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Using performance contracts for facilities upgrades

Ben Speed

This post is sponsored by Johnson Controls.

As infrastructure ages, many local governments are looking for cost-effective ways to pay for upgrades and other investments. One type of financing is a performance contract, where municipalities use guaranteed savings to offset initial capital costs.

Here we talk with Ben Speed, executive director, structured finance at Johnson Controls, about how local governments can finance infrastructure upgrades and what options are available.

Question: How do local governments benefit from using a performance contract (PC) to procure capital improvements?

Ben Speed: A performance contract enables a local government to upgrade its infrastructure with new, reliable and more efficient assets without incurring additional budget expense. It’s designed to be a budget-neutral arrangement, where guaranteed savings offset capital costs. The local government is able to redirect its current expenses to pay the financing cost of new facility improvements. Money that was going to the utility can now be reinvested into the local government’s buildings.

Q: How do local governments typically finance PC projects?

BS: The tax-exempt lease-purchase (TELP) is the most popular way to finance PC projects. Local governments can obtain a TELP either from a third-party bank or through their Energy Services Company (ESCO). Customers also use general obligation bonds and revenue bonds. However, a TELP is often the easiest way to raise capital for projects that cost less than $20 million. A TELP has lighter documentation, a faster closing process and lower fees than a bond issuance.

Q: What are some financing challenges that local governments face with PC projects?

BS: Since they are budget-neutral and allow local governments to redirect wasteful expenses to facility improvements, PC projects make good financial sense. At the end of the day, the biggest financing challenge is fiscal politics. We have found that since the recession, local government boards and communities have become more conservative and reluctant to take on debt. In order to build confidence in a PC program, it is important for local governments to work with an ESCO that has the strength and track record to support the savings guaranty. 

Q: Are there any alternative financing programs?

BS: Yes. Qualified Energy Conservation Bonds are a great federal program with a net cost of capital that is lower than traditional debt financing. If a local government is more concerned about the appearance of an unconditional debt service obligation, there are pay-from-savings models, where the payment is variable and contingent upon the amount of savings that the local government receives.

Q: Can you cite an example where financing played a part in the success of a PC project?

BS: In 2013, the Metro Government of Louisville, Ky., wanted to maintain its favorable credit rating and therefore was sensitive to any financing of infrastructure improvements. At the same time, many Metro Government facilities were energy-inefficient and in need of repair. Johnson Controls offered a¬†Contingent Payment Program to install energy-efficiency improvements for the Metro Government with no required public bond issuance or bank loan. The program allows Metro Government to pay Johnson Controls over 20 years for facility improvements. The contract does not require any fixed debt service payment. Metro Government’s payment obligations are limited to actual benefits received from the installed improvements. The ability to deliver improvements, avoid traditional debt financing and offer long-term performance support from Johnson Controls provided a unique solution for the Louisville Metro Government.