Frequently Asked Questions about Qualified Energy Conservation Bonds
Learn the answers to the following frequently asked questions (FAQs) about Qualified Energy Conservation Bonds (QECBs) concerning the:
The answers to these FAQs are for informational purposes only and do not represent formal guidance or approval from the U.S. Department of the Treasury.
What are qualified energy conservation bonds (QECBs)?
QECBs are debt instruments; they are not grants. “Qualified issuers” can issue QECBs to fund “qualified energy conservation projects.” The bonds may be structured as either a “tax credit” bond in which the bondholder receives a tax credit as a part of its return together with taxable interest, or a “direct payment subsidy option” in which the bondholder receives taxable interest and the issuer receives a direct subsidy (Direct Payment) from the U.S. Treasury for a portion of the interest paid to the bondholder. Virtually all QECBs are expected to be issued using the direct payment subsidy due to the relative benefits of these options and the lack of investor appetite for tax credit bonds. For that reason, only the direct payment subsidy option (Direct Pay QECBs) will be described in detail below.
What is a qualified issuer?
A qualified issuer is a state, local, or tribal government that has been allocated the right to issue QECBs by the federal government. Local governments include municipalities and unincorporated counties. Under the federal tax rules, certain authorities may issue the QECBs on behalf of state, local, and tribal governments.
Why are QECBs attractive?
QECBs reduce borrowing costs for qualified issuers. Simply put, QECBs are among the cheapest public financing tools. The Direct Pay QECBs are directly subsidized by the U.S. Treasury, allowing issuers to raise funds at very low interest rates. The subsidy comes in the form of a cash payment, treated for federal income tax purposes as a refund of taxes, with which issuers recoup part of the interest they pay on the QECBs.
Where did QECBs come from?
QECBs were established by The Energy Improvement and Extension Act of 2008 (EIEA). EIEA authorized the issuance of $800 million in the principal amount of QECBs. The American Recovery and Reinvestment Act (ARRA) expanded the issuance capacity from $800 million to $3.2 billion. QECBs were initially structured as tax credit bonds. In 2010, the Hiring Incentives to Restore Employment Act (HIRE) introduced the option to recoup part of the interest issuers pay on QECBs through a direct subsidy from the U.S. Treasury rather than a tax credit to the bondholder.
How are QECBs allocated?
The U.S. Treasury allocated $3.2 billion of QECB issuance capacity to states based on population. Each state is required to allocate issuance capacity to municipalities with populations above 100,000 based on the municipality’s percentage of total state population (based on 2008 population figures). For example, if a municipality has 150,000 residents and the state has 1.5 million residents, the state must allocate 10% of its QECB issuance capacity to the municipality. If the municipality does not intend to issue QECBs, it may reallocate its issuance capacity back to the state. Procedures for the reallocation back to the state (and deadlines for doing so) vary by state.
What is a qualified energy conservation project?
The EIEA permits QECBs to fund capital expenditures for the following conservation purposes:
- Reducing energy consumption in publicly owned buildings by at least 20%.
- Implementing green community programs (including loans, grants, or other repayment mechanisms).
- Developing rural capacity, specifically involving the production of electricity from renewable energy resources.
- Improving any “qualified facility,” including for example, solar, wind energy, geothermal and biomass facilities.
- Supporting research facilities, research grants, and research in the—
- Development of cellulosic ethanol or other nonfossil fuels
- Capture and sequestration of carbon dioxide (CO2) produced by fossil fuels
- Expanded efficiency of existing technologies for producing nonfossil fuels
- Automobile battery technology or other fossil-fuel reduction technology in transportation
- Technologies to reduce energy use in buildings.
- Implementing mass commuting and related facilities that reduce energy consumption and pollution.
- Designing/running demonstration projects to promote the commercialization of—
- Green building technology
- Conversion of agricultural waste to fuel
- Advanced battery manufacturing technologies
- Technologies to reduce peak use of electricity
- Technologies for the capture and sequestration of carbon dioxide produced from making electricity.
- Launching public education campaigns to promote energy efficiency.
Who decides what constitutes a qualified project?
QECBs will be issued with an opinion of bond counsel that the bonds qualify as QECBs and that the issuer will receive the Direct Payment. The opinion will be conditioned on the issuer (and conduit borrower, if applicable) meeting the requirements for qualification throughout the term of the QECBs. The Internal Revenue Service (IRS) may conduct an audit at any time the bonds are outstanding (plus 3 years) to determine whether a project constitutes a Qualified Energy Conservation Project.
What is a green community program?
