Qualified Energy Conservation Bonds

Part 2: Bond Financing and Eligible Projects

Moderator:Katie Southworth, Program ManagerTDEC Office of Energy Programs

ORNL’s 3rd Annual Southeast Sustainability Summit

August 21, 2013

Qualified Energy Conservation BondsPublic Finance Perspective

George Masterson615-742-6263

gmasterson@bassberry.com

What are qualified energy conservation bonds (QECBs)? QECBs are

− taxable bonds− issued by a state or local governmental entity or

instrumentality− partially subsidized by U.S. government if:

• proceeds finance specified types of energy conservation projects and

• issuer meets other detailed Internal Revenue Code requirements at time of issuance and during life of bonds

How does the federal subsidy for QECBs work? Historically, federal government has used three approaches to

subsidizing state and local bonds

� Tax-exemption – bond investors accept a lower rate of interest because interest is exempt from gross income for federal

income tax purposes

� Tax credits – bond investors accept a lower (or, in some cases, zero) taxable rate of interest because ownership of bond carries tax credits that can be applied against any federal tax liability

� Direct payments – bond investors receive a market, taxable rate of interest and U.S. Treasury makes regular subsidy payments directly to the issuer of the bonds on each interest payment date

How does the federal subsidy for QECBs work? (continued) Tax-exemption – relevant to QECBs because most

projects that qualify for QECB financing also qualify for financing with traditional tax-exempt bonds

Tax credits – default subsidy method for QECBs

Direct payments – may be elected by a QECB issuer in lieu of tax credits

How does the federal subsidy for QECBs work? (continued) Tax-credit mechanics

− holders of QECBs receive annual tax credits equal to: 70% of “applicable tax rate” times principal amount of bond

− “applicable tax rate” • U.S. Treasury’s estimate of credit rate that will permit the

issuer to sell bonds at zero interest and no discount

• announced periodically by the U.S. Treasury at https://www.treasurydirect.gov/GA-SL/SLGS/selectQTCDate.htm

• determined on the date issuer sells the bonds

How does the federal subsidy for QECBs work? (continued)

What requirements apply to QECBs at issuance? State or local government issuer Issuer reasonably expects to:

− enter into a binding commitment with a third party to spend 10% of proceeds within six months of issue date

− spend proceeds on “qualified conservation purposes” within three years

Issuer has allocation of a portion of the nationwide $3.2 billion cap on the amount of QECBs that may be issued

Maturity does not exceed the maximum term for QECBs announced by the Treasury Department at time of issuance

What requirements apply to QECBs at issuance? (continued) Issuer formally designates bonds as QECBs

Issuer formally elects direct payment treatment as opposed to tax credit (if desired)

No more than a de minimis amount of original issue premium

No more than 2% of proceeds used to pay costs of issuance

No prohibited conflicts of interest

What requirements apply to QECBs at issuance? (continued) Qualified conservation purposes include:

− capital expenditures that:• reduce energy consumption in publicly-owned buildings

by at least 20%• implement green community programs• rural development including the production of electricity

from renewable energy sources• renewable energy facilities

− mass commuting facilities− demonstration projects and public education campaigns− research facilities or grants relating to energy reduction and

efficiency and production of non-fossil fuels

What requirements apply to QECBs at issuance? (continued) QECB allocation process

− nationwide: $3.2 billion of capacity− Internal Revenue Code mandates allocation among

states and “large local governments” (i.e, cities and counties with populations greater than 100,000)

− states and large local governments may re-allocate their cap to other issuers

What requirements apply to QECB during life of bonds? Davis Bacon prevailing wage rules apply Spending requirements

− three-year spending requirement• basic requirement:

o 100% of “available project proceeds” spent on qualified conservation purposes within three years OR

o unspent available project proceeds used to redeem corresponding portion of bonds

• limits on reimbursement of prior expenditures and refunding of other obligations

What requirements apply to QECB during life of bonds? (continued) Arbitrage requirements

− For tax-exempt bonds, Internal Revenue Code prohibits, with many exceptions, investment of bond proceeds at a yield that is greater than yield on bonds

− For QECBs, tax-exempt bond arbitrage rules apply, with the following exceptions:

