Helping Clients Improve Economic Return with Energy Project Financing

1. Helping Clients Improve Economic Return with Energy Project Financing Energy Tax Savers, Inc. Charles Goulding Charles.Goulding@EnergyTaxSavers.com

2. Why Finance an Energy Project? • Rapid economic payback • Large, immediate energy savings can be realized sooner • Match the debt with the energy savings • Outdated building equipment can be retrofitted immediately • Many market finance options now available that did not exist just a few years ago

3. Energy Project Financing • Building energy products & alternative energy investments offer excellent economic returns • In recent years multiple energy-financing project strategies have become quite popular • CPA's to assist their clients in reducing operating costs while enhancing their ability to obtain related tax incentives • Leading lenders are increasingly interested in this strong expanding market

4. Financing Options • Vendor Provided Financing • Bank Financing • On Bill Utility Financing • State/Municipal Loan Programs • Municipal Lease-Purchases • Property Assessed Clean Energy Bonds (PACE) • Preferential Treatment for Green/EE Buildings • Performance Contracting • Power Purchase Agreements • Energy Service Agreements

5. Vendor Financing • Capital Lease: • End users with tax capacity are advised to structure these as capital leases to take the EPAct tax benefits • Operating Lease: • Lessor owns the equipment and leases it out for a pre-determined contract period • Lessor takes the tax benefits, and lessee writes off the lease payments as a business expense • With energy efficiency equipment, vendor often guarantees that the customer will pay no more for the lease than the energy savings it generates

6. Vendor Financing • The energy efficiency savings realized from new equipment can offset the lease payment • This will result in a positive cash flow situation for the company. • Cost and length of available finance terms will depend on the equipment itself as well as the parties’ own creditworthiness

7. Vendor Financing • Often tailored to the product being sold.   • E.g., vendor lighting will typically cover installation and old fixture removal.   • Bank financing is often limited to hard costs and won't cover soft costs, such as: • Installation • Removal of old equipment.   • Bank financing is often document intensive. • Bank financing usually requires: • Additional security • Down payments

8. Vendor Financing • Try to piggy-back existing credit approvals • This may save you and your client a lot of time and effort.   • For example, multiple major hospital equipment lenders such as GE, Philips and Siemens are also in the lighting business and the same lines of credit can be used for energy projects.

9. Bank Financing: Mortgage-Backed Energy Efficiency Financing • Energy Efficient Mortgage (EEM): • Provides additional borrowing capacity • Better terms to borrowers buying new energy-efficient home or investing in energy improvements in existing home • Energy efficiency financing is rolled into home mortgage • Requires compliance with the Home Energy Rating System (HERS)

10. Bank Financing: Mortgage-Backed Energy Efficiency Financing • Either for purchase or refinancing • EEM assumes that energy savings exceed amortized cost of improvements • Results in NOI positive investment that improves the borrower’s ability to pay, hence lowering risk of default

11. Bank Financing: Mortgage-Backed Energy Efficiency Financing Energy Star Mortgage programs in Maine, New York, and Colorado inject capital into mortgage products to “buy down” the interest rate charged to borrowers as an incentive to finance energy improvements

12. CPE Questions • Should clients with tax capacity structure vendor financing as an operating lease or capital lease? • What are the ramifications of each? • What is the major benefit to using vendor financing over traditional bank financing?

13. On Bill Utility Financing • The utility, fuel commodity supplier or a third party financier covers the up-front cost of an energy efficiency upgrade • Customer repays the investment through a charge on their monthly utility bill • Major advantage: • Overcomes program set-up barriers • Leverages existing billing relationship utilities have with customers and builds on access utilities have to energy use information

14. On Bill Utility Financing • Two types: • Loans tied to the customer: if the customer moves, the balance must be paid • Loans tied to the meter: if customer moves, the next building occupant has an obligation to pay • Most utility-administered on-bill financing programs offer low or no interest loans and short repayment periods

15. On Bill Utility Financing • New London Resource Project • Electric Cooperatives of South Carolina • Clean Energy Work Oregon • AFC First Financial • MACED: How$martKY • City of Portland Housing Bureau • ECG • NYSERDA • Utility Examples: • United Illuminating • Hess • Public Service Company of New Hampshire • New Hampshire Electric Cooperative • National Grid • Sempra Utilities • Manitoba Hydro (Loans) • Midwest Energy How$mart (tariff) • Nstar • PG&E

16. State/Municipal Loan Programs • American Recovery and Reinvestment Act: • $11.6-bil in 2010 to state and local governments • States allocate funds from: • General fund • Federal grant allocations • Ratepayer funds • Loans to ratepayers cover up-front project costs

17. State/Municipal Loan Programs • Ratepayers pay loan back via an additional charge on their utility bill • Example: Pennsylvania’s Keystone HELP • Secured loans for basic retrofit improvements • 5-7% over 3, 5, or 10 year terms • 2011: California, Connecticut, Hawaii, Maine, New Hampshire, New York, Texas, and Washington • Made critical advancements to unlocking financing for energy efficiency and green building

18. State/Municipal Loan Programs • Biggest advantage: consolidation of information and resources across governmental agencies • Biggest disadvantage: Access to secondary sources of capital are typically necessary, such as: • Bank debt • Foundation investments • Municipal bonds

19. CPE Questions • What are the two types of on-bill utility financing? • What are the differences between them? • What is the major benefit to using vendor financing over traditional bank financing?

