in an innovative energy technology project located within the state. The financing support is necessary to create liquid markets for energy securities. The financing support otherwise addresses barriers that have prevented adequate commercial financing of clean energy projects. The Bank shall allocate between 15% and 30% of its capital to fund innovative energy technology projects. The bank can provide convertible debt or warrants for these projects, including nonvoting equity or membership interest in projects or developers. In the event of default, the bank can complete, maintain, operate, lease, or otherwise dispose of any property it acquires pursuant to a guarantee or related agreement, and direct the sponsor or developer to continue to pursue the purposes of the project if the SB 1121 (De Leon) - 2/19/14 -- Page 6 bank determines it to be in the public interest. The bank may fix and collect insurance premiums and loan loss reserve contributions adequate to cover the financial risks associated with the bank's financing support programs. The Bank must use clean energy development networks to identify projects, including creating advisory committees of public and private stakeholders. The Bank will endeavor to coordinate with existing clean energy research, development, and deployment programs. The bank also can facilitate financing transactions in the tax equity market. Any recipient of funds from the Bank shall certify that its contractors are properly licensed, and apply for financial assistance in the form and manner required by the board. The bill exempts interest paid on bonds from state taxation; however, federal taxes would still apply. II. Bank Board. SB 1121 creates the Green Bank Board, composed of: Three members appointed by the Governor, One member appointed by the Senate Committee on Rules, One member appointed by the Speaker of Assembly, One member appointed by the State Treasurer, One member appointed by the Director of Finance, One member appointed by the California Public Utilities Commission, One member appointed by the California Energy Commission, One member appointed by the State Air Resources Board, One member appointed by the Department of Water Resources, Members appointed by the Governor, Senate Committee on Rules, and Assembly Speaker must have private sector financial experience. The measure directs the Bank to stagger terms of two, three, and four years after the first four-year term, provides that members can serve after their terms expire under specified circumstances, and enacts other provisions for appointments. The bill applies the Political Reform Act to board members. III. General Powers. SB 1121 creates the Green Bank as an SB 1121 (De Leon) - 2/19/14 -- Page 7 independent entity within state government. The measure also creates the California Green Bank Fund within the State Treasury, which is continuously appropriated to the Bank, which can draw on it for the purposes of the bill. Additionally, the bill allows the Board to: Adopt and amend bylaws, Adopt an official seal, Establish committees and subcommittees, Sue or be sued in its own name. Purchase insurance for itself or its fiduciaries for acts or omissions, so long as it allows recourse against the fiduciary for breach of obligation. To receive a salary of an unspecified amount. The bill also allows the Chair to place an item pertaining to the policies and procedures of the Bank on the agenda at the request of any two board members. Any item must be discussed at a meeting of the board within 30 days of the request. The bank also can receive charitable gifts, grants, and other conveyances from a variety of sources, so long as the money isn't donated to support any specific project or category of projects. The bank also can own or take interest in property to the extent necessary to carry out its activities. Additionally, the bank must assess reasonable fees to cover its reasonable costs. IV. Staff. SB 1121 directs the Board to select a Chief Executive Officer (CEO), who shall manage and conduct the Bank's affairs at the direction of the Board. The CEO must have significant experience in management and administration of a financial institution, or in the financing and development of energy or infrastructure projects. However, the CEO cannot have any financial interest in any project considered by the board, or an interest in an investment institution or its affiliates that seek or are likely to seek financial assistance from the bank, unless the interest is placed in a blind trust. Interests in institutions seeking or likely to seek assistance must be placed into a blind trust for the tenure of the CEO's service, plus two years. The CEO shall be compensated in an amount set by the Board commensurate with private sector positions. The CEO shall select an executive vice president to serve SB 1121 (De Leon) - 2/19/14 -- Page 8 as CEO during his or her absence or disability, or a vacancy. The CEO may appoint divisional vice presidents to oversee each of its two divisions, and set compensation amounts for the positions at amounts commensurate with similar private sector financial positions. The CEO also may employ staff as he or she determines necessary, except as the Board determines otherwise. The Bank may contract with banks, credit agencies, and attorneys at customary commercial rates to provide services, including administrative and operating functions, consistent with the California Constitution's civil service provisions. The Bank may compensate its employees at prevailing rates of compensation for similar positions in private industry. However, no director, officer, attorney, agent, or employee shall participate in the deliberation or determination of any question affecting his or her personal interest. The bill doesn't apply these provisions to persons or entities entering into contracts with the bank, and also doesn't apply the Political Reform Act to its staff. V. Performance Measurement. The CEO must: Require any entity receiving financial