Department of Energy: New Loan Guarantee Program Should Complete Activities Necessary for Effective and Accountable Program Management
Published: 2008-07-07T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Title XVII of the Energy Policy Act of 2005 established DOE's loan guarantee program (LGP) for innovative energy projects that should decrease air pollutants or greenhouse gases and that have a reasonable prospect of repayment. For fiscal years 2008 and 2009, Congress authorized the use of borrower fees to pay the costs of loan guarantees through Title XVII's "borrower pays" option, under which DOE will limit loan guarantees to $38.5 billion. Congress mandated that GAO review DOE's progress in implementing the LGP. GAO assessed DOE's progress in (1) issuing final regulations and (2) taking actions to help ensure that the program is managed effectively and to maintain accountability. GAO also assessed how inherent risks due to the nature of the LGP may affect DOE's ability to achieve intended program outcomes. GAO analyzed DOE's regulations, guidance, and program documents and files; reviewed Title XVII; and interviewed DOE officials.
section_title: What GAO Found
paragraphs: In October 2007, DOE issued regulations that govern the LGP and include requirements for application submissions, project evaluation factors, and lender eligibility and servicing requirements. The regulations also generally address requirements set forth in applicable guidance. Some key aspects of the initial LGP guidelines were revised in the regulations to help make the program more attractive to lenders and potentially reduce financing costs for projects. For example, the maximum loan guarantee percentage increased from 80 to 100 percent of the loan. In addition, the regulations define equity as "cash contributed by the borrowers," but DOE officials told us they also plan to consider certain non-cash contributions, such as land, as equity. As a result, applicants may not fully understand the program's equity requirements. DOE is not well positioned to manage the LGP effectively and maintain accountability because it has not completed a number of key management and internal control activities. As a result, DOE may not be able to process applications efficiently and effectively, although it has begun to do so. DOE has not sufficiently determined the resources it will need or completed detailed policies, criteria, and procedures for evaluating applications, identifying eligible lenders, monitoring loans and lenders, estimating program costs, or accounting for the program--key steps that GAO recommended DOE take over a year ago. DOE also has not established key measures to use in evaluating program progress. Risks inherent to the LGP will make it difficult for DOE to estimate subsidy costs, which could lead to financial losses and may introduce biases in the projects that receive guarantees. The nature and characteristics of the LGP and uncertain future economic conditions increase the difficulty in estimating the LGP's subsidy costs. Because the LGP targets innovative technologies and the projects will have unique characteristics--varying in size, technology, and experience of the project sponsor--evaluating the risks of individual projects will be complicated and could result in misestimates. The likelihood that DOE will misestimate costs, along with the practice of charging fees to cover the estimated costs, may lead to biases in the projects that receive guarantees. Borrowers who believe DOE has underestimated costs and has consequently set fees that are less than the risks of the projects are the most likely to accept guarantees. To the extent that DOE underestimates the costs and does not collect sufficient fees from borrowers to cover the full costs, taxpayers will ultimately bear the costs of shortfalls. Even if DOE's estimates of subsidy costs are reasonably accurate, some borrowers may not pursue a guarantee because they perceive the fee to be too high relative to the benefits of the guarantee, affecting the project's financial viability. To the extent that this financial viability is not distributed evenly across the technologies targeted by Title XVII, projects in DOE's portfolio may not represent the range of technologies targeted by the program.

section_title: Letter
paragraphs: Title XVII of the Energy Policy Act of 2005 (EPAct 2005)—Incentives for  Innovative Technologies—authorized the Secretary of Energy to  implement a new loan guarantee program (LGP) for energy projects that  satisfy three criteria: avoid, reduce, or sequester air pollutants or  greenhouse gases; employ new or significantly improved technologies  compared with commercial technologies in service at the time the  guarantee is issued; and provide a reasonable prospect of repayment. To  date, the Department of Energy (DOE) has not approved any loan  guarantees under the LGP.
Federal loan guarantee programs help borrowers obtain access to credit  with more favorable terms than they may otherwise obtain in private  lending markets because the federal government guarantees to pay lenders  if the borrowers default, which makes extending credit more attractive to  lenders. However, loan guarantee programs can expose the government to  substantial financial risks. In the past, problems with loan guarantee  programs have occurred, in part, because agencies did not exercise due  diligence during the loan origination and monitoring processes. In  addition, agencies have had difficulty estimating program costs because of  faulty assumptions that caused cost estimates to be too low, limited  historical data, and deficient policies and procedures for assessing risk  and estimating costs.
Title XVII has a requirement related to the subsidy cost of the LGP: DOE  must either receive an appropriation for the subsidy cost or it must collect  fees from borrowers to cover the subsidy cost (referred to as the  “borrower pays” option). In DOE’s appropriations acts for fiscal years 2007  and 2008, Congress specifically instructed DOE to proceed under the  borrower pays option. The subsidy cost, as defined by the Federal Credit  Reform Act (FCRA) of 1990, is the government’s estimated net long-term  cost, in present value terms, of direct or guaranteed loans over the entire  period the loans are outstanding (not including administrative costs). In  calculating the subsidy cost for a guaranteed loan program, agencies  estimate (1) payments from the government to cover interest subsidies,  defaults, delinquencies, or other payments, and (2) payments to the  government, including fees, penalties, and recoveries on defaults. Under  FCRA, DOE would estimate the expected subsidy costs before issuing loan  guarantees and is generally required to annually update, or reestimate, this  cost to reflect actual loan performance and changes in expected future  loan performance. To the extent that DOE underestimates subsidy costs  and does not collect enough fees from borrowers, taxpayers will  ultimately make up the difference.
Through the appropriations process, Congress authorizes the amount of  loans that may be guaranteed, thereby setting limits on the government’s  exposure to financial losses. For DOE’s LGP, Congress appropriated funds  out of any borrower fees to be received for DOE to make up to $4 billion  of loan guarantees for fiscal year 2007 and placed no cap on guarantees for  fiscal years 2008 and 2009. Because of the financial risks associated with  loan guarantees under the LGP, we assessed DOE’s efforts to implement  the program in early 2007. We reported that rather than taking and  completing key steps to better ensure that the LGP would be well managed  and accomplish its objectives, DOE focused on soliciting preapplications  for proposed projects. We recommended that before DOE select eligible  projects for loan guarantees, it first issue program regulations, develop  policies and procedures for operating the program, and define goals and  metrics to measure program effectiveness. Subsequently, in Public Law  110-5, Congress directed DOE not to award any loan guarantees until it  issued final regulations. These regulations were to include programmatic,  technical, and financial factors for the Secretary of Energy to use in  selecting projects, as well as policies and procedures to monitor loans and  lenders.
Congress also mandated that we annually review DOE’s progress in  implementing the LGP and directed us to report to the House and Senate  Committees on Appropriations to help inform their oversight. In response,  we assessed DOE’s progress in (1) issuing final regulations to govern the  program and (2) taking actions to help ensure that the program is  managed effectively and to maintain accountability. We also examined  whether inherent risks due to the nature and characteristics of the LGP  may affect DOE’s ability to make the program pay for itself and support a  broad spectrum of innovative energy technologies.
