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CDFA Spotlight:
Overview of Clean Renewable Energy Bonds (CREBs)

By Stan Provus

Preface

Clean, renewable energy is a high priority for many state and local governments and their political subdivisions. In July 2005, Congress passed the Energy Tax Incentives Act of 2005 (the “Act”). Among a number of other tax incentives, the Act permits State and local governments and their political subdivisions like public universities or Industrial Development Authorities (IDA’s), cooperative electric companies, clean renewable energy bond lenders and Indian tribal governments to issue “clean renewable energy bonds” (“CREBs”) to finance certain renewable energy and clean coal facilities. This article reviews the basic features of CREBs.

Initially, the Treasury set a deadline of April 26, 2006 for applications to be submitted to the IRS for an allocation of bonding authority for CREBs. Applications needed to identify the Issuer and Borrower and also describe the project in detail, including a certification by an independent, licensed engineer that the project is eligible and technically viable. The Act authorized the Treasury to allocate $800 million of bonding authority for CREBs. The program was recently expanded to permit the issuance of up to $1.2 billion of tax credit CREB bonds through December 31, 2008. The IRS is now accepting applications for the remaining $400 million of bonding authority through July 16, 2007. The IRS allocates bonding authority on a project-by-project basis, prioritizing eligible projects from smallest to largest dollar amount of CREBs requested (with the smallest project first in line). There is also legislation pending to extend the program to 2013.

How CREB Tax Credit Bonds Work

CREBs are a new form of tax credit bond in which interest on the bonds is paid in the form of federal tax credits by the United States government in lieu of interest paid by the issuer. CREBs, therefore, provide qualified issuers/qualified borrowers with the ability to borrow at a 0% interest rate. The federal tax benefit to the holder of a CREB is greater than the benefit derived from tax-exempt municipal bonds in that the tax credit derived from a CREB can be used to offset, on a dollar-for-dollar basis, a holder’s current-year tax liability, as opposed to excluding interest from gross income, as permitted for tax-exempt bonds. Unlike tax-exempt bonds, CREBs are taxable bonds, and the tax credits received are treated as interest and included in a bondholder’s taxable income. With a few notable distinctions, CREBs share many of the same features as qualified zone academy bonds (“QZABs”), which permit qualified schools and education agencies to borrow at a 0% interest rate, with holders of the QZABs receiving
federal tax credits in lieu of interest.

Treasury sets the rate of the credit on a daily basis, at a level that permits the issuance of the CREBs without discount and without interest cost to the Issuer (see Treasury web site below). Credit rates are based upon a yield on outstanding AA rated corporate bonds of a similar maturity, as estimated by Treasury the day before the CREB is sold. When the bondholder purchases the bond, the credit rate is locked in for the term of the bond. The credit accrues quarterly and is included in gross income of the bondholder (as if it were an interest payment on the bond). The bondholder takes the amount of the tax credit as a credit against its regular income tax liability and alternative minimum tax liability.

Repayment of principal to the bondholder occurs on a “level annual repayment” basis, meaning equal payments each year of the term of the bond, commencing in the first year of issuance. The value of the CREB to a bondholder for any year is equal to the credit, less the amount of tax payable on the credit. For example, if the credit amount is $100 and the bondholder is in the 35 percent tax bracket, the credit provides a $65 benefit to the bondholder.

Example – Tax Credit Calculation: Assume the credit rate for an issue of CREBs sold on July 1, 2006 is 5%. Further assume that, on June 15, 2009, the principal outstanding amount of the issue is $15,000,000. On June 15, 2009, the taxpayer will receive a tax credit in the amount of $187,500, which is 25% of the tax credit rate of 5%, multiplied by the principal amount of the outstanding bonds of $15,000,000. The CREB’s legislation provides in Section 54(b)(4) that the term “credit allowance date” means March 15, June 15, September 15, December 15, and the last day on which the bond is outstanding. The amount of the credit for a credit allowance date is a ratable portion of the credit—therefore, in the above example the credit is multiplied by 25%, since the credit is paid four times a year.

As principal is paid annually on an issue of CREBs as required by the statute, the amount of the tax credit (and interest deemed received by the holder of the CREB) will decrease. The holder of a CREB treats the bond as if it pays interest on the credit allowance date. In addition, a feature that enhances the marketability of the CREB is “serialization” of the credit rate. In other words, each level annual repayment of principal will be structured as a separate bond paying a separate credit rate to a bondholder.