assistance to report quarterly on its use of support and its progress fulfilling its objectives. The CEO must make these reports public. Pursue a diversified portfolio of clean energy projects, Establish appropriate mechanisms to ensure appropriate use and compliance with all terms of any financing support made by the Bank, Create and maintain a fully searchable database accessible on the bank's Internet Website at no cost to the public that contains specific information, Assist in and ensure the development of underwriting standards for financing of clean energy projects consistent with good industry practices for public and private financial institutions, Establish a risk committee that develops and publishes operational performance metrics including operations, risk management, financial and market metrics, and energy and environmental metrics. Receive public comment. The CEO may: SB 1121 (De Leon) - 2/19/14 -- Page 9 Establish additional reporting and informational requirements of any recipient of financing, Withdraw financing support made to entities that demonstrate insufficient performance, or wasteful or fraudulent spending as defined in advance. The CEO may award these funds competitively to a new or existing project. Redact any information regarding applicants and borrowers to protect confidential business information. On February 1st of each year, the Bank shall report to the Governor and the Joint Legislative Budget Committee regarding: A listing of applications received, A specification of bonds sold and the interest rates thereon, The amount of public and private funds leveraged by the assistance provided, A report of revenues and expenditures, including all the bank's costs, with specified contents, Projection of the bank's needs and requirements for the coming year, and Recommendations for changes in state law. An independent certified public accountant shall audit the bank each year using generally accepted accounting standards. The Board also must commission independent comprehensive biennial evaluations of the bank's performance. The evaluation shall assess the effectiveness and cost-effectiveness of all the bank's activities. The measure changes the Greenhouse Gas Reduction Fund Investment Plan and Communities Revitalization Act to allow proceeds of regulatory fee revenues from auction of greenhouse gas allowances required by the California Global Warming Solutions Act of 2006 through the Green Bank (AB 32, Pavley). The measure states legislative findings and declarations to support its purposes, and sunsets its provisions on January 1, 2036. SB 1121 also states legislative intent relative to redacting confidential business information of purposes of Section 3 of Article 1 of the California Constitution. State Revenue Impact SB 1121 (De Leon) - 2/19/14 -- Page 10 No estimate. Comments 1. Purpose of the bill . A publicly funded Green Bank would provide low-cost, long-term financing to support clean, low-carbon projects. And it would leverage the public funds through the use of financial mechanisms to attract private investment so that each public dollar supports multiple dollars of private investment. The concept of a green bank is part of a long tradition of our country supporting new energy transitions. In the 1800s, states rallied to help new businesses exploit their coal resources. In the early 1900s, tax and accounting benefits helped to allow oil and gas development to proliferate. In the mid-20th century, government programs including insurance guarantees put the nuclear power industry on the map. A California Green Bank can help low-carbon industries get to scale, a critical point in a new product's evolution. There are several "Valleys of Death" a company has to survive before it produces its product at scale. It has to get from concept to demonstration phase. It has to get from demonstration to commercialization - the ability to make not one but thousands of a product. Then it has to make that product at scale - being able to manufacture product as the market demands, at a price competitive with the traditional alternative. 2. Dangerous business ? SB 1121 would inject the State of California into the banking business and authorize it to issue myriad highly complex securities outside of the Treasurer's Office, a significant expansion over its current operations far from its core competency. Additionally, the measure would require state bank officials to invest state money not in traditional lines of business, but into clean technology companies, where the financial sector's investment results have been mixed to date because it's hard to tell with certainty whether many firms in the space will make money. While wind and solar energy finance is overflowing with capital, other clean technology companies aren't there yet. Joseph Dear, former CALPERS chief investment officer stated in 2013 that its cleantech investments had not experienced the J-curve: losses followed by steep gains. It's been "an L-curve, for SB 1121 (De Leon) - 2/19/14 -- Page 11 'lose. This had been a noble way to lose money. Just because it's a good idea doesn't make it a good investment." Consulting firm McKinsey notes the following: The sector has experienced a cycle of excitement followed by high (and often inflated) expectations, disillusionment, consolidation, and then stability as survivors pick up the pieces. We've seen this before with other once-emerging technologies, such as cars, railroads, elevators, oil, and the Internet. Much of cleantech is just leaving its disillusionment or consolidation phase. For example, in transport, Tesla Motors is looking good; Fisker Automotive went into bankruptcy in 2013. In energy, SunPower is making healthy margins and SolarCity raised $450 million in 2013, but over a hundred other solar companies are gone. The shakeout is brutal-and typical. It has weeded out weaker players, making the industry as a whole more robust. Despite the rough patch, annual growth is at double-digit rates. Should the state expand its footprint to grant credit to a sector of the economy where it's notoriously hard to assess risk, especially given the CALPERS's warning? If so, should they do so by issuing securities traditionally reserved for sophisticated financial institutions and investment banks, and allow issuance without the state Treasurer, who usually serves as the state's intermediary with capital markets? The Committee may wish to consider SB 1121's risks. 