• yield is net of direct payments received

• issuer permitted to establish a level-funded “sinking fund” invested at yield no greater than a target yield announced by U.S. Treasury immediately prior to issue date

What special rules apply to QECBs that are “private activity bonds?” “Private activity bonds” = more than 10% of the

proceeds are used for private rather than governmental projects AND more than 10% of the debt service of which is from payments related to the private use

QECBs may be “private activity bonds” as long as− all “qualified conservation purpose” expenditures are capital

expenditures− no more than 30% of the volume cap allocation of any state or

large local government consists of private activity bonds, with green community bonds NOT treated as private activity bonds

Summary• QECBs benefit from significant federal

subsidy

• Detailed requirements to be met

at issuance

during life of QECBs

National View of QECBs

Elizabeth Bellis, Energy Programs Consortium SE Sustainability Conference

Draft: 8/8/13

August 21, 2013

Disclaimers

Circular 230: This presentation was not intended or written to be used, and it cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer under U.S. Federal tax law.

This presentation is intended to serve as a general introduction to the use of qualified energy conservation bonds to finance renewable energy projects. Nothing contained in this presentation should be construed or relied upon as legal advice.

QECB Review

• QECBs are effectively a federal interest rate buydown program for state and local bonds.

• Interest is taxable.

• Issuer elects: Cash payments to the issuer OR tax credits to the bondholder.• Cash payments = 100% of the interest OR, if lower, 70% of the

“qualified tax credit rate” set periodically and available at Treasury Direct’s website.

• These payments are subject to sequestration (discussed below).

• Maturities are also set periodically and have ranged from 12 to 22 years (see Treasury Direct website)

QECB Uses

• Reduction of energy consumption in publicly owned buildings by at least 20%

• Implementing green community programs (PACE financing, LED streetlights, etc.)

• Rural Development

• Renewable energy facilities (wind, solar, biomass, geothermal, landfill gas, trash to energy, hydropower facilities)

• Certain mass commuting projects

QECBs by Use

QECBs for School Projects

Who got the allocations?QECB Regional Allocation

How much is left?

• Up to 75% of the original $3.2b may be available.

• State utilization rates range from complete lack of known utilization (22 states) to complete exhaustion of allocation (Kansas). • A number of states are approaching exhaustion of funds,

including Colorado, Kentucky, and Montana.

• On the other hand, a few states, including Hawaii, Mississippi, and Florida are not known to have authorized QECBs at this time.

QECB Utilization Nationally

QECB Issuances by Region

QECB Utilization by Region

QECB Utilization by State

Volume of known issuances

Known Utilization Rate

Southeastern Region

• Of $776,381,000 in QECBs available to the region, only $58,859,000 (7.6%) has been issued.

• All of these issuances have been for EE retrofits in municipal buildings and schools.

• In the southeastern region, Arkansas, Florida, Louisiana, Mississippi, North Carolina, and South Carolina have had no known issuances.

• Kentucky leads the way with 3 issuances, followed by Tennessee, Georgia and Alabama with 1 issuance each.

• Kentucky’s 3 issuances account for 93% of available funds, making it among the states with the highest utilization rates nationwide.

• Louisiana’s 1 issuance (of $30M) accounts for 66% of the states allocation.

Barriers to Use

• Initial legal uncertainty• Notice 2012-44 clarified many of the FAQs regarding

“green community programs” and proper measurement of energy savings

• Sequester

• Admin Costs

• Lack of familiarity

• Debt capacity/debt aversion

• Pooling issues

Reasons for Success

• Issuing QECBs as part of larger bond issuance

• Proactive, persistent outreach

• Engaging with facilities managers at schools, prisons, and public housing who may have projects

• Engaging with private developers where there are debt issues or insufficient public pipeline

• Working with local bonding authorities (where applicable) to expedite process

• Experienced bond counsel

QECB News

• Sequester cuts in place through September. No known current proposals on the table to continue the cuts after September.

• Congress is conducting an intensive reviewing of the tax code, including energy provisions. However, the end effect on QECBs is not yet known.

• Some have proposed renewing and expanding the 179D credit, which may be available for certain QECB-financed projects to sweeten the deal (for certain energy efficiency improvements to qualifying commercial and government buildings).