A green community program is an undefined statutory term. The Conference Report to ARRA includes the following statement regarding Congressional intent about the broad intended scope of this term:
"Also, the provision clarifies that capital expenditures to implement green community programs include grants, loans, and other repayment mechanisms to implement such programs. For example, this expansion will enable States to issue these tax credit bonds to finance retrofits of existing private buildings through loans and/or grants to individual homeowners or businesses, or through other repayment mechanisms…. Retrofits can include heating, cooling, lighting, water-saving, storm water-reducing, or other efficiency measures” (February 12, 2009 Congressional Record – HOUSE H1473).
Why does the green community program designation matter?
A maximum of 30% of QECB allocations may be used for private business activity or private loan purposes. However, green community programs, which can finance retrofits on private and public property, are designated as “public activities.” As such, there is no limit to the percent of QECB funds that may be allocated to qualifying green community programs.
What are some of the challenges to issuing QECBs?
Potential challenges to issuing QECBs include the following:
- Low QECB volume allocations to local governments may be insufficient to whet investor appetite.
- Taxable investors have not typically invested in municipal bonds, and they may be unfamiliar with municipal credits. Other municipal taxable bonds, such as Build America Bonds, which became available in 2009, have helped address this challenge by familiarizing the taxable investor base with municipal securities.
- QECB bond issuances may take several months to structure, market, price, and close.
- QECBs may strain state or local debt limits for some issuers (government entities).
Rates and Terms
How does the direct payment cash subsidy work?
The U.S. Treasury pays the QECB issuer the lesser of (a) the taxable interest rate of the bonds or (b) 70% of the qualified tax credit rate (QTCR) as of the bond sale date. That Direct Payment is paid directly to issuers contemporaneously with the scheduled debt service payments to the bondholders if the issuer properly files for the Direct Payment. The Direct Payment reduces the NET interest rate that issuers pay to the investors. (See example below.)
For example, assume the interest rate to holders is 5.50% and the QTCR is 5.00%:
5.50% – Taxable interest rate paid by the bond issuer to the investor (taxable interest rate)
3.50% – Cash subsidy from U.S. Treasury (70% of 5.0% QTCR) to the issuer (Direct Payment)
2.00% – NET interest rate paid by issuer to investor (taxable interest rate minus cash subsidy)
What is the qualified tax credit rate?
The QTCR is set daily by the U.S. Treasury and can be found at Treasury Direct.
What is the longest allowable maturity for QECBs?
The U.S. Treasury sets the maximum maturity on a monthly basis. The current allowable maturity can be found at Treasury Direct.
Issuers can choose to issue bonds of any maturity up to the maximum maturity. The rate is set so that the present value of principal payments equals 50% of the original principal amount.
How can QECBs be secured?
The tax rules do not determine how QECBs will be secured. As debt of a municipal issuer, QECBs would generally be secured in one of three ways: revenues, a general obligation from the issuer, or with collateral.
- Revenues: Revenue bonds are secured by a specific revenue stream (of the government issuer)—to the extent the revenue stream is not sufficient to pay back the principal and interest on a bond, the issuer is not liable for the shortfall. Revenues could include loan payments from a private business if the QECBs were issued within the permitted 30% of private activity bonds.
- General Obligation: A general obligation bond is backed by the full faith and credit of the government issuer.
- Collateral: A bond secured with collateral, typically either specific equipment or property(ies), provides investors with the right to ownership of that collateral should the bond principal and interest not be paid.
Recent experiences with the QECBs that have been issued so far—in Boulder, Colorado; Rochester, New York; Utah County, Utah, and Tucson, Arizona—demonstrate that, if the QECB is initially secured by revenues or by collateral, investors might also require a “backstop” general obligation from the issuer.
In some cases, bondholders may require a debt service reserve fund. No QECB bond proceeds can be used (directly or indirectly) to fund a debt service reserve fund.
Can building energy efficiency savings be used to secure QECBs?
While energy efficiency savings may be used to repay QECBs, investors have not traditionally accepted these savings as bond security, on their own. Investors have, however, accepted energy efficiency savings backed by a performance guarantee (typically from an Energy Service Company or ESCO), although investors may still require the “backstop” general obligation from the issuer as described above.
How can QECBs be structured?
QECBs can generally be structured in three ways—as bullet bonds, serial bonds, or term bonds.
- Issuers of bullet bonds pay only the interest during the life of the bond and pay back all of the principal at maturity.
- Serial bonds are structured so that a portion of the bond matures at regular intervals, thus both interest and principal are paid back during the life of the bond.