For this assessment, we reviewed and analyzed Title XVII of EPAct 2005,  Office of Management and Budget (OMB) guidance on federal credit  programs, GAO’s guidance on Government Performance and Results Act  and standards for internal control, DOE’s program guidance and  regulations, and other information. We interviewed relevant DOE officials.  We also reviewed preapplication files to determine if DOE conducted its  review process consistently and documented its decisions sufficiently. We  did not evaluate the technical or financial soundness of the projects DOE  invited to apply for loan guarantees. To examine whether the inherent risks  due to the nature and characteristics of the LGP may affect DOE’s ability to  make the program pay for itself and support a broad spectrum of innovative  energy technologies, we reviewed reports by the Congressional Budget  Office (CBO) and reviewed past GAO reports of other loan programs that  had some similar characteristics with the LGP. We did not assess the  benefits of this program because doing so at this stage would be premature.  It remains to be seen what projects will receive loan guarantees and when  this may occur. We recognize that the program could have substantial  benefits; our assessment of how the nature and characteristics of the LGP  may affect its effectiveness is not intended to address its overall merits.  Rather, our intent is to highlight how these aspects of the program could  have a bearing on program performance and what the LGP can achieve. We  conducted this performance audit from September 2007 through June 2008,  with limited updates after we sent the draft report to DOE for comment on  May 13, in accordance with generally accepted government auditing  standards. Those standards require that we plan and perform the audit to  obtain sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that the  evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives. A further discussion of our scope  and methodology is presented in appendix I.
subsections: section_title: Background
paragraphs: Title XVII of EPAct 2005—Incentives for Innovative Technologies— authorized DOE to guarantee loans for projects that satisfy all three of the  following criteria: (1) decrease air pollutants or man-made greenhouse  gases by reducing their production or by sequestering them (storing them  to prevent their release into the atmosphere); (2) employ new or  significantly improved technologies compared with current commercial  technologies; and (3) have a “reasonable prospect” of repayment. Title  XVII identifies 10 categories of projects that are eligible for a loan  guarantee, such as renewable energy systems, advanced fossil energy  technologies, and efficient end-use energy technologies. Appendix II  provides a list of these categories.
The LGP office is under DOE’s Office of the Chief Financial Officer. LGP’s  actions are subject to review and approval by a Credit Review Board. The  Board met for the first time in April 2007; it approves major policy  decisions of the LGP, reviews LGP’s recommendations to the Secretary of  Energy regarding the issuance of loan guarantees for specific projects, and  advises the Secretary on loan guarantee matters. DOE first received  appropriated funds for the LGP’s administrative costs in early 2007 and  began processing preapplications—in response to the August 2006  solicitation—and at the same time began to obtain staff and take other  steps to initiate the program. During 2007, it reviewed preapplications for  143 projects and in October 2007 invited 16 of the preapplicants to submit  full applications for loan guarantees. Appendix II includes information on  the 16 projects invited to submit full applications. In general, according to  DOE, the processing of full applications will require DOE to have  numerous interactions with the applicants and private lenders. It will also  require financial, technical, environmental, and legal advisors to assist  with underwriting, approving, and issuing a loan guarantee. DOE  estimated that the time between receiving an application and completing  negotiations for a loan guarantee contract would range from 9 to 25  months, with additional time at the beginning to prepare and issue the  solicitation and at the end to close the loan.
On April 11, 2008, DOE issued a fiscal year 2008 implementation plan for  $38.5 billion in solicitations, to respond to a requirement that DOE provide  Congress information about future solicitations 45 days prior to issuing  them. On June 30, 2008, DOE simultaneously issued three solicitations  that total $30.5 billion—on (1) efficiency, renewable energy, and electric  transmission ($10 billion), (2) nuclear power facilities ($18.5 billion), and  (3) nuclear facilities for the “front end” of the nuclear fuel cycle ($2  billion). DOE plans to subsequently issue a fourth solicitation in late  summer 2008 for advanced fossil energy projects ($8 billion). DOE is also  required to annually provide Congress a report on all activities under Title  XVII and issued the first report on June 15, 2007. Figure 1 shows a  timeline of these and other key program events since 2005 that illustrate  the status of the LGP through June 2008.
section_title: DOE Issued Regulations That Contained Required Elements, but One Key Aspect Is Not Clear
paragraphs: On October 23, 2007, DOE’s final regulations for the LGP were published  in the Federal Register. DOE had previously issued program guidelines in  August 2006. The final regulations contain requirements for preapplication  and application submissions; programmatic, technical and financial  evaluation factors for applications; and lender eligibility and servicing  requirements. The regulations incorporate and further clarify requirements  of Title XVII related to eligibility, fees, default conditions, and audit  documentation. The regulations also generally incorporate requirements  set forth in OMB Circular A-129 Policies for Federal Credit Programs and  Non-Tax Receivables, which prescribes policies and procedures for  federal credit programs, such as applicant screening, lender eligibility, and  corrective actions. Because loan guarantee programs pose significant  financial risks, it is important to include appropriate mechanisms to help  protect the federal government and American taxpayers from excessive or  unnecessary losses.
DOE changed some key aspects of the initial program guidelines in its final  regulations to help make the program more attractive to lenders and  potentially reduce financing costs for projects. These changes included  increasing the maximum guarantee percentage, allowing the lender to  separate or “strip” the nonguaranteed portion of the debt, and revising its  interpretation of a Title XVII requirement that DOE have superior right to  project assets pledged as collateral. Other important changes relate to  increased specificity in key definitions and a requirement for independent  engineering reports. Specifically, we found the following:    Guarantee percentage. The final regulations allow for loan guarantees of  up to 100 percent of the loan amount, which is limited to no more than 80  percent of the project costs, provided that, for a 100 percent guarantee, the  loan must be disbursed by the Federal Financing Bank (FFB). The use of  the FFB is required, in part, because a private lender may exercise less  caution when underwriting and monitoring a loan with a 100 percent  guarantee. The guidelines stated that DOE preferred not to guarantee  more than 80 percent of the loan amount, which was limited to no more  than 80 percent of the project costs. Because the regulations increased the  maximum guarantee percentage, this change increases the risk that the  government is willing to assume on a project by project basis.
Stripping the nonguaranteed portion. When DOE guarantees 90 percent  or less of a loan, the final regulations allow the nonguaranteed portion of a  loan to be separated or “stripped” from the guaranteed portion. This  change allows lenders greater flexibility in selling portions of a loan on the  secondary market and could reduce overall funding costs for projects. In  contrast, the guidelines and the proposed regulations did not allow  stripping.
Superiority of rights. Title XVII requires DOE to have superior rights to  project assets pledged as collateral. In the proposed regulations, DOE  interpreted this provision to require DOE to possess first lien priority to  assets pledged as collateral. Therefore, holders of nonguaranteed portions  of loans would be subordinate to DOE in the event of a default. In the final  regulations, DOE changed its interpretation to allow proceeds received  from the sale of project assets to be shared with the holders of  nonguaranteed portions of loans in the event of a default. As noted in  public comments on the proposed regulations, this practice is an  established norm in project lending. DOE stated that it retains superiority  of rights, as required by Title XVII, because DOE has sole authority to  determine whether, and under what terms, the project assets will be sold  at all.
Key definitions. In the context of “innovative technologies,” the final  regulations added a definition that clarified the definition of what  constitutes a “new or significantly improved” technology, considerably  expanded the definition of “commercial” technology already in use, and  clearly linked the definitions to each other. According to the regulations, a  new or significantly improved technology is one that has only recently  been developed or discovered and involves a meaningful and important  improvement in productivity or value in comparison with the commercial  technology in use. DOE’s regulations define a commercial technology as  being in general use if it is employed by three or more commercial projects  in the United States for at least 5 years.
