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Municipal Prepayment Structure (cont’d)
Introduction
- Municipal finance techniques have been employed on various transactions involving
Municipal Prepayment Structure Applied Solutions Annual Conference: - - PowerPoint PPT Presentation
Municipal Prepayment Structure Applied Solutions Annual Conference: - - PowerPoint PPT Presentation
Municipal Prepayment Structure Applied Solutions Annual Conference: Adapting Existing Financial Instruments Bolder, Colorado November 11, 2010 Presented by John Wang Municipal Prepayment Structure (contd) Introduction Municipal finance
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SLIDE 3
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Municipal Prepayment Structure (cont’d)
Introduction (cont’d)
Why consider tax-exempt bonds?
- Cheaper. Because interest on municipal bonds is typically tax-exempt, interest rates can
be lower while providing the same after tax return to the investor that taxable investments provide.
- Better terms. The tax-exempt market has generally offered more favorable terms and
conditions than bank loans and other conventional lending sources.
- Combination with Other Sources. Proceeds of tax exempt bonds can be and often are
combined with other funding sources, including equity and conventional debt financing as an additional funding source and to bring down the overall cost of projects.
- More receptive market. The tax-exempt market may be more receptive to new
issuances than traditional credit sources, other debt markets or equity markets during the recent economic crisis.
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Municipal Prepayment Structure (cont’d)
Introduction (cont’d) General requirements for municipal debt financing opportunities:
- Capital expenditures. While there are some limited exceptions, generally
proceeds of tax-exempt debt can only be used for capital expenditures.
- Project Requirements. Typical projects that qualify are facility construction,
acquisition or improvement, equipment purchases, and real estate acquisition and development.
- Credit Requirements. Can be project credit, corporate credit or a third party
guaranty, but on one basis or another the company must be creditworthy enough to induce investors to buy the bonds.
- Government Involvement. Slightly more complicated and bureaucratic
when compared to corporate taxable bond offerings, and much more so when compared to private equity offerings since muni bonds can only be issued by governmental entities.
- Environmental Approvals. All environmental approvals typically need to be
- btained prior to financing.
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Municipal Prepayment Structure (cont’d)
Introduction (cont’d)
- Prepay Energy Power Purchase Agreements (PPAs). Under a Prepay PPA
structure, a municipal owned utility (MOU) as offtaker, enters into a PPA with a special purpose project developer (the “Project Developer”) whereby the Project Developer agrees to construct, own and operate the facility (the “Facility”) and the MOU agrees to prepay for a portion of the output of the Facility to be delivered over time in certain situations. The MOU issues tax exempt municipal bonds to fund the prepayment in a lump sum amount and the Project Developer, in turn, uses such proceeds to fund project costs.
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Municipal Prepayment Structure (cont’d)
How is an Prepay PPA Financing structured?
- Project Sponsor (i,.e., a developer or energy company) forms a special
purpose power company (the “Project Developer”), which is typically a bankruptcy remote limited liability entity with no material obligations other than the construction, ownership and operation of the Project (the “Project Developer”).
- Project Developer and MOU enter into a Power Purchase Agreement (“PPA”)
for the prepayment for a fixed amount of the energy output from the Facility from the Project Developer at a fixed price (the “Prepayment Amount”) to a specified term.
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Municipal Prepayment Structure (cont’d)
- Project Developer finances the construction of the Facility using conventional financing, such
conventional financing to be taken out through a combination of tax exempt bond proceeds (discussed below), equity and grant moneys. Such equity investors will be allocated Facility- related investment tax credits, accelerated depreciation and other tax attributes.
- At or around the commercial operation date, the MOU issues tax exempt bonds to fund the
Prepayment Amount as a lump sum up front payment to the developer, which may be used by the Project Developer for any purpose, including for reimbursement of the costs of the construction of the Facility.
- The MOU is responsible for repayment of debt service on the bonds. As a result, the MOU’s
bonds would be sold and marketed on the credit of the MOU’s utility, not the Facility itself or the Project Developer, thereby reducing or eliminating the need to procure credit enhancement for the bonds depending on the overall credit quality of the MOU’s utility. Therefore, the Prepay PPA structure is a way to provide for significant capital from an MOU offtaker for a large portion of the Facility, while at the same time reducing overall Facility costs through the issuance of municipal debt.
- Project Developer is tax owner of facility, but with no direct active involvement (typically) in
the production or delivery of the energy to the MOU. Typically, an operating company will manage the facility pursuant to an O&M agreement.
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Typical Pre-Pay PPA Finance Structure
Equity Investor TBD Equity Investor TBD Municipally Owned Utility (MOU) The Project Assets Project Sponsor Project Company LLC
Prepaid PPA Sale of Project Bond Proceeds
Bond Holders
Debt Service Bond Proceeds Bond Proceeds Tax Credits Equity
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Municipal Prepayment Structure (cont’d)
What are the Benefits to the Developer?
- Tax exempt bond proceeds representing the Prepayment Amount provide a
significant funding source (can be 50% or more) to a Facility based on the credit and balance sheet of the MOU, not that of the developer, equity owner
- r project.
- The tax exemption of interest on the bonds results in a lower overall costs of
the Facilities.
- Several tax benefits to the Project Developer under typical PPA structure can
be achieved. Equity owners will be entitled to federal tax benefits, without reduction due to tax exempt bond financing; these include production tax credits, investment tax credits, accelerated depreciation, and/or federal 30% grant.
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Municipal Prepayment Structure (cont’d)
Key Municipal Finance Tax Issues on Pre-Pay Structures:
- Tax exempt bond proceeds can only be used to make a fixed price
prepayment; i.e., fixed payment for fixed amount of energy (referred to as Tier I below). Due to variability of amount of energy and O&M costs (which are also passed on to the MOU) a two tiered PPA structured is required.
- Tier I is for the Prepayment Amount. Tier I can be thought of as the fixed price
contract, for example to prepay for all of the power that has a 99% probability
- f being produced in every year, as well as some fixed portion of O&M costs.
Tier II, or the excess energy and O&M cost contract, will be a pay as you go contract and will include all variable elements of the structure. Each PPA needs to be at FMV, determined without regard to the other and independently from each other.
- Equity must be the "tax" owner of the Facility. Thus, term of PPAs cannot
exceed 80% of projects estimated useful life. Tax equity should have some meaningful investment in the project aside from the federal 30% grant and the MOU's Prepayment Account. MOU cannot control plant operations, may not be able to foreclose on the facility in an event of breach by the developer, and MOU may have a purchase option only at FMV at the time of exercise.
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Municipal Prepayment Structure (cont’d)
Key Municipal Finance Tax Issues on Pre-Pay Structures (cont’d):
- Weighted Average Maturity of Tier I contract cannot exceed bonds by more
than 20%.
- No portion of Prepayment Amount, once paid to developer, can be reduced or
returned to MOU based on the actions of the MOU.
- Use of prepaid energy is limited to retail use, through government owned
utilities and/or customers in qualified service areas.
- Prepayment Amount probably cannot be used for electricity transmission
services.
- Tax treatment to Project Developer of lump sum Prepayment Amount should