Who Can Issue CREBs and Own Projects

An application for CREB bonding authority must be submitted by a qualified issuer within the meaning of section 54(j)(4). A “qualified issuer” is: (1) a clean renewable energy bond lender (as defined in section 54(j)(2)); (2) a cooperative electric company (as defined in section 54(j)(1)); or (3) a governmental body (as defined in section 54 (j)(3)). This basically means State and local governments and their political subdivisions like public universities or Industrial Development Authorities (IDA’s), cooperative electric companies, clean renewable energy bond lenders and Indian tribal governments. Generally, If you can borrow with tax-exempt debt, you can borrow with CREBs. However, your project must qualify as well. Qualified issuers must also own projects, although private entities may manage them.

Qualified Projects

Renewable energy generation projects that qualify for CREB bonds include: wind, closed-loop biomass, open-loop biomass (including agricultural livestock waste), geothermal, solar, municipal solid waste (including landfill gas and trash combustion facilities), small irrigation power and hydropower. Facilities that are “functionally related and subordinate” to the generation facility itself are also eligible for CREB financing. These facilities may include a radial transmission line to the nearest substation, interconnection upgrades made necessary as a result of the renewable project, offices, storage, or other items.

What Has Been Funded

To date, projects for governmental and cooperative borrowers have been funded in 24 and 22 states, respectively. The allocations for governmental borrowers range from $23,000 to $3.2 million and for the cooperatives from $120,548 to $31 million. Of the approved projects for governmental borrowers, 401 are for solar facilities, 99 for wind facilities, 23 for landfill gas facilities, eight for hydropower and one for an open loop biomass facility. For example, the Washington Metropolitan Transit Authority received about $15 million in bonding authority to outfit six of its buildings with solar energy equipment, which the Authority estimates will save them $75,000 per year.

CREB Maturity Limitations, Credit Rate and Amortization

The maximum term for an issue of CREBs is the term that the Secretary of the Treasury estimates will result in the present value of the obligation to repay the principal on the bond being equal to 50% of the face amount of such bond. A discount rate equal to 110% of the long-term adjusted applicable federal rate, compounded semi-annually, for the month in which the bond is sold
Is used for this purpose. The maximum term and rate for a CREB is published daily by the Bureau of Public Debt on its Internet site at: https://www.treasurydirect.gov/SZ/SPESRates

For each issue of clean renewable energy bonds, a separate credit rate will apply to each of the level annual repayments of principal of the issue (each, a “principal maturity”). The credit rate for a principal maturity of an issue of clean renewable energy bonds is the applicable clean renewable energy bond credit rate published each business day by the Bureau of Public Debt on the above Internet site. The applicable clean renewable energy bond credit rate shall be applied to a principal maturity of an issue of clean renewable energy bonds on the day the issue is sold. Again, the credit rates will be determined by the Treasury Department based on its estimate of the yield on outstanding AA rated corporate bonds of a similar maturity for the business day immediately prior to the date on which the issue is sold.

For example, the CREB credit rates on various maturities on May 29, 2007 were:


Term to Maturity
Credit Rate
-----------------
-----------
1-year
5.31%
2-year
5.40%
3-year
5.45%
4-year
5.46%
5-year
5.53%
6-year
5.58%
7-year
5.61%
8-year
5.68%
9-year
5.72%
10-year
5.65%
11-year
5.67%
12-year
5.71%
13-year
5.76%
14-year
5.77%
15-year
5.77%
16-year
5.80%

At this site, a table of maturities (and the maximum maturity) and rates specify the appropriate credit rates for the specified maturities under the CREB program. For example, assume that an issuer issues $20,000,000 of CREBs on January 1, 2007 to finance a qualified solar facility. Further assume that the long-term adjusted applicable federal rate for the month that the CREBs issue was sold was 5%. The maximum term of the issue would be the number of years that $10,000,000 (50% multiplied by $20,000,000) present valued at 5.50% (110% of 5%), compounded semi-annually, will take to equal $20,000,000. This is 12.77 years.

Spend Down Rules

CREB issuers must adhere to specific project timeframes for spending CREB proceeds. After issuing the CREBs for a qualified project, the Issuer must spend 95% of the proceeds within five years for that project.

Conclusion

CREBs are an excellent resource for state and local governments and their political subdivisions to lower their energy costs, since it provides a zero interest cost of funds for qualified renewable energy projects.

Sources
IRS website; Bondbuyer; and the California State Treasurer, among others. CREB maturity calculations made on a HP 10B calculator.


This article is intended to provide accurate and authoritative information in regard to the subject matter covered. The author and CDFA are not herein engaged in rendering legal, accounting or other professional services, nor does it intend that the material included herein be relied upon to the exclusion of outside counsel. CDFA is not responsible for the accuracy of the information provided in this fact sheet. The information provided has been collected from a variety of sources. Those seeking to conduct complex financial deals using the tools mentioned in this document are encouraged to seek the advice of a skilled legal/consulting professional.

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