- Term bonds are a combination of bullet bonds and serial bonds. The issuer has scheduled principal payments but provides for mandatory sinking fund redemptions, generally by lot, of a specified amount leading up to the term maturity. In any of these structures, the issuer can negotiate call provisions. Call provisions give the bond issuer the right to purchase (or call) part or all of a bond issue at specified times. Whether call provisions are included in a bond’s structure is a matter of negotiation between the bond issuer and the investor.
Government issuers of bonds are allowed to establish a principal sinking fund to support a bullet or term bond. A principal sinking fund is a fund into which the issuer deposits money that will eventually be used to pay the principal of a bond issuance. Typically, the issuer makes regular payments into the sinking fund and uses the balance to pay off bond principal either at maturity or at times specified during issuer/investor negotiations that occur prior to bond issuance. Under the federal tax rules, there are limits on the amount of the deposits that can be placed into the sinking fund for a QECB and the investment yield on the sinking fund.
On a related note, it is not clear whether issuers get any credit for the value of the direct pay subsidy. Credit agencies, for example, do not take the direct pay subsidies into account when determining the likelihood of repayment, even though the direct pay subsidy payments can go directly to repay the bond funds. In other words, using the example above in FAQ 11, credit agencies currently would treat the bonds as if the interest rate were the 5.5% taxable rate instead of the 2% net interest rate paid by the issuer.
Which is better, a tax-exempt bond with a tax credit subsidy paid to the investor or a taxable bond with a cash subsidy paid to the issuer?
In theory, a tax-exempt bond and tax credit bond with a direct cash subsidy provide the same ultimate benefit to state, local, and tribal governments—they both reduce borrowing costs. However, the tax credit bond subsidy was intended to provide an even greater subsidy and to open up the market for municipal debt. There are advantages and disadvantages to issuing taxable bonds like QECBs.
- Advantage: Taxable bond issuers have access to the much larger taxable bond market instead of being forced to market bonds solely to tax-exempt municipal investors (i.e., those who may benefit from interest income that is exempt from federal income tax. Such a group excludes pension funds, nonprofit foundations, and foreign investors that do not benefit from exempt income.).
- Disadvantage: Taxable bond investors are less familiar with public credits than are their counterparts, the tax-exempt bond investors. As noted earlier, Build America Bonds have increased investor understanding of public credits; however, demand for these securities is still limited by low investor awareness. Similarly, the original version of the tax credit bonds, which provided investors with a credit against federal income tax liability, was also expected to attract the taxable investor.
A key motivation in 2010 for allowing issuers to structure QECBs as direct cash subsidy bonds was that, given the economic downturn, few investors had taxable income against which to apply the tax credits.
What interest rate can issuers generally expect to pay on QECBs?
Interest rates will vary based on the credit strength of the issuer and on the security offered for the QECB (i.e., revenues, general obligation, or collateral), market conditions, and bond terms (length, call provisions, etc). Typical net interest rates for the limited number of Direct Pay QECBs issued thus far, however, have been at or below 2%.
What is the minimum QECB issuance size that is attractive to investors?
There is no rule of thumb for a minimum QECB issuance size that investors will accept although larger bond issuances typically garner more attractive interest rates. State, local, and tribal governments should contact bond underwriters or financial advisors for more information on current market conditions.
How can ARRA funds be used to support a QECB issuance?
ARRA monies can be used to support QECB issuances by funding a debt-service reserve fund, a capitalized interest fund, and/or a principal sinking fund. Those funds can reduce risk to the issuer, the investor, or both—and, in so doing, can reduce the bond interest rate. A debt service reserve fund is used to repay principal and interest in the event that the issuer is unable to pay (or, to the extent a bond is not supported by a general obligation, in the event that revenues or collateral value are insufficient). A capitalized interest fund is used to make bond interest payments during construction and stabilization of the project. A principal sinking fund is used to make bond principal payments. Earnings on amounts held as a debt service reserve fund, even if funded by ARRA funds or other equity of an issuer, are subject to rebate to the U.S. Treasury unless the reserve fund meets the special sinking fund limitations described herein.
When grantees use ARRA funds to support the issuance of QECBs, those funds are subject to the same obligation, drawdown, and federal identity requirements as loan loss reserve funds and revolving loan funds. The U.S. Department of Energy (DOE) offers the following guidance on using ARRA funds to support QECBs:
Can ARRA funds be combined with QECB bond proceeds for use in specific projects?