Where can I find more information?

• The current version of the EPC QECB paper is available at http://www.energyprograms.org/wp-content/uploads/2013/06/QECB_Memo_June13.pdf. Updates will be posted periodically on our Publications page.

• The NASEO website has a variety of resources, including documents other states have used and the EPC QECB memo which contains information about all known issuances.• http://www.naseo.org/resources/financing/qecb/index.html

• DSIRE has a QECB page with links to relevant statutory provisions and IRS guidance.• http://www.dsireusa.org/incentives/incentive.cfm?

Incentive_Code=US51F&re=1&ee=1• The Department of Energy’s website has resources including a QECB

Primer and webinars.• http://www1.eere.energy.gov/wip/solutioncenter/financialproducts/m/

qecb.html

Questions? Please keep in touch.

Elizabeth Bellis

Director, QECB & WHEEL Programs, EPC

Email: ebellis@energyprograms.org

Sequestration Review

• “Sequestration” -- government-wide budget cuts mandated by the Budget Control Act of 2011.

• The sequester reduction is applied to section 6431 amounts claimed by an issuer on any Form 8038-CP filed with the Service which results in a payment to such issuer on or after March 1, 2013.

• As determined by the Office of Management and Budget, payments to issuers from the budget accounts associated to these qualified bonds are subject to a reduction of 8.7% of the amount budgeted for such payments.

• The sequestration reduction rate will be applied until the end of the fiscal year (September 30, 2013) or intervening Congressional action, at which time the sequestration rate is subject to change.

• It is unclear whether the sequester reduction applies to tax credit QECB issuances that did not opt for direct payments and file Form 8038-TC rather than 8038-CP, as the IRS statement does not mention these issuances. EPC is looking into this.

Where did 8.7% come from?

• Originally OMB released a report in 2012 stating the subsidy payments for the federal fiscal year ending September 30, 2013, may be cut by 7.6%.

• OMB has now indicated in a report to Congress dated March 1, 2013, that the current percentage reduction will be 5.3%.

• The 5.3% is the overall reduction in the program's total FY 2013 level.

• Since the beginning of FY 2013 last October 1 some issuers have received payments that were not reduced. In order to achieve the overall annual savings of 5.3 percent, the remaining payments will have to be cut by a larger percentage.

• The Tax Exempt Bond office ("TEB") of the Internal Revenue Service has now advised that subsidy payments to issuers through September 30, 2013, will be reduced 8.7%. 

What Does It Mean?

• Existing issuers have faced higher net interest payments.• Future issuers may consider tax credit QECBs in lieu of direct

pay QECBs if they are exempt from sequestration.• All issuers and purchasers may now “discount” the value of

the subsidy going forward due to uncertainty about the amount and continuity of its provision.

• Many issuers have the right to repurchase their QECBs in the event of a subsidy reduction. • Such issuers may weigh alternative capital sources that could be

drawn upon to fund a repurchase, and the costs thereof (including transaction costs) relative to the increase in interest payments on QECBs.

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The Parker Ranch installation in Hawaii

Qualified Energy Conservation Bonds In Action

Glenn Barnes August 21, 2013

Environmental Finance CenterUniversity of North Carolina at Chapel Hillwww.efc.unc.edu

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UNC Environmental Finance Center

Dedicated to enhancing the ability of governments and organizations to provide environmental programs and services in fair, effective and financially sustainable ways

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Choosing Projects

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$9.3 million QECB for energy efficiency improvements to County Jail and Regional Center, annual positive cash flow of $1.56 million•Upgrades included: Lighting & HVAC upgrades, new waste disposal system and domestic water pumping upgrades for the jail, and water upgrades & new high efficiency boilers for the regional center

Allegheny County, PA: Municipal Building Efficiency Improvements

Initial guaranteed energy savings agreement project (both buildings)

$14,186,509

EECBG (Energy Efficiency and Conservation Block Grant) $4,848,602

QECB $9,337,907

1st year annual guaranteed energy savings (Starting 2012) $2,107,866

1st year payment (Starting 2012) ($523,994)

Measurement and verification service payment ($24,219)

1st year annual positive cash flow $1,559,653

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$1.95 million in total avoided energy costs (2009-2012) for Manchester School District with ARAMARK as performance contractor

