Financing Public Sector Projects with Clean Renewable Energy Bonds; Fact Sheet Series on Financing Renewable Energy Projects, National Renewable Energy Laboratory (NREL) Page: 4 of 6
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invested during the three-year construction spending period
are now exempt from arbitrage restrictions.
Furthermore, an invested sinking fund6 option was created
under the "New CREBs" legislation. Issuers can set aside
project revenues (or other funds, such as tax revenues in the
case of general obligation bonds) in equal installments annu-
ally to an invested sinking fund in order to accumulate the
funds needed to pay the CREBs when due.
For this fund to comply with arbitrage-rebate rules, it is
expected to be used to repay the issue. The issuer can invest
this sinking fund, but the yield on any such investments
cannot exceed the discount rate used to determine the
maximum maturity on the bonds (Hunton & Williams 2008).7
6 The title to IRC Section 54A(d)(4)(C) refers to this as a "reserve fund." How-
ever, this term can confuse those familiar with the law of tax-exempt bonds
because it customarily refers to a "debt service reserve fund," which consists
of money set aside for paying debt service if and only if the issuer encounters
financial difficulties and has no other funds to pay debt service. Rather, the
provision under discussion here relates to what is usually called an "invested
sinking fund"-a fund set up to accumulate money to pay scheduled debt ser-
vice. For example, if $1 million in principal is due in five years, an investor may
be concerned about the issuer's ability to produce the entire $1 million in year
five. To alleviate this concern, the issuer may create a covenant to set up an
invested sinking fund into which the investor will pay and set aside $200,000
from project revenues each year. In this way, the $1 million will be on hand in
year five and the investor can pay the amount due. (Because payment of debt
service on the CREBs is not a qualified cost, project revenues-not CREBs
proceeds-must fund the invested sinking fund.) An invested sinking fund is a
type of "reserve fund" broadly speaking, but it needs to be distinguished from
the debt service reserve fund found in many tax-exempt bond issues. For
regular tax-exempt bonds (i.e., those that bear tax-exempt interest in lieu of
granting tax credits), a debt service reserve fund can be funded with the bond
proceeds (subject to limits set forth in the Code and Regulations). But, as
noted above, no portion of the CREBs proceeds can be used to fund a debt
service reserve. Thus, the distinction between a debt service reserve fund and
an invested sinking fund is particularly important to understand in the case of
7 That is, the maximum "permitted sinking fund yield" (PSFY) is a rate equal
to 110% of the long-term adjusted AFR, compounded semi-annually, for the
month in which the bond was sold (U.S. Department of the Treasury 2009a).
The PSFY is published monthly at https://www.treasurydirect.gov/govt/rates/
irs/ratesqtcb.htm and was approximately 5% for April and May of 2009.
This special rule on invested sinking funds is quite favor-
able to issuers in that it allows them to earn a return on the
amounts accumulated in the fund (and these earnings can
be used to pay the debt service). Under the normal invested
sinking fund rules applicable to tax-exempt bonds (referred
to as the "bona fide debt service fund" rules), issuers are not
afforded a similar investment opportunity.
Investors will only invest in CREBs if they offer a return that
is comparable to tax-exempt municipal bonds and the credit
risk is reasonable. Because issuers are not required to repay
principal until the final maturity date, investors are likely to
require the creation of a sinking fund or the pledge of assets
as additional collateral.
Tables 2, 3, and 4 compare 16-year "New CREBs" with aver-
age tax-exempt bonds (TEB) issued the week of June 15, 2009
when the tax credit rate was 7.59% and the effective rate
5.31% given the 70% credit reduction. This analysis ignores
the differences in term, amortization, and liquidity. Table 2
shows that the net benefit after taxes for CREBs is less than
tax-exempt bond net benefits, even though the CREBs tax
credit rate of 5.31% is higher than certain 20-year tax-
exempt rates. If the tax rate is less than 35%, the gap in net
benefit is reduced.
Under a scenario such as this, an investor requires supple-
mental interest payments from the issuer; the interest rate
depends on the bondholder's tax rate, the project risk profile,
and the issuer's credit rating. If bondholders are assumed
to have to pay taxes on the interest income (Benge 2009),
an investor with a 35% corporate tax rate might require 2%
supplemental interest, which is comparable to estimates from
Bank of America, a major CREBs investor (Coughlin 2009).
If the municipal bond is rated an investor might require as
much as 3% supplemental interest.
Table 3 examines a 35% corporate tax rate and includes the
benefits of the tax credit as well as the corporation's ability
to deduct interest payments with a tax-exempt bond. This
scenario also "nets out" the taxes paid on the tax credit and
the interest. At these interest coupons, the net benefits of the
"New CREBs" are shown to be approximately the same as
tax-exempt bonds, from the standpoint of the investor.
Subsidiaries of companies with lower tax rates may be able
to structure bonds such that less supplemental interest is
required. For example, if a subsidiary has a tax rate of 20%
(as in Table 4), it might be able to offer bonds to AAA-rated
borrowers with 0.5% supplemental interest and AA-rated
and A-rated borrowers with 1% supplemental interest. In this
case, "New CREBs" offer a slight advantage over traditional
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Kreycik, C. & Couglin, J. Financing Public Sector Projects with Clean Renewable Energy Bonds; Fact Sheet Series on Financing Renewable Energy Projects, National Renewable Energy Laboratory (NREL), report, December 1, 2009; Golden, Colorado. (digital.library.unt.edu/ark:/67531/metadc933350/m1/4/: accessed February 19, 2019), University of North Texas Libraries, Digital Library, digital.library.unt.edu; crediting UNT Libraries Government Documents Department.