Part 1: The What and Why
America’s higher education institutions are facing an unprecedented “perfect storm” of adverse conditions. A national decline in state funding has heightened pressure to increase revenue through tuition, philanthropy, and other ancillary sources. At the same time, operational expenses continue to rise—often outpacing year-over-year tuition increases. Colleges and universities are confronted with declining liquidity, tighter operating margins, and an often-mountainous backlog of capital renewal and deferred maintenance.
Recognizing that a business-as-usual approach is no longer viable, many higher education institutions have turned to creative transactions that monetize core assets, while also transferring the College or University’s risk over a long period of time. One such transaction is the energy asset concession arrangement, a transaction that Bernhard (among a small group of other firms) has pioneered in North America.
What is an Energy Asset Concession?
The energy asset concession is a transaction under which a third-party Concessionaire purchases from the College or University the right to use, maintain, and renew the institution’s existing utility assets over a given term. Utility assets may include equipment that produces and distributes chilled water, heating water, steam, or electricity to the campus. In some cases, the transaction can also include water and wastewater treatment assets.
The University leases utility assets to the Concessionaire, who is responsible for effective operation, maintenance, renewal, and optimization of equipment for the term of the agreement, usually between 25 and 50 years.
Why Consider an Energy Asset Concession?
The energy asset concession arrangement offers tangible financial and operational benefits for higher education institutions, including:
- Liquidity Through Asset Monetization. In a Concession, the Concessionaire makes an advance, upfront lease payment (“Advance Lease Payment”) to the University in exchange for the right to use the assets over the term of the agreement. The amount of the Advance Lease Payment is indexed to the fair value of the assets and is often large enough to double or triple the University’s pre-transaction endowment fund.
- Increased Annual Net Income. If the University opts to invest some or all of the Advance Lease Payment in its endowment, the investment’s annual return often exceeds the effective cost of capital of the transaction, which generates a positive interest rate arbitrage. The gain realized from the positive interest rate arbitrage generates discretionary investment income, or non-operating revenue, which the University can use to fund core research and education initiatives.
- Credit Rating Uplift. The Concession bolsters both the University’s balance sheet and its income statement, often yielding a credit rating uplift from rating agencies such as Moody’s or Fitch.
- Infrastructure Renewal. As part of the agreement, the University dedicates a portion of the Advance Lease Payment to an infrastructure renewal program. The Concessionaire implements this program immediately, allowing the University to swiftly and comprehensively address the backlog of capital renewal and deferred maintenance priorities. The implementation of an upfront scope of work generates guaranteed annual energy savings that, when leveraged, typically exceed the costs of engineering, procurement, and construction, generating additional net consideration for the University. Finally, the upfront infrastructure renewal program optimizes the University’s asset inventory immediately, yielding significantly lower operational and renewal costs over the term of the Concession.
- Risk Transfer. The Concessionaire is responsible for on-going operation and maintenance of the energy assets and assumes risks that would otherwise fall on the University. These risks may include hiring, training, and retaining employees as well as renewing assets that unexpectedly fail during the term of the agreement. The University is able to shed these risks, which are not core to their business, and focus instead on core functions of research and education.
- Monetization of Tax Credits and Incentives. Because the Concessionaire is a taxable entity and the University is tax-exempt, the Concessionaire is eligible to claim accelerated depreciation (Section 168(k) of the Internal Revenue Code) of certain qualifying assets and may be eligible for other tax credits and incentives. This creates a significant after-tax benefit that can be readily shared with the tax-exempt University in the form of a reduced monthly service charge.
- Off Balance Sheet Recognition. The Energy Asset Concession involves a recurring monthly thermal service agreement (“TSA”) charge from the University to the Concessionaire. The TSA charge is comprised of a capacity charge; operations and maintenance charge; and capital renewal charge. This charge is typically structured to be recognized as an executory contract or operational expense, avoiding classification as a long-term liability on the Customer’s balance sheet. This allows the University to preserve its pre-transaction leverage ratios and debt capacity.
Over the next few months, Bernhard’s team of experts will provide a detailed look at each element of the energy asset concession arrangement — Finance, Operations and Maintenance, Program Management, Engineering, and Energy Management. This series offers a comprehensive view of the energy asset concession as a unique solution for improving financial outcomes at higher education institutions.
Rob Guthrie, CEM
Vice President of Business Development
firstname.lastname@example.org | 205.292.7467