Episode 15: Financing RePowerEU – shared management financial instruments combined with grants

Buildings in Europe are responsible for 40% of total energy consumption and 36% of greenhouse gas emissions. So, it's very important that we talk about renovating the buildings in Europe. That is not only good for the climate and energy security in Europe, we shouldn't forget we spend most of our time in buildings, so improving buildings means we will have a better life. 

Hello and welcome to a new episode of the fi-compass Jam Sessions podcast. My name is Robert Pernetta and I'm a Holding Fund Manager at the European Investment Bank. I'm pleased that you're listening in today. Today, we're going to discuss how to use financial instruments to renovate buildings and to make them more energy efficient. So there are two things we're going to talk about today: 

A) How do we combine loans and guarantees with grants?

B) How do we develop a pipeline of bankable buildings? 

Lithuania and Latvia are among the countries that have already tried the combination of grants and financial instruments, and what both countries have done is really impressive. I'm very pleased to welcome two great speakers today: Kristina Vaskelienė, labus Kristina. She is Business Development Officer at INVEGA, the National Promotional Bank of Lithuania. Kristina and I met many years ago and I was always very curious to follow what you're developing in Lithuania. And Aleksejs Kaņējevs, who is Deputy Head of Programme Development at ALTUM, the National Promotional Bank of Latvia. I have to say, I learned a great deal from Aleksejs and his team about combination, and he is my “go to man” when I have any technical questions on combination. It's great to have you here and we are looking forward to learning from your experiences.

Kristina: Hello from Lithuania. Thank you, Robert, for having me on this podcast.

Aleksejs: Hello, Robert, from Latvia. It's a pleasure being here. Thank you for the invitation.

So I did a bit of research on the topic, and learned that the Baltic countries have the highest share of people living in multifamily buildings and also learned that you inherited your buildings from the Soviet Union. Can you tell us more about what that means in practical terms when you renovate buildings?

Kristina: Definitely, I'd be pleased to. So actually, there are 35 000 buildings that, as you mentioned, we inherited. What we can say about these buildings is that the majority of them, probably around 90% to 95%, are extremely energy inefficient. They were built up until 1993, and usually they have a very low energy class, so it's like D, E or even F in many cases. Speaking about the building sector in Lithuania in general, buildings and the residential housing sector ranks second by energy consumption among other sectors. So only the transport sector is in the top spot. The building sector is extremely energy inefficient, and that is why we really need to put a lot of effort into making this sector more energy efficient.

Thank you Kristina. I see that's a really important topic for you. Aleksejs, can you contrast the Latvian situation? Is it similar, or is it different?

Aleksejs: Yes, it is very similar. We are pleased to share our knowledge and to learn from our neighbouring countries, like in this case Lithuania, but also from Estonia and also from other countries as well. In our case, we have quite an active financial sector, but the situation is quite the same. We have 27 000 multi-apartment buildings which are in need of renovation. So, the demand for such support is quite huge. We have calculated that around EUR 1.5 billion is required to finance and renovate these buildings.

Thank you very much, that's very insightful. Kristina, now I have a question. How do you use financial instruments to retrofit buildings? What is your role at INVEGA?

Kristina: So, at INVEGA we are acting as a fund of funds manager, and we are directly implementing the financial instruments that you want to talk about today. We are combining these financial instruments with various grants. Actually, what is interesting is that for building modernisation in Lithuania, we have probably tried all the possible options for grant and financial instrument combination. So we tried technical support, we tried capital rebate, we tried an investment grant, and all these forms, we have quite some experience about them because we tried them all. About the financial instruments, we started doing this with the ERDF financing coming from 2014/2020 European Union funding programming period, and we had three different financial instruments financed from the ERDF. All these financial instruments were used to issue loans for building modernisation. They were basically differentiated by the final beneficiaries. So, one financial instrument was for state-owned infrastructure, another one was for municipality owned buildings, and the third one, the largest one by far, is for the residential multi-apartment buildings modernisation. All of these financial instruments were actually combined with grants, and all of them achieved very good results.

Thank you, that sounds really good. In Latvia, Aleksejs, did you also try everything or have you been less experimental than the Lithuanians?

Aleksejs: In regards of ALTUM, we have been involved in residential multi-apartment building renovations since 2016. Before it was done by a special agency, Latvian Development Agency, who were providing grants, but in 2016, the Cabinet of Ministers approved a new set of regulations which state that ALTUM is implementing grant instruments and financial instruments, that's one scheme but two different instruments which we are implementing at the moment. In December last year, we started a new programme financed by the Resilience and Recovery Facility, where we are going further, and we are using already combined financial instruments, one scheme, one operation. 