Independent engineering report. The final regulations require the  applicant to provide an independent engineering report on the project,  which was not required under the guidelines. According to the regulations,  the engineering report should assess the project, including its site  information, status of permits, engineering and design, contractual  requirements, environmental compliance, testing and commissioning, and  operations and maintenance.
Although the final regulations generally address requirements from  applicable guidance, we identified one key aspect related to equity  requirements that is not clear. The final regulations state that DOE will  evaluate whether an applicant is contributing significant equity to the  project. The regulations define equity as “cash contributed by the  borrowers and other principals.” Based on this definition, it appears that  non-cash contributions, such as land, would not be considered equity.  However, the LGP director told us that land and certain other non-cash  contributions could be considered equity. As a result, the regulations do  not fully reflect how DOE is interpreting equity and potential applicants  may not have a full understanding of the program’s equity requirements.
section_title: DOE Has Not Fully Implemented Activities Necessary for Effective and Accountable Program Management
paragraphs: DOE may not be well positioned to manage the LGP effectively and  maintain accountability because it has not completed a number of  management and internal control activities key to carrying out the  program. As a result, DOE may not be able to process applications  efficiently and effectively, even though DOE has begun to review its first  application, and officials told us they will begin reviewing other  applications as soon as they are submitted. The key activities that DOE  has not sufficiently completed include (1) clearly defining its key  milestones and its specific resource needs, (2) establishing policies and  procedures for operating the program, and (3) agreeing upon key  measures to evaluate program progress. The nature and characteristics of  the LGP expose the government to substantial inherent risk; implementing  these management and internal control tools is a means of mitigating some  risks.
subsections: section_title: DOE Has Begun Its Application Review Process before Clearly Defining Program Milestones and Specific Resource Needs
paragraphs: According to our work on leading performance management practices,  agencies should have plans for managing their programs that identify  goals, strategies, time frames, resources, and stakeholder involvement in  decision making. In January 2008 DOE completed a “concept of  operations” document that contains, among other things: information on  the LGP’s organizational structure; mission, goals, and objectives; and  timelines, milestones, and major program activities that must be  accomplished and their sequence. However, LGP officials told us they do  not consider the concept of operations a strategic or performance  planning document. In addition, it is unclear whether LGP plans to set  other timelines and milestones that would be available to stakeholders,  such as applicants and Congress. Without associating key activities with  the time frames it aims to meet, it is unclear how DOE can adequately  gauge its progress or establish and maintain accountability to itself and  stakeholders.
As of March 2008, 14 of the 16 companies invited to submit full  applications reported that they plan to submit their applications to DOE by  the end of September 2008, and the other 2 plan to submit by the end of  January 2009. DOE received one application in April 2008, which it has  begun to review, and DOE officials told us they will begin reviewing other  applications as soon as they are submitted. This influx of applications  could cause a surge in workload, but it is not clear that DOE has obtained  the resources it needs to carry out its application review activities.  Although it is critical for agencies to determine the timing and type of  resources needed, DOE has not determined the number and type of  contractor resources it will need to review the applications, which could  lead to delays. For example, DOE expects to need legal, engineering,  environmental, and financial contracting expertise but has not completed  plans describing the types of expertise needed, estimated when   the expertise will be required, or determined to what extent each type   of expertise will be needed. According to the LGP director, much of this  expertise will have to be acquired through new contracts that DOE must  negotiate and that generally take some months to put into place. To the  extent that these resources are not available when needed, DOE could  experience delays in reviewing the applications. In early April 2008, the  LGP director said that his office is working with other DOE offices to  develop these contracts and considers this activity high priority; while the  completion date for an acquisition and contract vehicles strategy was  initially set for the end of April, the timetable DOE includes in its agency  comments letter indicates an August 2008 completion date. In addition, as  of April the LGP office was 7 staff short of its authorized level of 16 for  fiscal year 2008; the director told us it has faced delays in hiring permanent  staff, although he indicated that the office has enough permanent staff to  review the first 16 applications. He also said that the permanent and  contractor staff LGP has hired have many years of project finance or loan  guarantee experience at other institutions.
section_title: DOE Has Not Completed Key Policies and Procedures
paragraphs: Management has a fundamental responsibility to develop and maintain  effective internal controls to help ensure that programs operate and  resources are used efficiently and effectively to achieve desired objectives  and safeguard the integrity of their programs. As of May 2008, DOE had  not completed policies and procedures to select loans, identify eligible  lenders and monitor loans and lenders, estimate the costs of the program,  or account for the program, despite reporting to Congress in June 2007  that it would have completed most of these activities by the end of fiscal  year 2007.
subsections: section_title: Selecting Loans
paragraphs: OMB Circular A-129 calls for agencies to develop policies and procedures  to select loans, including appropriate applicant screening standards to  determine eligibility and creditworthiness. In this regard, from August  2006 through October 2007, DOE conducted a preapplication process to  help it develop final regulations; develop and test policies, criteria, and  procedures for reviewing preapplications; and determine which projects it  would invite to apply for loan guarantees. Conducting the preapplication  process also enabled DOE to respond to congressional interest in  launching the program, according to DOE officials.
We found that, during its preapplication review process, DOE did not  always sufficiently document why it ultimately selected projects that  reviewers did not score highly or recommend initially. DOE documented  the results of the selection process, including its technical and financial  reviews for individual projects, its joint technical-financial reviews for  categories of projects, and its decisions made during its secondary review  process. However, we found that DOE’s documentation for deciding which  projects to recommend to the Credit Review Board did not always provide  sufficient justification. While our discussions with DOE officials helped  clarify the documentation for 6 of the 16 invited projects, they did not for 2  of those projects. According to DOE officials, they gave greater weight to  the technical merit than the financial merit of the projects during the  preapplication selection process. In addition, a consultant DOE hired to  review the preapplication process found that although the files were in  “good working order,” DOE did not consistently conduct and document its  technical evaluations and did not document financial evaluations in depth.  The consultant recommended that DOE take steps to establish standards  for these evaluations and increase the level of transparency in the  preapplication evaluation process.
We also found that the financial and technical criteria DOE used to review  the preapplications were not sufficiently defined in some cases. For  example, a requirement that is central in considering projects’ overall  eligibility—whether it is “innovative,” also known as “new and  significantly improved”—was difficult to determine, according to several  program managers and reviewers. After the initial review process was  completed, DOE further defined what it considers “new and significantly  improved” in its final regulations, but has not correspondingly updated the  review criteria. In addition, when DOE conducted its financial reviews, it  evaluated projects by assigning scores between zero and four—with zero  being the weakest score and four being the strongest score. However,  DOE did not define what the possible scores signified. Moreover, 60  percent of a preapplicant’s financial score was based on creditworthiness;  yet, DOE did not require preapplicants to submit pertinent financial and  credit information such as audited financial statements or credit histories.
DOE has not fully developed detailed internal policies and procedures,  including criteria, for selecting applications. To review the first 16  projects, DOE officials told us they will use criteria developed for the  preapplication process. For projects that apply in response to future  solicitations, DOE plans to amend current preapplication criteria and  develop additional evaluation factors that will be specific to certain  technology areas or sectors. According to DOE officials, as of May 2008,  DOE has also hired one staff person to develop credit policies and  procedures specific to LGP, and to fully establish its credit policy function.  They also said that these credit policies and procedures would provide  internal guidance related to some aspects of application review.