20. Municipal Lease-Purchases • A conditional sales or installment sales agreement • Market alternative to a cash purchase or municipal bond issue • Lessee’s payment obligation usually terminates if lessee fails to appropriate funds to make lease payments • So lease may be kept off balance sheet

21. Municipal Lease-Purchases • During term of a municipal lease: • The municipality holds title to the leased equipment • Lessor retains a security interest • With each payment municipality establishes an equity interest in the equipment. • At the end of the original lease term: • Security interest is removed and the municipality has clear title to the equipment.

22. Municipal Lease-Purchases • Interest is tax free to the investor • If rate is lower than commercial rates • May not be considered debt by municipality • Right to walk away if funds not annually appropriated; no credit for prior payments • Lessor tries to control as much as possible • Eg. Municipality prohibited from engaging in further similar project transactions if in default on this one

23. Municipal Lease-Purchases • Two key ancillary forms • 838G • Confirms tax exempt municipal instrument • Opinion of Counsel • Signed by municipality’s counsel

24. Municipal bankruptcies • Central Falls, RI • Birmingham, AL • Vallejo, CA • Stockton, CA • San Bernardino, CA • Other California cities are in a precarious position

25. Property Assessed Clean Energy (PACE) - Residential • City/municipal liens on home value to enable community-wide energy efficiency funding • A secured benefit district of land or real property • City/municipality will provide financing for the project • Typically by selling bonds secured solely by payments made from participating property owners

26. Property Assessed Clean Energy (PACE) - Residential • Homeowners who receive a financing benefit from the municipality accept a property tax assessment or charge for up to 20 years • Problem: • Objections by the Federal Housing Finance Agency have largely closed this PACE options for residential energy efficiency financing

27. PACE - Commercial • Program funds energy improvements on: • Multifamily (>4 units) • Commercial • Industrial • Long-term loans • Secured by a lien on owner’s property • Paid back via a charge on property tax bill

28. PACE - Commercial • Municipal loan pools funded by: • Issuing bonds • State/federal grant funding • Mortgage-holder’s consent required • DOE: • Reduced monthly energy bills should more than offset the additional charge on property tax bill

29. PACE - Commercial • Carbon War Room (think-tank) example: • Project developer obtains exclusive right to market PACE • Creditworthy contractor implement efficiency measures • Contractor guarantees energy savings • Works with third party to underwrite insurance policy to back guarantee • Capital provider offers low-interest short-term loan • Loans bundles into long-term bonds and sold to institutional investors

30. CPE Questions What results if a municipal lessee fails to allocate the funds to make a lease payment on energy-efficient equipment? How does a commercial property owner repay the municipality for PACE loans?

31. Preferential Treatment for Green/EE Buildings • So far mortgage lenders and insurance providers largely do not recognize the lower risk/higher return attributes of investments in energy efficient buildings • Despite documented findings about the innumerable benefits to a “green” building, • These parties need to be convinced with robust data to give preferential treatment

32. Preferential Treatment for Green/EE Buildings Being a first mover in this area could be attractive to institutional investors to received positive PR benefits and gain access to a high-quality demographic with substantial opportunities for add-on services and brand loyalty.

33. Performance Contracting • A method for developing and implementing comprehensive energy efficiency or clean energy projects • Typically provided by an Energy Service Company (ESCO) • Typically used for projects in federal government buildings and in public institutions such as municipalities, universities, schools and hospitals (MUSH)

34. Performance Contracting • Dodd-Frank: • ESCO’s won’t be able to administer programs or originate loans unless they are registered Municipal Financial Advisors • Administrator/originator role will be taken by 3rd party companies who will add full finance consulting to their loans or to specialty brokers

35. Performance Contracting • After project completion, the ESCO monitors energy savings and maintains equipment • The savings produced typically exceeds the loans payments over the term of the contract • During the contract: • Customer shares in a portion of the savings • After contract term: • Customer ceases payments and enjoys all of the residual energy savings

36. Performance Contracting In nearly all of these projects implemented in public buildings the ESCO guarantees the savings to the customer If retrofits produce less than the guaranteed savings, the ESCO will pay the difference The value of savings in excess of the guaranteed savings remains with the customer

37. Performance Contracting • These projects take several months to develop, involve complex contracts, and blend several sources of funds: • Utility incentives and rebates • Public revolving loan funds • State/federal government grants • Bonds • Tax equity • Loans • Leases

38. Performance Contracting Advantages and Disadvantages • Advantages • Reduced risk involved in comprehensive retrofits • Can be combined with other incentive programs to enhance project returns • Rigorous monitoring and verification • A time-tested, standardized methodology • Disadvantages • Substantial negotiation and documentation • Increased transaction costs • Difficult to finance smaller projects

39. CPE Questions What incentive is there for institutional investors to become first movers in the field of preferential financing for “green” buildings? What result for the customer after the performance contract term has ended?