That is very interesting. What I would like to understand, you use a loan instrument and you use a guarantee instrument and you combine both with grants. Can you tell us more? Why have you chosen this way?

Aleksejs: We are trying to use the commercial banks as much as possible in this programme, providing the loans for residential multi-apartment buildings. They already have experience providing loans for this specific sector for many years, so they are continuing to do that. Since loans for energy efficiency purposes are usually are long term, from 10 to 20 years in some cases, which is around 60% of the cases, they require a loan guarantee. So we have designed a special product for this purpose. There is a loan guarantee available for the commercial banks in this case, and what we are adding on top of that, we have the grant instrument and we are providing grants. So, we have special cooperation agreements with the commercial banks, we have a specific grants contract with a final beneficiary, usually this is an authorised person representing the building, the owners of the apartments in that particular building, and the commercial banks are servicing those authorised persons, they are disbursing the loan funding and also grant funding from the programme and for the loan, as you mentioned, they are receiving the guarantee when it's required.

Thank you, Aleksejs. You also mentioned that there is a loan programme run by ALTUM. Why do you have a guarantee programme and a loan programme?

Aleksejs: Yes, that's a very good question. Usually there are some credit policies run by the credit institutions, by commercial banks. So, there are some cases where they are not able to finance or not willing to finance a project, so we are stepping in. ALTUM in this case can provide a direct loan with a grant. It is still two instruments, but we are putting those instruments under one financial contract. We are signing one financial contract with the end beneficiary, with the final recipient. We are providing and disbursing the loan amount and grant amount. Actually, the grant amount that we are disbursing, that's an advance. So we reserve 10% of the final payment, which is disbursed after project completion. So the 10% of the grant amount is reserved and is paid out when the project is completed and all the documents are settled.

Well thank you, Aleksejs. It's good to hear that ALTUM offers the support to everybody, even to lower income households. How do you address this challenge in Lithuania, Kristina?

Kristina: Well, regarding the lower income owners of the apartments, we involve the municipalities and their support comes in, because if there are financially challenged people living in the apartment building, the municipality actually covers the loan instalments and pays back the loan on behalf of the lower income people. So in this way, they can benefit from the energy efficient apartment and do not have challenging financial expenses.

Wow, that's really impressive. So good to hear that energy efficiency can be for everyone. Now, you talk about very different types of grants, Kristina. You talk about technical support, capital rebate, interest rate subsidy. How do these work together? 

Kristina: So I think the overarching elements are actually available in all of the financial instruments that we have. First of all, we want to take care that there is sufficient technical support for the project implementation. We think that this is very important in order to keep the project pipeline sufficient, and also to keep the motivation of the project administrators and the final beneficiaries to implement and move forward with the project. So, technical support has really proved a very important prevailing element throughout all the financial instruments. Regarding the grant, I think another prevailing element is that, this grant is always well attached to the results of the project. So the form of the grant itself can be a little bit different. For example, for state-owned institutions and their buildings, we used a repayable grant model in combination with the financial instrument. So, even though it could be a 100% grant, we still need to check and achieve the results that were initially planned by the project; so energy savings, energy class, etc. For the residential multi-apartment buildings, the grant element is paid only after the results are approved and it has been checked that the energy class is achieved and energy savings are achieved as well. So, in this way, we are keeping the motivation up to implement the project on time, to plan it accordingly, to implement it in a good way, in a good quality, and ensure the achievement of the results. I think this is one important element for a combination of financial instruments with the grant.

We talk about financial instruments and we talk about investments in projects that should pay for themselves, they generate cost savings. Why do we need so many different forms of grants? Aleksejs, do you want to talk about your experience?

Aleksejs: Yes, in our case, the Ministry of Economics paid great attention to this specific feature of the programme. We had to check the payback period of those particular projects. In our case, initially, the maximum payback period was 20 years, but due to the increase in energy prices, the Ministry of Economics amended it. So at the later stage of the programme, it was 35 years, and that was already taking into account that grant element, meaning that without the grant, the payback period would be twice as long for apartment owners, which speaking about the apartment owners, they are worried; a 20 year loan for them, it's too much in many cases, especially for persons in the retirement age, let's say. So that's the main reason.

So now let's change a bit the perspective. Let's look at the people who live in the house, what you call the final recipient. What is their journey? Kristina, can you tell how in Lithuania, when you live in a multi-apartment building, how do you get your building renovated and financed?