DOE officials told us they also expect the application process guidance  they developed for companies to also serve as internal review policies and  procedures. This guidance provides instructions on the content and format  applicants should adhere to when applying for a guarantee, such as  background information; a project description; and technical, business,  and financing plans. The guidance generally aligns with information in the  final regulations on the factors DOE plans to review and should make it  easier for companies to develop applications. However, in some cases the  guidance lacks specificity for applicants. In addition, when considering the  guidance for use as internal policies and procedures, as DOE has indicated  it will be used, we determined that it does not contain criteria or guidance  that would be sufficient for DOE reviewers. Specifically, it lacks  instruction and detail regarding how DOE will determine project eligibility  and review applications, such as roles and responsibilities, criteria for  conducting and documenting analyses, and decision making. For example,  we found the following:    Project eligibility. DOE does not delineate how it will evaluate project  eligibility—that is, how each project achieves substantial environmental  benefits and employs new or significantly improved technologies. The  guidance requires applicants to submit background information on the  technologies and their anticipated benefits but does not require enough  detail for DOE to assess the information. Without such detail, it is unclear  how DOE will measure each project’s contribution to the program.
Independent engineer’s report. DOE’s guidance does not provide  sufficient detail on the technical information applicants should submit in  this report, even though the guidance requires that the report  comprehensively evaluate five technical elements as well as contractual  requirements and arrangements. DOE officials told us that applicants  generally develop this report for investors and that the reports will likely  be of varying quality and detail. DOE officials also expect that, in  developing a separate report that assesses this information, they will likely  need to fill considerable gaps and conduct additional analyses. While DOE  recognizes these reports serve an important due diligence function, DOE  has not provided applicants with specific instructions on what to include.  As a result, DOE is likely to lose efficiency and effectiveness when it uses  the reports to aid in evaluating loan guarantee applications.
Creditworthiness. For a company to be eligible for a loan guarantee, a  reasonable prospect of repayment must exist and the applicant cannot  have delinquent federal debt, which is critical to determine at the  beginning of the review process to assess whether an applicant is even  eligible. Therefore, a sound assessment of creditworthiness is essential.  However, the criteria DOE has established to evaluate creditworthiness— which it used during the preapplication process and plans to use for future  applications—did not take into account the more meaningful and thorough  information required for the full application process. In addition, while  DOE’s guidance requests applicants to submit more complete information,  such as a credit assessment, it does not provide details regarding how  DOE will evaluate the information to determine creditworthiness.
Project cost information. DOE’s guidance for the application process  instructs applicants to indicate if their cost estimates are firm or subject to  change, but it does not request applicants to report a level-of-confidence in  their total project estimates. GAO has reported that for management to  make good decisions and determine if a program is realistically budgeted,  the estimate must quantify the uncertainty so that a level of confidence  can be given about the estimate. For example, an uncertainty analysis  could inform DOE management that there is a 60 percent chance that a  project’s cost will be greater than estimated. Without requiring information  on the uncertainty in project cost estimates and specifying how it will  assess that information, DOE may not be able to appropriately determine a  project’s feasibility and identify projects that could eventually require  substantially more investment or loans for completion.
Without sufficient internal policies and procedures that correspond to  application components, DOE’s application review process will lack  transparency and it will be difficult for DOE to consistently, thoroughly,  and efficiently evaluate project applications.
section_title: Identifying Eligible Lenders and Monitoring Loans and Lenders
paragraphs: OMB Circular A-129 calls for agencies to establish policies and procedures  to identify eligible lenders and to monitor loans and lenders. DOE has  hired a director of monitoring and, according to DOE officials, is currently  developing policies and procedures that will include (1) processes for  identifying eligible lenders through a competitive process, as well as an  associated checklist and guide for evaluating potential lenders, and (2)  loan servicing and monitoring guidelines. These policies and procedures  may build upon the monitoring policies of the Overseas Private Investment  Corporation (OPIC). Implementing rigorous monitoring policies and  procedures will help DOE ensure the success of the loan guarantee  program. According to DOE officials, these policies and procedures will be  completed before DOE issues the first loan guarantees.
section_title: Estimating Subsidy Costs
paragraphs: As required by the LGP’s fiscal years 2007 and 2008 appropriation, DOE  plans to charge borrowers fees to cover subsidy costs, as permitted by  Title XVII. However, estimating the subsidy cost for the LGP will be  difficult because of inherent risks due to the nature and characteristics of  the program. To the extent that DOE underestimates the costs and does  not collect enough fees from borrowers, taxpayers will ultimately be  responsible for any shortfall. Therefore, it is critical that DOE have a  sound and comprehensive methodology to develop its cost estimates.  Guidance on preparing subsidy cost estimates lists procedures necessary  to estimate subsidy costs, such as the development of a cash flow model;  the review and approval process; and documentation of the cash flow  model and underlying assumptions. OMB Circular A-129 requires  agencies to develop models to estimate subsidy costs before obligating  direct loans and committing loan guarantees. According to LGP officials,  DOE has submitted a draft subsidy cost model to OMB for approval and  has drafted documentation for the subsidy calculation process.
section_title: Estimating Administrative Costs
paragraphs: Title XVII requires DOE to collect fees from borrowers to cover applicable  administrative costs. Such costs could include costs associated with  evaluating applications; offering, negotiating, and closing guarantees; and  servicing and monitoring the guarantees. The federal accounting standard  for cost accounting states that cost information is an important basis for  setting fees and reimbursements and that entities should report the full  cost of programs, including the costs of (1) resources the office uses that  directly or indirectly contribute to the program, and (2) identifiable  supporting services other offices provide within the reporting entity. While  DOE has prepared a schedule of fees to be charged for the first  solicitation, it could not provide support for how it calculated the fees.  DOE officials stated that they used professional judgment as a basis for  the fee structure. However, DOE has not developed polices and  procedures to estimate administrative costs, including a determination of  which costs need to be tracked. For example, DOE has not tracked  administrative costs associated with the time general counsel staff have  spent working on issues related to the LGP. Therefore, DOE lacks  assurance that the fees it collects will fully cover applicable administrative  costs, particularly support costs from offices outside of the LGP office,  such as the general counsel. According to DOE officials, some element of  judgment must be used at this time in the determination of fees and as  more experience is gained they will be able to develop policies and  procedures designed to ensure that adequate fees are collected to cover  administrative costs.
section_title: Accounting for the Loan Guarantee Program
paragraphs: In April 2008, DOE officials told us that policies and procedures to account  for the LGP are nearly complete. Under the LGP regulations, DOE may  issue loan guarantees for up to 100 percent of the loan amount as long as  FFB disburses the loan. OMB Circular A-11, Preparation, Submission and  Execution of the Budget, calls for credit issued by FFB to be budgeted for  as a direct loan. Because the accounting treatment mirrors the budgeting,  DOE would also account for such loans as direct loans. Accordingly, DOE  has indicated that the policies and procedures will cover accounting for  both direct loans and loan guarantees.
section_title: DOE Has Not Completed Its Framework for Evaluating Program Progress
paragraphs: DOE has also not completed the measures and metrics it will use to  evaluate program progress. DOE included some of these in its fiscal year  2009 budget request and its concept of operations document, but LGP’s  director told us the measures and metrics have not been made final  because DOE and OMB have not yet agreed on them. In assessing the draft  measures and metrics, we observed the following shortcomings:    DOE intends to measure outcomes directly tied to overall program  goals—installing new capacity, reducing greenhouse gas emissions,  and reducing air pollution—and has said it will develop baselines or  benchmarks for these outcomes. However, it has not yet gathered and  analyzed the necessary data on, for example, existing capacity or  current emission levels for categories of LGP project technologies.
