Over the last decade, various legislation has been enacted by the Arkansas General Assembly that allows Arkansas cities, counties, school districts, universities, and other governmental entities to enter into energy savings contracts to implement energy efficiency upgrades, such as lighting, chillers, boilers, water systems, and renewable generation, over time.
In these projects, the governmental entity embarking on such a project (the Issuer) enters into a guaranteed energy savings contract (an EPC) with a qualified energy service company (an ESCO) that agrees to design and implement the energy savings measures. Pursuant to an EPC, the ESCO guarantees a minimum amount of annual cost savings resulting from the project in excess of the amounts necessary to construct and finance the improvements. The costs of the project and the resulting savings are monitored on an annual basis by the Arkansas Energy Office of the Arkansas Department of Energy & Environment. In the event that the projected energy savings are not realized, the ESCO is contractually required to reimburse the Issuer for the shortfall.
These projects are typically financed through tax-exempt financing leases between the Issuer and a bank or other financial company. The interest portion of the rental payments is exempt for federal and state income tax purposes and, if the necessary requirements are met, the lease obligations can be bank qualified investments under Internal Revenue Code Section 265(b), allowing the bank to deduct 80% of the interest expense associated with funds invested in tax-exempt securities.
Pursuant to the Act, the obligations under the lease are paid from the energy cost savings realized from the project. However, the obligations can be paid from any legally available funds of the Issuer. The strength of the security is thus dependent on the general creditworthiness of the Issuer in a manner similar to a general obligation municipal bond issue.
Banks looking to increase their portfolio of tax-exempt investments might consider these types of debt obligations as a way to simultaneously invest in their local community and diversify their assets with strong borrowers. If this sounds like an attractive investment for your bank, please contact the local governmental entities in your market area, or give us a call at Wright Lindsey Jennings.