If you’re an energy services project sales rep or originator, you have heard of the benefits of off-balance sheet (OBS) financing, particularly when using C-PACE to fund energy efficiency projects. I, too, have pitched OBS financing structures for many years and appreciate its benefits when properly deployed (see bottom of article for my OBS background and Lessons Learned).
However, energy services originators often overemphasize the importance of OBS when it comes to efficiency projects. Truth is, OBS is very difficult to achieve. Based on my conversations with various C-PACE lenders, the vast majority of projects that have been closed to date did not qualify for OBS - they were ON balance sheet.
Going forward, new 2019 lease accounting rules will make OBS even more difficult for C-PACE and bundled energy service agreements (ESAs).
A primary goal of the new accounting rules is to identify capital repayment obligations embedded in services agreements and to place them on the balance sheet as a capital lease.I recently heard an energy services originator say "if C-PACE payments can’t be an expense item and treated OBS, you can forget about it.” He implied this was the only reason building owners would be interested in C-PACE.
In my experience, this is a common misconception. The truth is, CFOs embrace C-PACE for many reasons that have nothing at all to do with accounting treatment. Some are provided below.
1. Increase net cash flow from efficiency retrofits: energy and maintenance savings more than offset low annual payments from 20+ year financing.
2. Freedom to sell the building, giving your customer more operating flexibility because the remaining obligation transfers to the buyer.
3. More flexible credit requirements: the credit decision is based on the ability to collect the C-PACE assessment (similar to a property tax) rather than the overall credit quality of the owner. This can allow some lower credit quality customers to qualify for C-PACE.
4. Absence of typical lender requirements such as reporting, debt covenants and other restrictions.
5. Owners can invest less of their own money in purchasing, constructing or retrofitting equipment in a building with 100% financing.
(For a more in-depth discussion of the benefits of C-PACE written in the CFO’s language, see the article titled 5 Reasons CFO's Should Embrace C-PACE Funding.)
If you suggest OBS is achievable and it becomes a huge focus for your customer, you may be going down a destructive path. You and your customer might invest many days/weeks negotiating the basics of an agreement that gets presented to the auditors who say OBS financing is not possible.
This could frustrate your customer and even cause them to pass on the deal if OBS was a large driver for them to do the project. You have lost a deal for all the wrong reasons. Even worse, you will have wasted your most valuable asset as an originator - your time.
What if instead of the distraction of OBS, you pitch projects based on the traditional project benefits with an added emphasis on economic merits?
Many projects will have energy and maintenance savings that more than offset any associated debt payments. This is easily achieved if your customer can use C-PACE financing because of the lower payments from a 20+ year funding.
Even if your project is in an area where C-PACE is not available, traditional financing is still quite attractive. For example, a 3.7-year project payback generates savings that cover debt payments for a 5-year financing. C-PACE is not the only answer and traditional financing is still quite compelling!
There is a great deal of misunderstanding among originators as to the true value of C-PACE for building owners. C-PACE funding provides numerous benefits regardless of accounting treatment as restated below.
Don't place too much importance on OBS treatment when pitching replacement projects, regardless of the manner in which they are being financed. New accounting rules have changed the landscape and OBS will be much more difficult to achieve going forward.
When C-PACE is not available or appropriate for the project, introduce other financing techniques such as traditional equipment leasing. Many projects will stay pay for themselves even with shorter term financing.
I spent many years selling the benefits of OBS financing as an energy banker. I later joined Enron Energy Services where I formed the Structured Finance Group which worked with originators to provide financing for energy efficiency programs with large Fortune 500 companies.
Despite my efforts, I learned OBS treatment was not always the magic elixir to get deals closed. In some cases, customers were interested; others were indifferent. Interestingly, others were opposed to OBS for energy efficiency projects. That’s because OBS wasn’t as beneficial to their EBITDA versus on-balance sheet financing. Many companies care more about their EBITDA than whether a financing is OBS.
Disclaimer: I’m not suggesting C-PACE can never be treated OBS. Accounting decisions are not always black and white and are influenced by facts and circumstances surrounding the project. I am also respectful of the skills of ESCOs with smart financing staffs which may have already built a better mouse trap to work around the new accounting rules. Only time will tell if new structures survive the scrutiny of their customers’ auditors. One thing is certain: OBS will be more difficult to achieve than it was in the past.
Want to know more? Contractors servicing building owners can click here to learn how to introduce the program to your customers/prospects. Building owners can click here to learn more about how C-PACE funding can help your business.
I appreciate any comments and am always happy to benefit from the knowledge of others. Please do not hesitate to contact me with any thoughts or questions at lderrett@enfluxbuildingsolutions.com, or, 713.714.0575.
By Larry Derrett, founder and CEO of EnFlux Building Solutions
