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State-chartered bond authorities exist in every state. They include healthcare facility authorities, housing finance agencies, higher education facility authorities, and industrial development finance authorities. For those authorities, eligible projects include energy efficiency retrofits for existing facilities owned by eligible borrowers. The eligible borrowers for tax-exempt bonds are defined in the federal tax code as:
- Nonprofit healthcare
- Nonprofit higher education
- Nonprofit K-12 schools
- Other nonprofit institutions such as museums, YMCAs, and YWCAs
- Low-income multifamily housing
- Industry and manufacturing for defined types of exempt facilities.
Tax-exempt bonds generally offer lower interest rates and longer tenors than most taxable bonds, making them a well-suited and attractive means of financing energy efficiency or renewable energy projects for eligible borrowers.
"Tax-exempt" means that the interest component of bond debt service payments is exempt from federal and sometimes state and local income taxes for the bond holder. Therefore, with regard to credit quality and term of the bonds, the interest rate will be lower than for a taxable bond. Fixed interest rate bonds with 10- to 15-year terms are common. Tax-exempt bonds also have a deep market of interested bond purchasers. The ability to sell bonds, as always, is subject to the credit quality of the borrower, but credit enhancements can improve the credit quality of the bond.
For these reasons—lower rate, longer term, and deep buyer market—state and local governments can investigate tax-exempt bonds as a financing alternative when clean energy finance programs target the eligible sectors (listed above). State and local governments are advised to hold discussions with their bond authorities to see how they can participate in local or state financing programs.
As public entities, bond authorities are generally mission driven and oriented to using their financing capacities for public good purposes. Many authorities also issue taxable bonds and offer other financial products to meet state economic development goals, such as supporting lending to small and medium enterprises. Bond authorities can be a conduit for financing and also a marketing partner; they have existing loan portfolios and can, for example, contact their existing borrowers with an offer of energy efficiency or renewable energy engineering assessments and services, if these can be arranged.
Availability of low-cost financing can help drive development of projects, but it needs to be coupled with marketing and project development. There are natural partnerships to be formed between bond authorities and state and local government energy efficiency finance programs. Utilities, energy efficiency companies and energy service companies, end-user associations (for hospitals, higher education, private schools, and industry), and others can pool their talents to generate project deal flow and market the energy efficiency/renewable energy finance products, which the bond authority can arrange.
Private Placements Versus Capital Markets Bond Sales
Loans for energy efficiency retrofits of existing facilities are often small—between $75,000 and $150,000 in many cases. These relatively small loan sizes can be challenging when trying to arrange financing, streamline bond issuance procedures, manage transaction costs, and find interested bond purchasers.
In general, bond authorities are conduits to financing, not sources of financing. That is, they issue bonds, but the bond purchasers must still be arranged and the credit of the borrower approved. Bonds can be sold on a private placement basis directly to a bond purchaser without a credit rating, or as a public sale in the capital markets with a credit rating for the bond from a bond rating agency like Fitch or Standard and Poor's. The minimum size for a private placement can be anywhere from $500,000 to $1 million. Some authorities have developed streamlined procedures for smaller bond issues.
The minimum size for a public bond sale is typically in the range of $10 million to $20 million, if not much larger. Credit enhancements or letters of credit can often help to secure a rating from the rating agencies. Some bond authorities can finance projects with their own resources, aggregate them, and then refinance with a bond issue. Or, the bond authorities can work with a partner financing institution that can originate the clean energy loans, which then can be pooled together for refinancing with a bond sale.