Kristina: The first step actually comes not from the owners of the multi-apartments, and that is maybe an interesting aspect that we have of the model for renovation in Lithuania. The first step is actually for the administrators or associations that are working and taking care of those particular buildings to initiate the gatherings of the owners of the multi-apartment building, and to discuss with them the potential investments, the need for the investments; so the alternatives of the investment needed for the building to be modernised and to achieve energy efficiency. These administrators, they can be private entities or associations are just established from the owners of the apartments, but they play a very crucial role. They initiate the gatherings of the owners, they facilitate the decision making, they prepare all the technical documents needed for the implementation of the project, and they later go on to contact the agencies regarding the grant element, they come and apply for the loan on behalf of the apartment owners. So they are playing the most important part in the project implementation. This works very well because the actual final beneficiaries, they do not have the experience to implement such a project, they do not have the tools or knowledge, sometimes they do not have enough motivation, and the facilitation of these administrators or associations is extremely important, because it means that final recipients actually do not need to lift a finger to do anything until the project is finalised. Finally, they are living in an energy efficient apartment.

Yes, the customer journey is really important, and I see you pay a lot of attention to this. I just want to mention, in a few weeks, on the 14 and 15 November, fi-compass will be on the road and we are going to have a workshop in Vilnius talking exactly about financial instruments and energy efficiency. We are going to visit two buildings. One of them is a multi-apartment building and the other one is a public building. Now Kristina, I have a question. What does this have to do with your coffee mug?

Kristina: When there was a fi-compass event in March (FI-Campus 2022), there was a competition for projects and we decided to make a movie about these particular modernisation projects. We used the project that we are going to visit as a very good example, because it's a nice quarter of a few buildings that we are going to see. Next to these buildings, there are even a few un-renovated houses. So the difference is very much seen and plain. We decided that because we had a drone, we had the possibility to climb to the roof of that building and to see beautiful views from the top and check how the roof was renovated as well. It was winter time, so it was really cold while filming the video, and I think it gave a very nice, unfamiliar touch to the video. We will not be able to climb to the roof this time however, I'm sure that the buildings we will see will look amazing from the bottom as well.

I'm really looking forward to seeing the building and to watch the side, and the difference between the old and the new ones. For those who won't have the chance to come to Vilnius, in the script of this episode, you will find the link to the video Kristina mentioned. Now Aleksejs, how is the customer journey in Latvia?

Aleksejs: Yes, it's pretty similar way to the one Kristina described. What we have done in addition to that, is we have introduced a one-stop-shop, and we are providing also consultancy and technical expertise on technical documentation. We have a specific unit within ALTUM that checks all the energy audits and also technical documentation and, in a way, also the construction contracts. We try to protect apartment owners and final recipients from unexpected changes in costs during the implementation. It's not always possible, sometimes there is a need for additional investments in projects, especially with the construction. It is likely there are hidden costs, but otherwise it's the same; final recipients or apartment owners should come together twice. First they have to initiate the project, and the second time they should come together to vote to approve the project cost and the loan and the features of the loan, interest rate and terms of the loan. In addition to that, in Latvia, project managers—usually they are private persons, but in some cases are also companies—they are quite important and they are managing all these projects, even though the authorised person, the legal person, is the one signing a contract with ALTUM, they [the project managers] are the main people working on these projects and their role is very important. So, the proficiency of those project managers are a key factor for us and also, of course, the quality of the construction companies. These are key elements which we are following closely. When we are deciding on project approval, that’s the most discussed issue, the quality of the project manager and quality of the construction company.

I often heard that renovating your building is like getting married. You do it only once in your life, and this is why you get a wedding planner who takes care of everything for you, because these people do it on a regular basis. So it's good that you have a one stop shop for building renovation. That's like your wedding planner for getting the Multi-apartment building done. Now, we talked a lot about how public money is used. Do you have any private investment involved in your schemes? Kristina, do you want to talk about the Lithuanian situation?

Kristina: I can speak quite a lot about this topic because this was a priority for us for almost a decade now. What we learned is that one of the most important lessons to attract additional financing from the market is to actually have a sufficient and stable project pipeline. The second lesson we learned is to manage and have a lot of data available on the loans. So basically, you need to be sure that you can show your portfolio and be able to slice it up into any details the potential investors could ask for. With the residential houses modernisation, we did that, and we approached international financial institutions and borrowed on behalf of the fund. So the repayment of those loans are guaranteed with the reflows coming from the projects. That is why we need a lot of data, good quality data, and also sufficient procedures for administering these loans. But with these lessons and with these efforts, we managed to achieve five times more funding, which was initially put into the fund, into the financial instrument. So I think that is an extremely good result.