40. Power Purchase Agreements • Contracts between two parties: • Seller generates electricity • Buyer who is looking to purchase electricity • Various forms of Power Purchase Agreements differentiated by source of energy harnessed • Solar • Wind • Geothermal

41. Power Purchase Agreements • Financing for the project is delineated in the contract, which also specifies: • Relevant dates of the project coming into effect • When the project will begin commercial operation • Termination date for which the contract may be renewed or abandoned.

42. Power Purchase Agreements • All sales of electricity are metered to provide both seller and buyer with information about the amount of electricity generated and bought • Rates for electricity are agreed upon in the contract between both parties • Such agreements play a key role in the financing of independently owned (i.e. not owned by a utility) electricity generating assets

43. Power Purchase Agreements The seller under the PPA is typically an independent power producer, or "IPP." Commercial PPA providers can enable businesses, schools, governments, and utilities to benefit from predictable, renewable energy

44. Solar Power Purchase Agreements (SPPA) • From EPA’s website: • “A Solar Power Purchase Agreement (SPPA) is a financial arrangement in which a third-party developer owns, operates, and maintains the photovoltaic (PV) system, and a host customer agrees to site the system on its roof or elsewhere on its property and purchases the system’s electric output from the solar services provider for a predetermined period. This financial arrangement allows the host customer to receive stable, and sometimes lower cost electricity, while the solar services provider or another party acquires valuable financial benefits such as tax credits and income generated from the sale of electricity to the host customer.”

45. Solar Power Purchase Agreements (SPPA) • From EPA’s website: • “With this business model, the host customer buys the services produced by the PV system rather than the PV system itself. This framework is referred to as the “solar services” model, and the developers who offer SPPAs are known as solar services providers. SPPA arrangements enable the host customer to avoid many of the traditional barriers to adoption for organizations looking to install solar systems: high up-front capital costs; system performance risk; and complex design and permitting processes. In addition, SPPA arrangements can be cash flow positive for the host customer from the day the system is commissioned.”

46. States with Renewable Energy Portfolio Standards • New Hampshire: 23.8% by 2025 • New Jersey: 22.5% by 2021 • New Mexico: 20% by 2020 • Nevada: 20% by 2015 • New York: 24% by 2013 • North Carolina: 12.5% by 2021 • North Dakota: 10% by 2015 • Oregon: 25% by 2025 • Pennsylvania: 8% by 2020 • Rhode Island: 16% by 2019 • South Dakota: 10% by 2015 • Texas: 5,880 MW by 2015 • Utah: 20% by 2025 • Vermont: 10% by 2013 • Virginia: 12% by 2022 • Washington: 15% by 2020 • Wisconsin: 10% by 2015 Arizona: 15% by 2025 California: 33% by 2030 Colorado: 20% by 2020 Connecticut: 23% by 2020 DC: 20% by 2020 Delaware: 20% by 2019 Hawaii: 20% by 2020 Iowa: 105 MW Illinois: 25% by 2025 Massachusetts: 15% by 2020 Maryland: 20% by 2022 Maine: 40% by 2017 Michigan: 10% by 2015 Minnesota: 25% by 2025 Missouri: 15% by 2021 Montana: 15% by 2015

47. Leading Commercial PPA Utilities Pacific Gas & Electric Xcel Energy San Diego Gas & Electric Duke Energy Corp. NextEra Energy Resources

48. Power Purchase Agreements – The Good News The installed cost of solar P.V. has plunged Many states are offering solar incentives Projects that didn’t pencil out two years ago may have totally different results today

49. Power Purchase Agreements – The Bad News • The solar industry is rapidly consolidating • Some large players have gone bankrupt or withdrawn from the U.S. market • There have been warranty issues in the past • Solutions: • Deal with major players that have staying power • Warranties are only as good as your ability to reach the warrantor

50. Energy Service Agreements • Special Purpose Entity (SPE) established for each project • Capitalized by 3rd party investors to finance the costs of the efficiency improvement • Host agrees to pay either a fixed or floating rate for energy savings received • Fixed: based on a cost per avoided energy basis • E.g., dollars per kWh avoided or dollar per therm of natural gas avoided • Floating: equal to a percentage of actual utility rate