What options are available for financing an energy retrofit?
An energy retrofit can be financed through several sources in Canada, from a chartered bank, leasing company or life insurance company to the energy service company (ESCO) providing the retrofit services.
The first thing for a building owner to determine is whether it wants on-balance sheet or off-balance sheet financing. On-balance sheet financing is a traditional financing structure in which the building owner borrows money directly using a term loan, capital lease or mortgage. Off-balance financing is a financial structure in which the loan obligation does not appear on the building owner’s balance sheet. An operating lease or tri-party agreement are two such examples.
In an operating lease, the lessor (or owner) only transfers the right to use the property to the lessee. At the end of the lease period, the lessee returns the property to the lessor. Since the lessee does not assume the risk of ownership, the lease expense is treated as an operating expense in the income statement and the lease does not affect the balance sheet. Basically, to be treated as an operating lease, the present value of the committed rental payments must be less than 90 per cent of the cost of the equipment and the term less than 75 per cent of its economic life. In other words, the lessor must be at real risk for 10 per cent or more of that cost. The advantages of this method is it conserves working capital, provides off-balance sheet borrowing, keeps bank operating lines unencumbered and offers tax advantages. One disadvantage is it can be slightly more expensive than traditional on-balance sheet financing.
A tri-party agreement is a deal structure that involves an agreement between the building owner, ESCO and financing company in such a way that the building owner has limited exposure with regards to the debt financing. The basic concept is the ESCO borrows the money using the future guaranteed energy savings stream as collateral and assigns all rights to savings payments from the building owner to the financial institution. If there is a shortfall in future guaranteed energy savings, then the ESCO is responsible for making up that difference and paying it to the financial institution. If the ESCO is no longer available to make up the savings shortfall, then the financial institution would look to the building owner to make up the difference or reduce the payment and extend the term, if possible. Advantages of a tri-party agreement are that it provides the client the guarantee that repayment will be provided exclusively from savings, and the client never has to use other resources to service this debt. This provides a balance sheet neutral solution for the client. The client also does not add debt onto their balance sheet and it does not affect financial ratios, which may add to borrowing capacity. Disadvantages include a “hell and high water clause,” which may be deemed by auditors as a significant risk to justify on-balance sheet treatment, and slightly higher loan set-up costs compared to traditional financial vehicles.
David Maksymuik is vice-president of finance at Ameresco Canada Inc.