Sunday, August 10, 2008

Text of BioWorld Article on CIRM Loan Program

Here is the text of a piece on the CIRM biotech loan proposal that ran Aug. 7, 2008, in BioWorld Perspectives.

Red Flags Remain in Plan to Help Biotechs

By David Jensen
BioWorld Perspectives Contributing Writer

Editor's note: David Jensen is the publisher of the California Stem Cell Report and has written more than 1,700 items involving CIRM since 2005.

California wants to help biotech enterprises navigate through the industry's famed financial "valley of death" with a $500 million loan program.

It comes at a good time for the bio biz. Money is tight, but in the Golden State, one agency has $3 billion to spread around for research and clinical trials. The cash comes from the California Institute for Regenerative Medicine (CIRM), the state's unprecedented stem cell research funding organization.

It was created less than four years ago under Proposition 71, a California ballot initiative that surfaced in reaction to President George W. Bush's restrictions on human embryonic stem cell research. Using funds from California state bonds, CIRM has already handed out more than $554 million in grants. Today, the agency is the largest source in the world for funding for human embryonic stem cell research.

Biotech Loans and Controversy

But CIRM is not without controversy. Recently some disgruntled grant applicants have complained of unfairness in reviews. Some in the biotech industry object to CIRM's rules for sharing the wealth from any state-financed therapies. And there is at least one catch to CIRM's plans to loan $500 million to biotech firms. Recipients of the state's bounty are going to need a California connection — probably a fairly strong one — since state law says CIRM's cash must be spent generally in California. But it probably wouldn't be too hard for an enterprising business to accommodate those needs if it wants, let's say, a $25 million loan.

Policies for the biotech loan program are likely to get the go-ahead next week from CIRM's board of directors. The main reason for its expected approval is CIRM Chairman Robert Klein, a multimillionaire real estate investment banker who has served in his state stem cell role without pay since 2004. His real estate background has taught him the value of financial leverage, which is exactly what the loan program is about.

The loan effort is Klein's brainchild, conceived as a way to not only help biotech enterprises (both for-profit and nonprofit), but also to extend the life of the state's stem cell effort. It is limited by law to only 10 years of state bond funding and currently has no other source of income.

According to a PricewaterhouseCoopers report commissioned by the agency, Klein's plan could generate at least a $100 million profit, although state government delicately avoids the use of the word "profit." The earnings then could be channeled back into more grants and loans. With expectations that default rates could soar as high as 50 percent in some cases, that seems to be almost too good to be true. There are skeptics, but not many public ones.

Firms Found in the 'Valley of Death'

The reason for high defaults? The loan program would target firms that otherwise could not find financing because they are wallowing in the "valley of death," a loose term that describes the financially difficult period between grant and "angel" financing and funding from venture capitalists.

PricewaterhouseCoopers performed an analysis of the proposal based on assumptions provided by the agency. They included a $500 million portfolio, disbursed over a seven-year period, loans up to $5 million, interest rates ranging from prime plus 2 percent to 4 percent with possible warrant coverage from 10 percent to 100 percent. Pricewaterhouse concluded, "Total assets of the program could increase from $500 million to between $600 million and $1 billion over 10 years."

Klein, however, has indicated that changes are likely in those assumptions. During a May meeting of CIRM's Finance Subcommittee, he indicated larger loans should be given and other changes be made to improve the proposal.

"It may take a very significantly sized loan, even on a matching fund basis, for companies to get through the preclinical, Phase I, and Phase II and Phase IIb stage before private capital would be prepared to step in," he said.

Klein said he plans to bring in Ed Penhoet, vice chairman of CIRM, co-founder of Chiron Corp. and currently a venture capitalist, to beef up his call for hefty loans.

Reception of the loan program by industry has generally been favorable. But some have raised questions. Menlo Park, Calif.-based Geron Corp., for example, said the loan sizes initially assumed in the Pricewaterhouse analysis were too small.

Red Flags in an Innovative Plan

Other hurdles remain as well. The Consumer Watchdog group of Santa Monica, Calif., has expressed concern about potential conflicts of interest. The nonprofit advocacy organization cited the possible use of delegated underwriting. CIRM Director Duane Roth, as well, has raised a flag about potential conflicts involving underwriters. Klein had suggested the use of underwriters because of the small size of the CIRM staff (between 30 and 40 persons) and its lack of lending expertise.

At one point, Klein cited Fannie Mae as an example of how underwriting could be used with biotech loans. But given the recent financial news about the Federal National Mortgage Association, it seems unlikely he will mention that enterprise again.

CIRM's biotech loan plan seems innovative, filling an important need in the biotech industry. The plan, however, does involve a substantial risk of public funds that has not been fully explained in a straightforward manner. Given today's difficult economic times and unease about aggressive lending practices, a clear explanation is certainly in order. The public, California lawmakers and industry should understand how it is possible that CIRM can turn a profit with default rates as high as 50 percent and the risks involved.

CIRM is a young government department and should move with caution in order to maintain public trust. Major failures in a biotech loan program could damage CIRM's credibility and cast a pall over its other important activities, including grants, ethical research standards and intellectual property policies.

Here are links to more information about the biotech proposal.
The California Stem Cell Report (search on the label "biotech loans"):
The California Institute for Regenerative Medicine:
PricewaterhouseCoopers report (in three parts):
Phase I (loan financial model):
Phase II – Gap Analysis, Capital Provider Feedback and Financial Model:
Phase III – Loan model scenarios:
Transcripts of the Biotech Loan Task Force:
Agendas of the Biotech Loan Task Force:
The agendas have links to multiple documents dealing with the plan.

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