Manchester, NH: Improving Efficiency in Schools

Fund Source Amount

ARRA – EECBG $406,391

QECBs $1,130,000

State Energy Loan Fund $400,000

Utility rebate “bank” $358,374

Public Service of New Hampshire Utility Smart-Start

$210,071

Total $2,551,673

1st Year Cost Savings$450,893

Source: Clean Air - Cool Planet (2012)

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Many local governments using QECBs for street light improvements including San Diego & Richmond CA, Las Vegas NV, & Surprise AZ•Surprise, AZ is a city with about 117,000 people•Issued a 15-year QECB bond of $723,803 in 2012 with a retirement date of July, 2027•Principally for replacing street and baseball field lights •Energy savings expected to more than cover planned Principal & Interest payments (which average ~$50,000)

Street Lights in Surprise, AZ

Source: Surprise, AZ 2013 Recommended Budget http://www.surpriseaz.gov/index.aspx?NID=223

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ESCO McKinstry guaranteed 25% annual dollar savings on energy & water ($280,000), higher than bond payments•Located in Littleton, CO, and received $1 million QECB allocation from State•Bond issuance cost ~3% with Dept. of Treasury subsidy, max payment of $278,000 per year•Energy efficiency HVACs, lighting, toilets, and ice machines for hockey arena (among other improvements)•Also, 100kw Solar PV system on the EDGE (Ice rink/arena)

Foothills Park & Rec Dept, CO

Source: Foothiils Board Meeting, March 2010 (http://www.ifoothills.org/page_includes/board/2010/Minutes_03_09_2010.pdf)

Image: Denver Post.com

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Energy is one of the largest controllable expenses of water and wastewater treatment•Deerfield, IL has a population of 18,225 and an MHI of about $107,000•Issued an 18-year QECB bond of $12.5 million with an effective interest rate of 1.12% (AAA bond rating)

– General Obligation bond—no voter approval required in IL

•Funded equipment replacement that is expected to realize a 21-22 percent energy savings•Part of a larger bond issuance

Wastewater Treatment in Deerfield, IL

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1 MW solar photovoltaic (PV) project to supply power to both a jail and juvenile center•Finance was a mix of new CREBs, QECBs, a California Energy Commission (CEC) loan, a Pacific Gas and Electric (PG&E) rebate, and a Tax Exempt Lease Program (TELP) loan•3.9 percent interest rate with a 15 year tenor for QECBs•Yolo is anticipating that it will have a net positive cash flow of $100,000 per year starting in year 1 and $600,000 per year starting in year 16 in utility expenditures

Yolo County, CA

Source: NREL (https://financere.nrel.gov/finance/content/first-known-use-qecbs-will-save-yolo-county-least-87-million-over-next-25-years) Image: NREL

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• QECBs used to fund an energy performance contract (about 1% interest)

• $3 million Phase 1 includes campus irrigation controls retrofit and domestic water conservation; HVAC exhaust energy recovery; and partial campus lighting retrofit

• First year project savings guaranteed at over $307,000, providing a simple payback of 9.1 years

• 2,600 metric tons of greenhouse gas emissions avoided every year

Colorado School of the Mines

Source: McKinstry Web Sitehttp://www.mckinstry.com/projects/220/Colorado-School-of-Mines

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St. Louis uses QECBs to fund residential energy efficiency loan program, with goal of retrofitting 1400+ homes across several years

Green Community Example: Saint Louis County

Source: Berkeley Labs QECB Case Study, http://eetd.lbl.gov/ea/emp/reports/ee-policybrief_062011.pdf

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5 total private activity bonds to this point, with three in Massachusetts, for renewable generation projects including the Lawrence dam project

Private Activity QECB: Lawrence, KS Dam Project

Source: SternBrothers & Co., May 2012. http://www.gscwest.com/Presentations/Session2ResourceMgmtDennisCiocca.pdfElizabeth Bellis, Energy Programs Consortium (2012) http://www.nga.org/files/live/sites/NGA/files/pdf/1206PolicyInstituteBellis.pdf

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• Glenn Barnes• 919.962.2789• glennbarnes@sog.unc.edu

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