That's a very good leverage. What about the losses? I mean, they lend to whoever lives in a building, these are very different kinds of people. There must be quite a lot of risk associated with that. Do you see that the money is coming back?

Kristina: Absolutely. Actually, we do not have a lot of delay regarding the payback of the loans. Usually throughout the whole portfolio, they are no more than 5%. But these are not defaults, these are just loans being paid a little later than they were initially planned to be paid. But after some additional efforts that we put into the administration of the loans after contacting the final recipients, we basically have no defaults.

So that must be pretty attractive for investors. From what I hear, investors are looking for long term investments that are green and that have a reliable payback. So that sounds really good, congratulations! Aleksejs, in the guarantee scheme you send the grant via banks. How do you motivate banks to touch public money and to touch grants? My experience is that they’d rather avoid that.

Aleksejs: Yes, it took us some time to agree with the commercial banks about the terms of cooperation, but I'm aware that commercial banks are willing to provide the best possible service for the customers, for the authorised persons and final recipients, apartment owners. Under these models, they can disburse the loan and grant in one payment, and they can follow the project implementation, they can follow the cash flow of those investments. That's probably the main reason why they were eager to implement this particular scheme, in cooperation with us. We have signed four cooperation agreements with four banks. So, four banks are active and then providing the loans under this particular scheme.

Well, that is good to hear, that banks are willing to undertake this. And they are not only undertaking this for their profit and for their green credentials, they really want to make their customers happy. Now, we talked about what you have done so far, and Aleksejs you have mentioned, the Recovery and Resilience Facility of the European Commission, can you tell us how this links to the instrument you have so far designed with the cohesion policy funding?

Aleksejs: We analysed our experience regarding the combination of grant instruments and financial instruments in one operation and the Ministry of Economics, based on that evaluation, developed a new scheme which is based on fi-compass experiences and fi-compass materials on combined financial instruments. We are now providing a loan with a capital rebate and also guarantee and capital rebate for the increase of energy efficiency in multi-apartment residential buildings. What does this mean? Let's say we are providing a loan of EUR 100 000, so we have to check whether the building is renovated and whether the results in energy efficiency increase, let's say by 30%, has been achieved. In this case we activate that capital rebate. So the loan amount was EUR 100 000, we check the result and capital rebate is activated, meaning that in this case, for example, EUR 49 000 would be used for repayment of the principal amount, so that in one night and one day the final beneficiaries, apartment owners, their liabilities would decrease substantially by 49% to the commercial banks, in this case towards the ALTUM, because we were the loan provider. In case of commercial banks, the effect of the scheme is similar. But what we are doing, we are providing the guarantee and capital rebate. So in theory, the authorised person would contact the commercial bank, sign the loan agreement, let's say the same, for EUR 100 000. On top of that we would provide the guarantee. Then the project results are achieved, we check and activate the capital rebate. So, we would repay the part of the loan provided by the commercial bank instead of the apartment owners. This is a new scheme we introduced in December last year and currently we are still working and the clients are applying for the scheme. We have approved the first projects but no deal signed yet.

Quite often we have this disruption when the one programming period ends and the new programming period starts, and what you have done in Latvia is you even use a different pot of EU money, but for the client nothing changes. It's a real seamless customer journey. I'm really impressed by that. Kristina, what are the plans for the future in Lithuania? How are you moving into the new programming period?

Kristina: Actually, very similar to what Aleksejs said. We are also making this very smooth transition, because we are still issuing loans even though the previous programming period is coming to an end, and we are doing that with the attracted additional resources from the market. But for the upcoming programming period, the existing programming period already, what we are planning to get is additional funding from the ERDF and Cohesion Fund, which would reach almost EUR 200 million. With the EUR 200 million, we are asked to once again achieve the leverage effect of five and achieve an additional EUR 700 million of funding from the private market and other resources in the market. So we need to do this quite quickly because the project pipeline is already building and we have around 500 projects that are already prepared and ready to come to INVEGA to ask for a loan for their modernisation projects. So we are moving into this programming period full speed, well prepared and with many ambitions.

How do you deal with the high interest rate in your financial instruments, and how does the high inflation affect your projects? We see that construction costs are rising very quickly. How do you manage this?

