Equipment leasing is often referred to as “creative financing” because payments can be structured to follow the cash flow of the projects and to be paid from energy savings. Both energy and energy efficient equipment can be acquired and financed using lease financing.
In fact, and in spite of the slow economy, the “energy renaissance” (generated by high oil prices, the advent of new technology, and interest in energy efficiency and renewable energy projects) has made “energy equipment” the fastest growing equipment sector within the leasing and finance industry.
From a financial reporting perspective, all leases fall into one of two categories: capital lease or operating lease. Capital lease obligations are reflected on the balance sheet and may be subject to lender and /or internal capital budget constraints. Operating leases, often referred to as “off balance sheet” financing, are usually treated as operating expenses1 (as of the date of this writing).
Tax treatment for leases may differ from financial reporting requirements.
In the case where the customer is a commercial entity and can use tax credits related to the energy equipment, the financing can be structured to allow the customer to capture the depreciation and associated tax benefits. In the case of public sector organizations, tax-exempt lease purchase financing (lower interest rate) can be offered, which often can avoid the capital budget approval process as it relates to issuing debt (state specific). See Tax Exempt Financing section for more information.
1 See FASB 13 for details. Note that the reporting treatment of operating leases is currently under revision
A more traditional approach includes an Equipment Finance Agreement or Conditional Sales Agreement. These financial instruments can be for terms from 2 to 7 years, based on the useful economic life of the equipment being financed. Similar to a loan, equipment ownership resides with the borrower and these financing agreements are reflected on the customer’s balance sheet. They work well for financing equipment in which there may exist some implied equipment liability, like pollution control, water treatment or remediation equipment.
Tax exempt lease purchase agreements are well accepted financial instruments commonly used to finance everything from school buses and photocopiers to jail cells. They are ideal for financing smaller and medium sized energy efficiency and water projects as well. Payments may be tied to the annual operating budget of the tax-exempt organization. These lease-purchase agreements often contain “non-appropriation” language limiting the lessee’s payment obligations to the current budget appropriation period. In most states, this allows the financing agreement to be treated not as a capital debt obligation, but part of the organization’s operating budget and an expense item for accounting purposes. Hence, the approval process for a lease is generally much easier, faster and sometimes less expensive than issuing a bond .With rare exception, tax-exempt lease financing payments are structured to be less than the energy savings.
Energy Service Agreements (“ESA”) typically allow the customer to bundle the acquisition, engineering, installation and servicing into one agreement, and is commonly used for energy efficiency, CHP, and anaerobic digester projects. The owner of the project (typically the customer) can take advantage of any tax benefits; however, with larger projects, the transaction can be structured so a third party (other than the beneficiary of the equipment) can be the owner. Third party debt for the project is normally with full recourse to the customer when the customer is the owner, and with partial or no recourse when owned by a third party using a special purpose entity (SPE). Catalyst can fund project sizes range between $1 to $20 million.
Shared Savings Agreements (SSAs) have been effectively used in the energy efficiency industry since the mid-1980s. Properly structured and marketed, they help mitigate a perceived customer risk that the installed equipment will not preform as promised.
The concept behind SSA is surprisingly simple and works on the following premises:
- The installation of energy efficiency equipment will reduce the kWh hours consumed at a customer’s location, resulting in lower utility bills and improved cash flow for the customer.
- The equipment can be paid for out of the energy savings realized by the installed equipment.
- The term of the agreement is determined by the percentage of the savings the customer wishes to keep. The more short term savings given to the lender, Catalyst Financial Group, Inc. (Catalyst), the shorter the financing term will be.
Installations financed under this structure start at $50k and can go into the millions.
Project Financing is a specialized financing structure in which the output from the project is sold to a large creditworthy organization, and the primary payment obligations are against the project itself, as opposed to the owners of the project. Project developers typically are well established, and the off-take agreement must be with financially strong entities such as utilities, major corporations, universities or public entities. There are significant benefits provided by this structure, but these are generally larger, complex projects requiring financial engineering and structuring.
Under the terms of Power purchase agreements (PPAs), also known as design-build-own- operate agreements, the customer purchases the measurable output of the project (e.g., kilowatt hours, steam, hot water) from a special purpose entity (SPE) established for the project, rather than from the local utility. Such purchases are at lower rates or on better terms than would have been received by staying with the utility. These agreements work well for on-site energy generation and/or central plant opportunities. PPAs are frequently used for renewable energy (i.e., solar and wind) and combined heat and power projects (also known as cogeneration). Due to the complexities of the contracts, projects using PPAs are typically 500KW s or larger though financing of smaller PPAs are beginning to emerge. PPAs are considered “off balance sheet” financing or a utility operating expense and are used in both the public and private sectors.