3. Overlap ? SB 1121 sets forth broad categories for projects that the Green Bank should assist. However, the California Public Utilities Commission, California Energy Commission, California Air Resources Board, the California Alternative Energy and Alternative Transportation Finance Authority also deploy financial assistance that overlaps with the bill's direction. These programs should be consistent with each other, and advance the state's overall goals. If some of the projects envisioned by the bill can be assisted through other programs, why set up a new state agency? While the bill also may be referred to the Committee on Energy, Utilities, and Communication, the Committee may wish to consider amending SB 1121 to select an existing agency and grant it new powers, instead of creating a new one. SB 1121 (De Leon) - 2/19/14 -- Page 12 4. Capitalization ? Banks make money when their net interest margin, or the interest paid on its loans over its cost of capital. To generate net interest margin, it must have access to capital to loan to individuals who will then repay it over time with interest, price the interest rate correctly, and avoid borrower defualt. However, it's unclear whether the current rules attached to the measure's proposed bank capital, AB 32 allowance auction proceeds, can be used to fund the bill's programs. In a November, 2013 trial court opinion in California Chamber of Commerce v. California Air Resources Board (#34-2012-80001313) , the Court stated: "Under the unique circumstances of this case, the court is not persuaded that the amounts charged for allowances must be closely linked to the payers' burdens on the specific regulatory programs that will be funded by them. Rather, all that is required is a reasonable relationship between the charges and the covered entities' (collective) responsibility for the harmful effects of GHG emissions." While the current standard set by the Courts is fairly broad, appeals are expected and the standard could change as higher courts consider the unique nature of AB 32 auction proceeds in the context of California's tax and fee rules. Should a higher court find that the auction proceeds are regulatory fees, or even taxes, the Legislature's spending flexibility will be sharply curtailed. The Committee may wish to consider whether it's premature to direct AB 32 revenues towards uses without resolution from the Courts regarding the use of the funds. 5. Other Issues . SB 1121 requires significant substantive and technical amendments, including, among others: The measure doesn't include consideration of the bank's investment risk, return of capital, or return on capital, The measure doesn't provide a process for creditors to repay it, and penalties or sanctions for failing to do, The proposed board includes representatives from agencies (CPUC, DWR, CEC, CARB) when their Presidents or Executive Directors generally serve on boards instead of appointing individuals. Additionally, the SB 1121 (De Leon) - 2/19/14 -- Page 13 Governor appoints directors of these agencies that SB 1121 allows to appoint to the Green Bank Board, creating a potential conflict. It's unclear that DWR is an appropriate agency to select a Green Bank board member given their separate charges, Some members must have private sector financial experience, but no specific knowledge of risk assessment, capital markets, venture capital funding of clean energy firms, etc. The process for the CEO placing both direct interests and institutional investments into a blind trust isn't clear. Verification isn't required. Additionally, direct investments can be removed from a blind trust immediately after the CEO ceases working for the Gren Bank, yet institutional investments cannot be removed for two years, resulting in an inconsistency. It's unclear whether the bank's employees will be state civil service. The bill requires them to be paid at industry prevailing rates, but doesn't say whether the state will pay benefits, or whether the employees will be subject to recent pension reforms, Conflict of interest provisions don't clearly apply to all the bank's direct employees and contractors, It's unclear why the Green Bank should issue tax or revenue anticipation notes, floating rate and variable rate securities, asset-backed certificates, bond guarantees, securitization, loan warehousing, credit enhancement, and other undefined financial instruments given the risk involved and the understanding necessary to accurately price these securities in capital markets, Provisions guarding the State's General Fund from claims in case the Bank cannot pay its creditors should be more robust, and more closely reflect conduit bond authorities and the State Infrastructure Bank, The term "a competitive bidding process that encourages aggressive bidding," is undefined, and it's unclear what happens if the process is not sufficiently competitive, To exempt bond interest from income, the measure needs a separate amendment so allowing in the Revenue and Taxation Code, and it's unclear whether the bill applies to capital gains from bond arbitrage. SB 1121 (De Leon) - 2/19/14 -- Page 14 Support and Opposition (4/21/14) Support : Agrion; Bernheim and Dean, Inc.; California Clean Energy Fund; Clean TECH San Diego; Chargepoint; Coalition for Green Capital Action Fund; DBL Investors; Environmental Defense Fund; EV Communities Alliance; Natural Resources Defense Council; Passive House Alliance US; Silicon Valley Leadership Group; Strategy and Finance Center for Market Innovation; Sungevity; SunRun. Opposition : None received.