DOE included a measure for the recovery of administrative costs but  not one for the recovery of subsidy costs, which will most likely be the  more significant program cost.
DOE’s metric to assess the effectiveness of financing decisions— containing the loss rate to 5 percent—may not be realistic; it is far  lower than the estimated loss rate of over 25 percent that we calculated  using the assumptions included in the fiscal year 2009 president’s  budget.
section_title: Inherent Risks Will Make Estimating Subsidy Costs Difficult and May Introduce Self- Selection Biases in the Projects That Ultimately Receive Loan Guarantees
paragraphs: The nature and characteristics of the LGP will make estimating the  program’s subsidy costs difficult even if DOE develops a sound and  comprehensive methodology. Evaluating the risks of individual projects  applying for loan guarantees will be difficult because the LGP targets  innovative energy technologies and because projects will likely have  unique characteristics—varying in size, technology, and experience of the  project sponsor. For the first solicitation alone, the technologies range  from a modest energy efficiency project to multiyear advanced coal  projects, and estimated project costs range from around $25 million to  more than $2 billion. In fiscal year 2008, DOE plans to further diversify the  types of technology projects that it will consider for its loan portfolio,  including nuclear power facilities, whose project costs may be more than  $5 billion for each facility. Further, DOE will not gain significant  experience in each technology because the program’s objective is to  commercialize a limited number of each type of innovative technologies.  Therefore, the types of projects will, by design, evolve over time, and the  experience and data that DOE gains may not be applicable to evaluating  the risks of projects applying in the future.
The composition of DOE’s eventual portfolio will even further limit the  data available to help DOE evaluate project risks. Unlike an agency that  provides a high volume of loan guarantees for relatively similar purposes,  such as student loans or home loans, DOE will likely approve a small  number of guarantees each year, leaving it with relatively little experience  to help inform estimates for the future. In addition, DOE’s loan guarantees  will probably be for large dollar amounts, several of which could range  from $500 million to more than $1 billion each. As a result, if defaults  occur, they will be for large dollar amounts and will likely not take place  during easily predicted time frames. Recoveries may be equally difficult to  predict and may be affected by the condition of the underlying collateral.  In addition, project risks and loan performance could depend heavily on  regulatory and legislative actions, as well as future economic conditions,  including energy prices and economic growth, which generally can not be  predicted accurately. These factors combine to make it difficult for DOE  to prepare reliable estimates of subsidy costs. To the extent that DOE  underestimates the costs of the LGP and does not collect enough fees from  borrowers, taxpayers will ultimately have to pay for any shortfalls. Under  FCRA, DOE is required to update, or reestimate, the subsidy costs of LGP  to reflect actual loan performance and changes in expected future loan  performance. Shortfalls identified in annual reestimates are automatically  funded by the federal government under the terms of the FCRA and are  not subject to congressional scrutiny during the annual appropriation  process.
The likelihood of misestimates and the practice of charging fees to cover  all the estimated costs may lead to biases in the projects that ultimately  receive loan guarantees and tilt the portfolio of loan guarantees toward  those that will not pay for themselves. In general, potential borrowers will  know more about their projects and creditworthiness than DOE. As a  result, borrowers will be more likely to accept loan guarantee offers if they  believe DOE has underestimated the projects’ risks and therefore set the  fee too low, than if they believe DOE has overestimated risks.  Underestimated fees amount to an implicit subsidy. The CBO reported that  such a bias in applicants’ acceptance of loan guarantees increases the  likelihood that DOE’s loan guarantee portfolio will have more projects for  which DOE underestimated the fee. CBO evaluated the cost of the LGP  and estimated that DOE would charge companies, on average, at least 1  percent lower than the likely costs of the guarantees. To the extent that  DOE underestimates the fee, and does not collect enough fees from  borrowers to cover the actual subsidy costs, taxpayers will bear the cost  of any shortfall.
Even if DOE estimates the subsidy cost with a reasonable degree of  accuracy and charges the applicants fees to cover the true costs, there is a  potential for a self-selection bias in the companies participating in the  program toward those for which the fee is small relative to the expected  benefits of the loan guarantee (such as more favorable loan terms or a  lower interest rate). As CBO recently reported about the LGP, a loan  guarantee would improve a project’s financial viability if the cost of the  guarantee is shifted to the federal government. However, when the  borrower pays a fee to cover the subsidy cost, as is the case with the LGP,  the cost and most of the risk stay with the project and the viability of the  project may not be substantially improved. Therefore, for such projects,  there is a practical limit to how large the fee can be without jeopardizing  the project’s financial prospects; these constraints add to the challenge of  setting fees high enough to compensate for uncertainties. To the extent  that some projects targeted by Title XVII are not financially viable without  some form of federal assistance or favorable treatment by regulators,  these projects will not pursue loan guarantees even though they are  otherwise eligible. As a result, if this financial viability is not distributed  evenly across technologies targeted by Title XVII, the projects that  ultimately receive loan guarantees may not represent the full range of  technologies targeted by Title XVII.
DOE officials noted that the borrower pays option may cause the more  risky potential borrowers that would be required to pay a higher fee to  either (1) contribute more equity to their projects to lower the fee or (2)  abandon their projects and not enter the program. If potential borrowers  contribute more equity, this could decrease default risk or improve  potential recoveries in the event of a default.
section_title: Conclusions
paragraphs: More than a year has passed since DOE received funding to administer the  LGP and we recommended steps it should take to help manage the  program effectively and maintain accountability. We recognize that it takes  some time to create a new office and hire staff to implement such a  program. However, instead of working to ensure that controls are in place  to help ensure the program’s effectiveness and to mitigate risks, DOE has  focused its efforts on accelerating program operations. Moreover, because  loan guarantee programs generally pose financial risk to the federal  government, and this program has additional inherent risks, it is critical  that DOE complete basic management and accountability activities to help  ensure that it will use taxpayer resources prudently. These include  establishing sufficient evaluation criteria and guidance for the selection  process, resource estimates, and methods to track costs and measure  program progress. Without completing these activities, DOE is hampering  its ability to mitigate risks of excessive or unnecessary losses to the  federal government and American taxpayers.
The difficulties DOE will face in estimating subsidy costs could increase  LGP’s financial risk to the taxpayer. If DOE underestimates costs, the  likely end result will be projects that do not fully pay for themselves and  an obligation to taxpayers to make up the difference. Furthermore, the  inherent risks of the program, along with the expectation that borrowers  will cover the costs of their loan guarantees, may lead to self-selection bias  that tilts the portfolio of projects toward those for which costs have been  underestimated. Neither we nor DOE will be able to fully evaluate the  extent or magnitude of the potential financial costs to the taxpayer until  DOE has developed some experience and expertise in administering the  program. Expanding the LGP at this juncture, when the program’s risks  and costs are not well understood, could unnecessarily result in significant  financial losses to the government. Self-selection bias may also—under  certain conditions—lead to less than the full range of projects of  technologies targeted by Title XVII represented in the LGP. The likely  costs to be borne by taxpayers and the potential for self-selection biases  call into question whether the program can fully pay for itself; they also  call into question whether the program will be fully effective in promoting  the commercialization of a broad range of innovative energy technologies.
