Private Funding of Energy Efficiency Retrofits

Although government, environmentalists and fiscal hawks rarely agree on environmental issues, a new public-private partnership to finance U.S. energy efficiency retrofits (the “Retrofit Program”) is attracting broad public support.  The Retrofit Program is being funded by a private consortium known as PACE Commercial Consortium (“PCC”) without any government loans, subsidies, tax credits or other govenrmental assistance, other than legislative support from state and local government.  Because the Retrofit Program combines market-based solutions with traditional property-secured municipal finance, PCC believes the Retrofit Program will pave the way for other profitable, long-term clean energy solutions.

Background:  Property-Secured Municipal Finance and PACE

In general, state and local agencies finance public infrastructure and improvements by issuance of property-secured municipal bonds.  Typically, municipal bonds are issued through or for the benefit of special tax districts.  Because municipal bonds are exempt from federal income taxes, they are an attractive form of fixed income investment.  Owners of properties benefitting from municipal bond-funded infrastructure and improvements consent to senior liens placed on their property to be paid off over time through special taxes or assessments.  The special taxes or assessments are then used to service the debt payments on the municipal bonds.  Because the special taxes or assessments constitute senior secured liens on the properties being assessed, they are superior to all private liens such as mortgage and mechanic’s liens.

In recent years, a number of states have looked to private bonds as a substitute for municipal bonds to finance various improvements, including energy efficiency retrofits.  By enactment of legislation known as Property Assessed Clean Energy (“PACE”) more than half of the states are now able to finance these types of projects on an exlusively privately-funded basis.  Similar to the methodology described above, property-secured private bonds are sold to finance the upfront retrofit costs.  A senior tax lien is then placed on the PACE-improved property, and the bonded indebtedness is repaid via special taxes or assessments over an extended period of years.  If appropriately implemented, there are no upfront costs to the property owner, and the long-term energy savings should exceed the incremental taxes or assessments on the PACE-improved property.  Unfortunately, PACE-funded residential retrofits have been slow to develop because of strong resistance from the Federal Housing Finance Agency (“FHFA”).  FHFA has objected to any federal guarantee of mortgages for residential properties with PACE liens senior to mortgage liens.  Whether this issue can be resolved legally and/or politically remains to be seen.

The Retrofit Program and PCC

The problems associated with PACE, however, have not materially impeded the Retrofit Program.  In lieu of government-backed guarantees, the Retrofit Program instead uses contractor warranties backed by insurers which are then backed by reinsurers.  The other PACE-funding mechanisms remain unaffected.  That is, private short-term loans are issued on the front end and then subsequently bundled into long-term private bonds.  The private bonds are repaid in the same manner as PACE by special taxes or assessments.  Taken together, the Retrofit Program arguably provides investors better returns, faster repayment of indebtedness, identical collateral security and a more reliable guarantee of performance.

As indicated above, the progenitor of the Retrofit Program is PCC.  PCC is comprised of well-respected finance, consulting, engineering, energy and insurance companies, including, Barclays Capital, Lockheed Martin, Hannover RE and Ygrene Energy Fund (“Ygrene”).  Ygrene is leading the effort and recently announced PCC’s first project under the Retrofit Program, an approximaely $650 million commercial retrofit in the Miami and Sacramento areas.  Ygrene is confident that the Retrofit Program will not result in material costs to local government and is actively working with Miami and Sacramento city and county officials to identify buildings for retrofitting.  Ygrene is also training local contractors to perform the retrofitting.  Time will tell if Ygrene can successfully implement the Retrofit Program in Miami and Sacramento.  If it can do so, it should be replicable across the United States.

The Retrofit Program is an innovative approach to the financing of U.S. energy retrofits.  As a public-private partnership, the Retrofit Program combines the strengths of private capital and innovation with the reliability of property-secured municipal financing.  Although the results are as yet uproven, it has the potential to unlock billions of investment dollars without material cost to government.  Ultimately, the Retrofit Program could achieve what government has heretofore failed to deliver; namely, profitable clean energy, green sector jobs, local economic growth, increased property values, lower business operating costs and meaningful reductions of emissions and energy consumption.

Craig Moyer is Chair of the Land, Environment & Natural Resources practice at Manatt, Phelps & Phillips, LLP, practicing in the Los Angeles office. He has extensive experience counseling clients on environmental regulatory issues and on environmental issues surrounding virtually all types of energy development arrangements. Mr. Moyer can be reached at [email protected] or 310.312.4353.

Matthew Portnoff is an Associate in the Los Angeles office of Manatt, Phelps & Phillips, LLP, and a member of the firm’s Tax, Employee Benefits & Global Compensation group. His practice covers a broad range of federal and state income tax matters, as well as counseling companies on general business tax planning. Mr. Portnoff can be reached at [email protected] or 310.312.4256.

This column is the ninth in a series of articles by law firm Manatt, Phelps & Phillips, LLP’s Energy, Environment & Natural Resources practice. Earlier columns discussed California’s Cap and Trade program, Green Marketing Regulation, Corporate Sustainability, Green Chemistry Regulation, Renewable Project Failures in California, Promoting Recycled Water, Environmental Liabilities in Bankruptcy Reorganizations, and California Renewable Policy.