As long as the specific conditions of the ARRA funds are satisfied and the project is a qualified energy conservation project, grantees may combine QECB bond proceeds with other ARRA funds to support specific projects. For example, in some cases, funds can be combined to be either loaned or granted to private project developers to implement energy efficiency or renewable energy projects. By making these funds available to private developers at low cost, the grantees may benefit indirectly from various tax and other financial incentives as a result of lower overall project costs.
Can QECBs be pooled, and how might pooling affect interest rates or other bond terms?
The answer to this question depends on two factors. The first is whether, under state law, localities can issue bonds on behalf of other localities. Some states explicitly allow this, for example, through interlocal government agreements. If the issuance is large enough, even with separate issuances, localities may benefit from economies of scale through informal bundling of the transaction.
The second factor is whether, under QECB regulations, a jurisdiction is permitted to issue QECBs, the proceeds from which are used in another jurisdiction. QECB rules allow funds to be issued for another jurisdiction if the proceeds are used for qualifying purposes in both the jurisdiction of the issuer and the jurisdiction of the entity authorized to allocate volume cap. In practice, this means that in most cases, the only way to issue a single bond for multiple jurisdictions (beneficiaries) and meet the QECB guidelines is for a state to issue the QECBs on behalf of multiple localities or on behalf of the state and multiple localities.
If the state does not have sufficient allocation to do so and the locality has already received its allocation, the locality could transfer its allocation back to the state, which could then issue the bonds for multiple jurisdictions (see IRS Notice 2009-29 section 3.05).
How many QECBs have been issued as of fall 2010, and where?
As of fall 2010, QECBs have been issued in Boulder, Colorado; Rochester, New York; Utah County, Utah; and Tucson, Arizona. Additional issuances are in the planning stages around the country, including in Salt Lake County, Utah.
Which websites provide DOE Guidance on QECBs?
The DOE Weatherization & Intergovernmental Program Solution Center website provides EECBG and SEP guidance on QECBs.
Additional Rules and Regulations
Do Davis-Bacon Act prevailing wage requirements or National Environmental Protection Act requirements apply to QECB-financed projects?
Davis-Bacon prevailing wage requirements do not apply to issuer employees but do apply to contracts entered into for construction, repair, or alteration.
Issuing a QECB does not in itself trigger National Environmental Protection Act (NEPA). All other NEPA rules that establish what does and does not require a NEPA assessment still apply, however.
What are the limitations on using QECBs to support private-sector clean energy activity?
A maximum of 30% of QECB allocations may be used for private activity purposes. Green community programs, however, are not subject to that restriction because they are treated as public purpose programs (see FAQ 8 above).
Is there a limit on the amount of bond proceeds that can be used to pay QECB issuance costs?
A maximum of 2% of the proceeds of a QECB can be used to pay for bond issuance costs. Issuers must find other sources of funding such as general budget funds or other energy-related budgets for issuance costs in excess of 2%. Issuance costs include the underwriter’s discount and various counsel and trustee fees.
Is there any risk that the federal government will stop appropriating the QECB subsidy in future budgets?
The Direct Payments are not appropriations. The statute was written to treat the Direct Payment as a refund of taxes and, therefore, not an appropriation item. Billions of dollars in Build America Bonds have been issued to date—indicating that state, local, and tribal government issuers are, in general, very comfortable with the risk. A more likely concern for grantees is the IRS audit described earlier to determine whether a project constitutes a Qualified Energy Conservation Project. Should that audit determine a project is not qualified, issuers may be forced to repay previous direct cash subsidy payments (originally from the U.S. Treasury) and forgo future payments.
When does QECB issuance capacity expire?
There is no federal “expiration date” after which QECBs may no longer be issued. They can be issued as long as there is an available allocation.
How long do issuers have to spend bond proceeds after QECBs are issued?
Bond issuers must have a binding commitment with a third party to spend at least 10% of the bond proceeds within 6 months of bond issuance. All bond proceeds must generally be spent within 3 years or used to redeem bonds at the end of that 3-year period. The U.S. Treasury has the authority to extend the 3-year spending deadline “for reasonable cause” if the expenditures will continue to proceed “with due diligence.” But the issuer must submit a private letter ruling request to the U.S. Treasury for an extension.
Where can I find more information on QECBs?
The following resources provide more information on QECBs?
- DOE QECB Webinar
- DOE QECB/CREB Primer
- DOE QECB/EECBG Guidance
- DOE QECB/SEP Guidance
- IRS Notice 2009-29 on QECB Allocations
- IRS Notice 2010-35 on Direct Pay QECBs.
To request technical assistance on QECBs, please visit the DOE Weatherization & Intergovernmental Program Solution Center website.