It is important to note that, while we found that inherent risks and certain  features of the program may lead to unintended taxpayer costs and that  self-selection biases may reduce the scope of participation in the program,  this is not an indication that the overall costs of the program outweigh the  benefits. Rather, it simply means that the costs may be higher and the  benefits lower than expected. Finally, the extent to which these costs and  benefits will differ from expectations over the life of the program is  something that cannot be reasonably estimated until DOE gains some  experience in administering the LGP. Even at the current planned pace of  the program, it will take a number of years before we can observe the  extent to which unintended taxpayer costs are incurred or the benefits of  innovative energy technologies emerge.
section_title: Matter for Congressional Consideration
paragraphs: To the extent that Congress intends for the program to fully pay for itself,  and to help minimize the government’s exposure to financial losses, we are  suggesting that Congress may wish to consider limiting the amount of loan  guarantee commitments that DOE can make under Title XVII until DOE  has put into place adequate management and internal controls. We are  also making recommendations to assist DOE in this regard.
section_title: Recommendations for Executive Action
paragraphs: To improve the implementation of the LGP and to help mitigate risk to the  federal government and American taxpayers, we recommend that the  Secretary of Energy direct the Chief Financial Officer to take the following  steps before substantially reviewing LGP applications:    complete detailed internal loan selection policies and procedures that  lay out roles and responsibilities and criteria and requirements for  conducting and documenting analyses and decision making;    clearly define needs for contractor expertise to facilitate timely    amend application guidance to include more specificity on the content  of independent engineering reports and on the development of project  cost estimates to provide the level of detail needed to better assess  overall project feasibility;  improve the LGP’s full tracking of the program’s administrative costs  by developing an approach to track and estimate costs associated with  offices that directly and indirectly support the program and including  those costs as appropriate in the fees charged to applicants;  further develop and define performance measures and metrics to  monitor and evaluate program efficiency, effectiveness, and outcomes;  and    clarify the program’s equity requirements to the 16 companies invited  to apply for loan guarantees and in future solicitations.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to the Secretary of Energy for review  and comment. DOE generally disagreed with our characterization of its  progress to date in implementing the LGP. DOE stated two of our six  recommendations were inapplicable to the LGP, indicated it has largely  accomplished the remaining four recommendations, and disagreed with  our matter for congressional consideration. DOE further stated that our  report contains flawed logic, significant inaccuracies, and omissions;  however, DOE did not provide evidence to support these assertions. Our  evaluation of DOE’s comments follows.  A more detailed analysis is  presented in appendix III.
In particular, DOE stated that we placed disproportionate emphasis on  activities that should be completed for a fully implemented loan guarantee  program rather than one that is currently being implemented, and that we  overlooked DOE’s accomplishments to date. We disagree. We believe that  our report accurately assesses the LGP in its early development stage and  focused our report’s analysis and recommendations on activities that  should be completed before DOE begins to substantively review any  applications. DOE states that it will have completed many of these  activities before it issues loan guarantees, but we continue to believe these  activities should be completed before DOE reviews applications and  negotiates with applicants so that it can operate the program prudently. In  several cases, DOE cites as complete documents and activities that were,  and still are at the time of this report, in draft form. For example, in  several instances DOE states that it has “implemented” its credit subsidy  model. However, as of June 24, 2008, DOE indicated that OMB has not  approved its model. Further, DOE illustrates in an updated timetable it  provides in its appendix B of its comment letter that a majority of these  activities are not yet complete and that several will not be complete until  the end of the calendar year 2008. DOE’s entire letter, including its  appendixes, is reproduced as appendix III of this report.
Regarding our recommendation on policies and procedures for conducting  reviews, DOE cites policies and procedures that it believes are adequate  for continuing program implementation. We disagree. DOE is developing  credit policies and procedures, but it does not have complete internal  application policies and procedures, which it should have as it begins to  review and negotiate its first loan guarantee applications. DOE also lacks  any substantive information in its external application guidance on how it  will select technologies. DOE has indicated that some of this information  will be included in future solicitations.
DOE partially agreed with our recommendation to define the expertise it  will need to contract for and stated that it is developing descriptions of  necessary contractor expertise on a solicitation-specific basis. Although  DOE may plan to complete such descriptions and other preparatory work  for future solicitations, DOE did not provide us with any information for  contractor expertise for the 2006 solicitation. DOE’s timetable provided in  Appendix B indicates an August 2008 completion date for its acquisition  strategy and contract vehicles; this target may be in time for future  solicitations but it is not in time for the applications that companies are  now submitting and DOE is reviewing. DOE also states that it is not  possible to develop generic definitions of needed contractor expertise  because the department’s needs will vary from solicitation to solicitation.  We continue to believe it is both reasonable and feasible for DOE to  develop estimates for the timing and type of resources the department will  require. To be transparent and consistent in its review and negotiation  processes, DOE’s statements of work within sectors and across sectors  should have similar frameworks and rationale. Specifically, DOE may need  assistance in areas common to all technologies, such as cost and risk  analysis, project management, and engineering and design reviews. DOE  should be able to start defining these and other areas on the basis of past  experience.
DOE disagreed with our recommendation to provide more specific  application guidance on the content of independent engineering reports.  DOE stated that this specificity is not required, necessary, or appropriate  for LGP implementation. We disagree. Providing more specificity to  companies on DOE’s expectations for an application’s content—and basic  information about how it will review the projects—will help companies  develop higher quality application materials and help ensure thorough,  consistent, and efficient evaluations. Taking this step is also likely to  decrease the number of requests for more analyses or information from  the applicant. We also continue to believe it is reasonable for DOE to  provide more specificity on how to develop project cost estimates,  including a level-of-confidence estimate, so that it can better evaluate  project cost estimates.
DOE disagreed with our recommendation that it track the administrative  costs associated with the LGP.  DOE stated it is appropriate to track the  costs of the LGP office and that it plans to develop a methodology for  doing so, but there is no reason to track the costs of certain support  activities.  We disagree.  Title XVII requires DOE to charge and collect fees  that the Secretary determines are sufficient to cover applicable  administrative expenses.  The federal accounting standard for managerial  cost accounting requires agencies to determine and report the full costs of  government goods and services, including both direct and indirect costs  associated with support activities.  Therefore, we believe it is appropriate  for DOE to consider costs associated with support activities, such as costs  associated with the time general counsel staff spend working on issues  related to the LGP, to be “applicable administrative costs.”  If DOE does  not consider support costs when setting fees, it cannot be assured that the  fees it collects will fully cover all administrative costs incurred to operate  the LGP.
Regarding our recommendation to further develop and define  performance measures and metrics before substantially reviewing LGP  applications, DOE stated it has developed initial draft performance  measures and metrics with the aim of completing them by the end of  calendar year 2008.  We continue to believe such measures and metrics  should be developed as soon as possible for the 16 projects DOE invited to  apply for guarantees.  In addition, DOE has emphasized its focus on  selecting technologies and projects that will produce significant  environmental benefits, in particular the avoidance of air pollutants and  greenhouse gases.  However, it is unclear how DOE will do so without  gathering data to establish baseline measures and metrics associated with  these benefits.