Kristina: These are two very important, very good questions. Regarding the inflation, absolutely, we see there is a huge rise in the investment costs. The grant basically covers this increase in the inflation and payback period comes back to 20 or something years for the project, so it solved in this way. Regarding the rising interest rates, since we have a huge portfolio of previous funding, a lot of loans are being repaid, we have agreed with the ministries that we are going to use the reef loans to cover basically the difference between the current market prices and the loan price for the final beneficiaries, because we want to keep the 3% interest rate on these renovation loans for final beneficiaries. We do not want them to be expensive because this would have an immediate effect on the project pipeline and their motivation to implement the project.

This shows also one great advantage of financial instruments. These are the reflows. And with the reflows you can do many things which you can't do with fresh money coming in from the EU funds. Thank you very much. Aleksejs, how do you address this in Latvia?

Aleksejs: Yes, that's an excellent question. And the solution… there is no silver bullet actually for that. What we are doing, is we are using public funds. Public funds allows us to provide the loans with a preferential interest rate. So the interest rate for the planning period 2014/2020, it was 3.5% fixed. Now, there is a slight increase. We are providing the loans with a 3.9% annually fixed, and the public funding, so the loans are provided mostly from the public funds on the moment from Recovery and Resilience facility and if there is a need, we will attract additional private funding, we will borrow on the financial markets for the increase of construction costs. Yes, obviously there was that increase, it is stabilised now, and we have to admit that grant element has decreased a little bit under the RRF facility. So previously it was 49% or 50%, and now on comparable terms it's at 40%. So there is a slight decrease in the grant element, but still there is an interest from the market. We have projects in our pipeline, and the number of those projects are going up obviously because of the huge need and demand from the market. What we can see is that construction companies, they are willing, actually it's very important that construction, there is specific construction companies which are willing to work in that specific market, because the market is quite demanding. Apartment owners, in some cases, they are very specific customers, and that's a very nice element and we see that the construction companies, they are still able to find a good deal and to provide on good terms those services. That's the answer: we are closely following the market development and adjusting our programme terms according to that.

Thank you Aleksejs. For those who are interested to read more about the Latvian experience, I know it sounded pretty complex. We are preparing a written case study, so you will have the chance to read this, and we will publish this case study on the fi-compass website. Before we finish, is there anything you would like to mention that we haven't covered so far? Kristina?

Kristina: Well, I think I can summarise by the most important lessons learned and for the listeners to consider these lessons of Lithuania, and if they are applicable to their countries as well. As I mentioned, data available on the whole portfolio of the loans, this is extremely important and it will definitely serve you in the future, even though you might not think it at the moment. Also, stable project pipeline development. We really need to take care and find a responsible body, maybe an agency or some state institution that could coordinate centrally in an organised way, the whole modernisation programme, and solve the problems or some issues that might occur at state or municipal level. Of course, the topic that we spoke about today, the right balance between the financial instrument and different forms of grants, is very important. I think what we also need to consider regarding this point, is that we should look into the projects and analyse these different projects that are in the main cities, and also in the regions, because the situation might be very different, real estate prices differ a lot, the size of the buildings differ a lot, the construction prices even might differ also quite substantially. So, we need to look into these differences and try to find the best model suitable for all the regions, cities and all the projects.

I think that is a very important message that there is no one size fits all. Aleksejs, can you tell us, as a last message, what you want to tell us from the Latvian experience?

Aleksejs: I just wanted to continue Kristina's message that actually there is a great opportunity to use combined financial instruments to set up a programme, which should be long term programme. A long term approach, that's very key for this specific market, so from my point of view it's the best possible solution. The programme is adjusted bit by bit, time by time, but actually the model is the same more or less because to start something new it creates a lot of burden. These programmes are so complex that it would take a lot of time and effort. So that would be the great opportunity: start the programme, use combined financial instrument features and adjust it when needed. 

Thank you very much. I always learn a lot listening to the two of you. So, I want to say finally a great Ačiū to Kristina, and Paldies to Aleksejs. 

Aleksejs: Thank you.

Kristina: Thank you, Robert, for having me. And I will be looking forward to our meeting in Vilnius.

I also want to say a big thank you to the listeners who were tuning in to today's episode of fi-compass Jam Sessions. I hope this podcast will inspire you in your journey to make Europe climate neutral and to make homes warmer in winter and cooler during any summer heatwaves. I also know that even during Baltic summers, it can get pretty hot and it's important to be in a well-insulated building. Hopefully I will see many of you in Vilnius at our free campus workshop on the 14th and 15th of November. Both Kristina and Aleksejs will be there, they will present their work and you will have the opportunity to talk to them face to face. For those who can't make it, we will publish the slides on the fi-compass website. If you have any questions, just drop us an email at contact@fi-compass.eu, we're looking forward to hearing from you.