The U.S. Department of Housing and Urban Development provides financial incentives for public housing authorities (PHAs) that enter into energy performance contracts (EPCs). The incentives are in the form of payments tied to annual energy savings. The payments can be used to pay debt service on obligations with terms of 10 or more years that were incurred to finance energy conservation projects. To take advantage of these incentives, PHAs should negotiate EPCs and consider the new financing options outlined below.

Negotiating Energy Performance Contracts. PHAs can enter into EPCs with qualified Energy Service Companies (ESCOs) to undertake energy conservation measures (ECMs). Typical ECMs include a variety of energy retrofits, such as energy-efficient appliances, water and lighting systems, windows, and heating, ventilation, and cooling systems, as well as combined heat and power or co-generation systems.

ECMs provide operating efficiencies and savings that increase the asset value and competitiveness of PHA stock and benefit public housing tenants.

Under the HUD regulations for EPCs (24 CFR 965.308), PHAs can select their own ESCOs using a request for proposal (RFP) process. Experienced and qualified ESCOs generally provide guarantees of performance, savings, and maintenance of energy-saving equipment.

A PHA should conduct an energy audit as a first step, then, working with HUD, do an RFP to select a qualified ESCO. Once a qualified ESCO is selected, a PHA, with proper financial and legal advice, can negotiate an EPC. The EPC will identify a base line for savings and performance guarantees.

Financing Options. In recent months, a variety of new financing techniques has been developed for PHAs to finance EPCs and take advantage of the HUD incentives to assist in paying back debt incurred to finance EPCs. Ballard Spahr has been assisting PHAs in structuring these transactions. Financing options include the following:

Lease Purchase Agreements. A PHA can finance the purchase and installation of ECMs with a lease purchase agreement. The entire lease purchase agreement can be held by one investor, or an investment banker can participate out interests in the agreement. The lease purchase agreement can be securitized as interests in custodial receipts to permit the investment by multiple investors. The source of repayment for the PHA’s payments under the lease purchase agreement can be negotiated with investors, just as in a municipal bond transaction. The repayment can be a general obligation of the PHA, an obligation limited to the energy savings payments from HUD, or any combination of the above. The lease purchase agreement may provide for early redemption of the agreement through payment of the ECMs’ purchase price.

Build America Bonds (BABs). If structured properly, lease purchase financing will qualify for tax-exempt bond financing. If the proceeds will be used exclusively for capital expenditures, PHAs may also be able to take advantage of the American Recovery and Reinvestment Act of 2009 (ARRA) provisions for taxable BABs, which provide a direct interest subsidy payment to the PHAs. BABs must qualify as if the bonds were being issued as governmental tax-exempt bonds, but the bondholder receives a full taxable interest rate, and the PHA files for a subsidy payment from the Internal Revenue Service equal to 35 percent of the interest paid to the bondholder. BABs must be issued by December 31, 2010, unless Congress extends their authorization.

Qualified Energy Conservation Bonds (QECBs). Legislation recently enacted gives PHAs another taxable bond option, which provides a direct subsidy payment from the IRS. The subsidy a PHA receives from a QECB is equal to the lesser of 70 percent of the tax credit rate published daily by the federal government or the taxable interest rate on the QECBs. For example, if the published tax credit rate is 5 percent and the taxable interest rate on the QECB is 7 percent, the PHA would receive an interest subsidy payment of 3.5 percent (70 percent of the 5 percent tax credit rate), leaving the PHA to pay the remaining 3.5 percent to the bondholder from HUD energy savings payments or other sources. QECBs may be used for a variety of conservation purposes, including capital expenditures for reducing energy consumption in publicly owned buildings, such as public housing; solar and other renewable energy equipment; and public education campaigns to promote energy efficiency. An allocation for QECBs may be obtained from a state or local government. Ballard Spahr is working with clients that have an allocation and with clients requesting allocations.

The bottom line is that if a PHA finances its EPC with BABs or QECBs, it can take advantage of both (i) the HUD incentives, which allow it to pledge its annual energy savings towards debt service, and (2) the BABs or QECBs subsidy, which entitles it to receive a direct payment of interest costs from the federal government under ARRA. Ballard Spahr has also been exploring the use of statewide pools of energy bonds to provide PHAs with potential economies of scale and more efficient financing terms.