DOE stated that it did not need to take additional action to implement our  recommendation that it clarify the LGP’s equity requirements with the 16  companies invited to apply and in future solicitations because it informed  the 16 companies invited to apply of DOE’s equity position. However, DOE  officials told us that they communicated this information orally and did  not provide specific documentation to the 16 companies. We believe it is  reasonable to provide potential applicants with key information, such as  the LGP’s equity requirement, in writing to help ensure that all potential  applicants receive the same information. Furthermore, we continue to  believe that this is appropriate information to include in future  solicitations.
In commenting on our matter for congressional consideration, DOE  disagreed with our findings that LGP does not have adequate management  and internal controls in place to proceed and that it is well on the way to  implementing the accepted recommendations contained in our report. We  disagree. DOE has been slow to recognize the inefficiencies and  inconsistencies it may face in not having key activities, policies, and  procedures completed or in place before proceeding with its operations.  While it is important that DOE make meaningful progress in accomplishing  its mission under Title XVII, it is also important to operate the program  prudently, given that billions of taxpayer dollars are at risk.
DOE also made minor technical suggestions, which we incorporated as  appropriate. DOE’s written comments and our more detailed responses  are provided in appendix III.
We are sending copies of this report to congressional committees with  responsibilities for energy and federal credit issues; the Secretary of  Energy; and the Director, Office of Management and Budget. We are also  making copies available to others upon request. This report will be  available at no charge on GAO’s Web site at http://www.gao.gov.
If you or your staff have any questions about this report, please contact  Frank Rusco at 202-512-3841 or ruscof@gao.gov. Contact points for our  Offices of Congressional Relations and Public Affairs may be found on the  last page of this report. Key contributors to this report are listed in  appendix IV.
section_title: Appendix I: Scope and Methodology
paragraphs: To assess the Department of Energy’s (DOE) progress in issuing final  regulations that govern the loan guarantee program (LGP), we reviewed  and analyzed relevant provisions of Title XVII of the Energy Policy Act of  2005; the LGP’s August 2006 guidelines and solicitation; its 2007 notice of  proposed rulemaking; public comments on the proposed rulemaking; and  final regulations published in the Federal Register. We compared the final  regulations to applicable requirements contained in Title XVII and OMB  Circular A-129 Policies for Federal Credit Programs and Non-Tax  Receivables, which prescribes policies and procedures for federal credit  programs. We also discussed the final regulations with DOE officials.
To assess DOE’s progress in taking actions to help ensure that the  program is managed effectively and to maintain accountability, we  reviewed documentation related to DOE’s implementation of the LGP.  Specifically, we reviewed and analyzed the LGP’s “concept of operations,”  technical and financial review criteria for the preapplication process,  DOE’s Application Process Overview Guidance, Preapplication Evaluation  Procedural Guidance, minutes of Credit Review Board meetings held  between April 2007 and February 2008, and other relevant documents. As  criteria, we used our Standards for Internal Control in the Federal  Government and budget and accounting guidance. Further, to assess  DOE’s progress to develop measures and metrics, we applied GAO’s  Government Performance and Results Act guidance and analyzed  information in Title XVII, DOE’s budget request documents and other  relevant documents.
When DOE had completed its preapplication review process, we obtained  documentation from DOE’s decision files related to the 140  preapplications for 143 projects. We reviewed all decision files DOE  provided to us and analyzed the documentation for the preapplications  that DOE considered responsive to the August 2006 solicitation to  determine if DOE conducted its review process consistently and  documented its decisions sufficiently. Responsive decision files generally  contained a summary of the technology; separate technical and financial  review scoring sheets; minutes documenting results of joint technical- financial meetings; and a DOE summary of its secondary review process.  We also reviewed other preapplication materials that DOE provided to us.  We did not evaluate the financial or technical soundness of the projects  that DOE invited to submit full applications.
Further, we interviewed cognizant DOE officials from the LGP office,  detailees from the Department of the Treasury, and contractor personnel  assisting DOE with the preapplication process, the development of  policies and procedures, and the implementation of the program. In  addition, we interviewed officials from DOE’s Office of General Counsel;  Office of the Chief Financial Officer; and program offices that participated  in the technical reviews of the preapplications, including the Office of  Energy Efficiency and Renewable Energy, the Office of Fossil Energy, the  Office of Nuclear Energy, and the Office of Electricity Delivery and Energy  Reliability. We also spoke with officials from the Departments of  Agriculture and Transportation to discuss policies and procedures for  managing their loan guarantee programs.
To examine the inherent risks associated with the LGP, including the  “borrower pays” option of Title XVII, we reviewed our prior work on  federal loan guarantee programs, including programs under the Maritime  Administration, the Federal Housing Administration, and the Small  Business Administration. We interviewed officials at and reviewed reports  by the Congressional Budget Office. We also discussed risks with DOE  officials.
We conducted this performance audit from August 2007 through June 2008  in accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
section_title: Appendix II: Title XVII Categories, DOE’s First Solicitation, and Projects DOE Invited to Submit Applications for Loan Guarantees
paragraphs: The Energy Policy Act of 2005 (EPAct 2005) listed 10 categories of  projects that would be eligible to apply for loan guarantees under Title  XVII. In August 2006, DOE issued a solicitation inviting companies to  submit preapplications for projects eligible to receive loan guarantees  under Title XVII. The solicitation listed categories falling within 8 of the 10  Title XVII categories. The solicitation did not invite projects for two Title  XVII categories: advanced nuclear energy facilities, and refineries,  meaning facilities at which crude oil is refined into gasoline. Table 1 shows  the 10 categories.
On October 4, 2007, DOE announced that it had invited 16 projects to  submit full applications for loan guarantees. Table 2 includes the projects’  sponsors, types, descriptions, and their current proposed locations.
section_title: Appendix III: Comments from the Department of Energy
paragraphs: The following are GAO’s comments on the Department of Energy’s letter  dated June 13, 2008.
subsections: section_title: GAO Comments
paragraphs: 1.  See “Agency Comments and Our Evaluation,” pages 27-30 of this  report.  2.  DOE’s comments incorrectly cite GAO’s finding. We specifically refer  to DOE’s determination of the type or timing of contractor resources.  As we stated in the draft report, LGP’s director told us he has enough  resources for reviewing and negotiating the loan guarantee  applications related to the 2006 solicitation that companies are  submitting.  3.  We recognize DOE is in the process of hiring experienced staff.
Nevertheless, the nature of the program may not allow DOE to develop  significant expertise for any particular technology.  4.  DOE has not yet developed final metrics and measures or gathered the  data necessary to establish meaningful sector-specific baselines for its  2006 solicitation, from which it formally invited 16 solar, biomass,  advanced fossil energy coal, and other projects to apply for loan  guarantees.  5.  We do not imply that DOE may be biased toward underestimating the  subsidy costs of the program. Rather, we point out that the LGP’s  inherent risks due to its nature and characteristics could cause DOE to  underestimate its subsidy costs and therefore not collect sufficient  fees from borrowers.  6.  We do not believe that our report creates the impression that DOE  could choose not to develop a methodology to calculate the credit  subsidy cost. On the contrary, we state that it is critical that DOE  develop a sound and comprehensive methodology to estimate subsidy  costs because inherent risks due to the nature and characteristics of  the program will make estimating subsidy costs difficult.  7.  DOE did not provide us with a detailed presentation of the LGP’s  credit subsidy model. On several occasions, the LGP director told us  that we would be given a detailed presentation once the Office of  Management and Budget (OMB) approved the credit subsidy model. As  of June 24, 2008, DOE stated that OMB had not approved the model.  8.  We believe that our report and the Congressional Budget Office (CBO)  report DOE cites adequately explain the rationale for potential biases  in applicants’ acceptance of loan guarantees that may increase the  likelihood that DOE’s loan portfolio will have more projects for which  DOE underestimated the fee.  9.  The fiscal year 2009 President’s budget states that the assumptions  related to the LGP reflect an illustrative portfolio; that is, the  assumptions do not apply to a specific loan. Nevertheless, the 25- percent loss rate assumption from the budget does call into question  whether the 5-percent loss rate draft metric DOE established to assess  the effectiveness of financing decisions is realistic.  10. We have not inaccurately characterized the operation of the Federal  Credit Reform Act of 1990 (FCRA). Instead, we specifically discuss  reestimates to explain that even though DOE is proceeding with LGP  under the provision that borrowers pay for the subsidy cost of the  program, taxpayers will bear the cost of any shortfall, depending on  the extent to which DOE underestimates the risks (subsidy cost) and  therefore does not collect sufficient fees from borrowers.  DOE  correctly states that reestimates that increase the subsidy costs are  funded by permanent indefinite budget authority, but DOE does not  explain that these funds come from taxpayers. Furthermore, because  of the nature and characteristics of the program, we believe it is  unlikely that the program as a whole will result in savings associated  with the subsidy cost because, to the extent that any loans default, the  cost of the default will likely be much larger than the fee collected.  Lastly, we did not discuss modifications under FCRA because DOE has  not completed its policies and procedures on estimating subsidy costs.  We would expect one component of these policies and procedures to  explain how DOE will identify, estimate the cost of, and fund  modifications.  11. If a project defaults, the cost of the default will likely be greater than  the fee collected, thus creating a shortfall. Under FCRA, this shortfall  would be identified during the reestimate process and would  ultimately be subsidized by taxpayers.  12. OMB Circular A-11, Preparation, Submission and Execution of the  Budget, describes the budgetary treatment for credit programs under  FCRA requirements. While DOE explains that the financing accounting  is nonbudgetary (its transactions are excluded from the budget totals),  DOE fails to explain the sources of the financing account funds.  According to OMB Circular A-11, “an upward reestimate indicates that  insufficient funds had been paid to the financing account, so the  increase is paid from the program account to the financing account to  make it whole.” The program account is a budgetary account, and its  transactions do affect the deficit and may require Treasury to borrow  from the public.  13. We recognize that DOE plans to take steps to assess risk and develop  mitigation strategies; however, we continue to believe that the nature  and characteristics of the LGP result in certain inherent risks that, by  definition, DOE is unlikely to be able to mitigate or accurately quantify.  As a result, there are likely to be many cases in which the risks will not  be covered by the borrower fee or a risk reserve.  In addition, even in  instances where DOE’s estimates of subsidy costs are reasonably  accurate, the “borrower pays” option may cause some potential  borrowers to not pursue loan guarantees because the fee is too high  relative to the benefits to the borrower of the loan guarantee.   14. As stated in the report, the inherent risks of the program, along with  the expectation that borrowers will cover the costs of their loan  guarantees, may lead to self-selection bias that tilts the portfolio of  projects toward those for which costs have been underestimated. To  the extent that some projects targeted by Title XVII are not financially  viable without some form of federal assistance or favorable treatment  by regulators, these projects will not pursue loan guarantees even  though they are otherwise eligible. As a result, if this financial viability  is not distributed evenly across technologies targeted by Title XVII, the  projects that ultimately receive loan guarantees may not represent the  full range of technologies targeted by Title XVII.  15. We changed “clearly” to “sufficiently.” We distinguish between the  technical and financial reviews that staff conducted, and the rational  and clarity of documentation that management provided for its  decision-making processes. We observed from our file review that,  when preapplications contained sufficient information, reviewers  applied the criteria LGP provided, and in some cases applied  additional criteria in their assessments. These assessments were  specific to the preapplication process, not the application process. At  times the preapplications lacked meaningful information for reviewers  to assess. The cases we highlight in our report are those in which the  LGP office did not provide sufficient justification for inviting projects.
GAO welcomes the LGP’s office efforts to establish formal standards  and procedures. In recommending that LGP complete its measures and  metrics associated with achieving benefits and employing new and  significantly improved technologies, we believe this effort will also  help inform future selection processes.  16. DOE did not require preapplications to include proforma “financial  statements.” Rather, preapplicants were required to submit financing  plans, estimated project costs, and a financial model detailing the  projected cash flows over the life cycle of the project. We believe that  audited financial statements and credit ratings would be more useful in  assessing creditworthiness. In addition, when evaluating  preapplications, DOE did not combine technical and financial scores.  Therefore, it is accurate to state that creditworthiness comprised 60  percent of the preapplicant’s financial score.  17. DOE erroneously refers to the preapplication process here. This  analysis on project evaluation is specific to our discussion of project  eligibility, and DOE’s use of external guidance as a proxy for internal  policies and procedures for applications.  18. The statement DOE cites is in context with the prior sentence, “While  DOE recognizes these reports serve an important due diligence  function, DOE has not provided applicants with specific instructions  on what to include.” This sentence is also prefaced with “as a result” in  the draft report. We changed the word “underwriting” to “evaluating”  and added “applications” after “loan guarantees” to clarify our  statement.  19. We generally agreed with the consultant’s finding. Specifically, we  found that DOE program offices used Credit Review Board-approved  criteria as well as other criteria. In one case, these criteria were  appropriate to differentiate projects in accordance with Title XVII. We  could not fully determine whether the use of these additional criteria  had any impact on the selection process.  20. See also comment 17. DOE’s response does not address our report’s  analysis; specifically, we are referring to DOE’s application guidance.  In addition, while DOE’s final rule states what applicants should  submit, it and the application guidance do not indicate how DOE will  evaluate these submissions.  21. Federal loan guarantees do help borrowers obtain more favorable  terms than they may otherwise obtain. For example, a borrower may  be able to get a lower interest rate, an extended grace period, or a  longer repayment period when the loan is guaranteed by the federal  government.  22. For clarification, we revised the report to indicate that DOE needs to  “identify eligible lenders.”  23. For clarification, we incorporated DOE’s suggested revision.  24. We revised the report to reflect this update of information.  25. We revised the report to state “According to DOE, as of May 2008, DOE  has hired one staff person to develop credit policies and procedures  specific to LGP, and to fully establish its credit policy function.”
section_title: Appendix IV: GAO Contact and Staff Acknowledgments
subsections: section_title: Staff Acknowledgments
paragraphs: In addition to the individuals named above, Marcia Carlsen and Karla  Springer, Assistant Directors; Abe Dymond; Richard Eiserman; Jeanette M.  Franzel; Carol Henn; Jason Kirwan; Kristen Kociolek; Steve Koons; Sarah  J. Lynch; Tom McCool; Madhav Panwar; Mehrunisa Qayyum; Carol  Herrnstadt Shulman; Emily C. Wold; and Barbara Timmerman made key  contributions to this report.