Municipal Bonds and Green Bonds

On this page:

Examples from the Field
Program Characteristics
Reaching Underserved Communities and Addressing Consumer Protections
Roles and Responsibilities
Getting Started

State and local governments may issue bonds to finance capital improvement projects, including clean energy projects. When a government issues a bond, it is offering bondholders the opportunity to earn a return on the funds put forth to purchase the bond.¹ Municipal bonds are the most traditional type of bonds and can be used with varying tax liability and forms of security.² State agencies and local governments can issue bonds to finance their own projects at lower interest rates than most other financing alternatives because they are backed by the full faith and credit of the government entity instead of the balance sheet of the issuing organization. Two types of municipal bonds are available for clean energy projects: tax-exempt municipal bonds and green bonds.

Each state has state-chartered bond authorities, such as housing finance and industrial development authorities.³ These authorities can finance eligible energy efficiency and renewable energy retrofits for facilities owned by eligible borrowers, including nonprofit healthcare, higher education, K-12 schools, institutions such as museums, low-income multifamily housing, and certain industry and manufacturing facilities.^4,5 These entities can use bond proceeds to implement clean energy projects for the public good.⁶

Tax-exempt municipal bonds are issued for a specific public purchase and deliver cash interest payments to the bondholder. The federal government exempts this interest income from federal taxes, thereby allowing an issuer to offer lower bond rates than a corporate bond with a similar credit rating. Interest on the bond may also be exempt from local and state income taxes, which can further lower interest rates (so that they are below comparable taxable debt).⁷ Tax-exempt bonds typically have low and sometimes fixed interest rates and longer maturity periods (10- to 30-year terms) compared to taxable bonds.⁸ Tax-exempt bonds thus offer more favorable financing terms than conventional sources. A tax-exempt bond can be either a general obligation bond that a government backs with its full taxing authority, or a revenue bond with repayments coming from project revenue.

Green bonds are a bond instrument that use proceeds to finance or refinance environmental, water, or clean energy projects. Green bonds are attractive financing tools as they couple financial returns and environmental benefits (e.g., improved air quality, reduced water use), do not require any new legislation, and are typically tax-exempt.⁹ Green bonds help governments finance new projects while enabling investors to reach sustainability targets.¹⁰ Investors include, but are not limited to, institutional investors such as insurance companies or pension funds.¹¹

Green bonds have similar risk-return profiles as municipal bonds; however, the green bonds framework, which specifies the green alignment of the bonds, may require providing more transparency into their environmental, social, and governance (ESG) risks relative to other municipal bonds from the same municipal issuer. The attractiveness of a bond to investors depends, in part, on the credit rating of the issuing body.¹² Green bonds are also an effective way for policymakers to signal energy efficiency and renewable energy policy priorities.¹³

To ensure the credibility of green bonds, many issuers seek to have their bonds meet frameworks such as the International Capital Market Association’s (ICMA’s) Green Bond Principals,¹⁴ which include guidelines for the evaluation and selection of projects; or the Climate Bonds Initiative’s (CBI’s) Taxonomy, which requires third-party verification. When issuing green bonds, a government may face the risk of greenwashing if it labels a project as having a significant environmental benefit but the benefit is negligible or nonexistent.^15,16 Some borrowers with high credit ratings who frequently issue bonds may not need to seek third-party verification for issuance of green bonds for certain projects such as clean energy and drinking water projects that have proven environmental benefits. While the issuance of green bonds has gained traction, it is not clear whether the “green bonds” label enhances the bonds sale or reduces the interest rate.

In 2020, there were $51 billion in green bonds issued in the United States.¹⁷ Globally, the green bond market has increased by 60% since 2015, reaching $1 trillion in 2020.¹⁸

Municipal bonds generally share the following key features:

They often exempt the shareholder from gross income for federal income tax purposes. They frequently have long tenures.
They often have low, fixed rates.
They generate proceeds that are frequently used by state or local governments or conduit borrowers for capital expenditures for public and economic development projects.

Green bonds generally share the following key features:

They are municipal bonds with the additional use of proceeds language specifying how the financing will support environmental or clean energy projects.
They often exempt the shareholder from gross income for federal income tax purposes.
They align with guidelines set forth in ICMA’s Green Bond Principals and may meet the more rigid standards developed by CBI that require third-party verification.

Municipal and green bonds may be administered by the following entities:

Local governments frequently issue bonds to facilitate capital expenditures, such as the construction of new public facilities (e.g., schools). Through this financing mechanism, local governments may also fund energy efficiency retrofits or improvements to existing buildings. Local governments may develop a green bond framework to allow the government to issue green bonds that identify the use of proceeds of the bond sale for environmental or clean energy purposes.
Local and regional authorities, such as housing or transit authorities, may issue bonds. The bonds issued by these organizations are generally for capital projects. Local or regional authorities may develop green bond programs to facilitate the issuance of green bonds in addition to general, tax-exempt municipal bonds.
State authorities may issue tax-exempt bonds to finance capital projects for public or economic development projects. In addition, state-funded entities may develop green bond frameworks and programs to allow for the issuance of green bonds.
Third-party and nonprofit organizations may implement clean energy programs after a bond is issued.

Examples from the Field

Vermont Municipal Bond Bank

The bank issued $38 million in bonds to fund 19 loans in 2020, one of which was $3 million to the St. Johnsbury School District to replace a broken oil boiler with a biomass powered boiler.¹⁹
The bank issued $41 million in bonds to fund 23 loans in 2018, one of which was $7.6 million to the Addison School District for an energy savings performance contract to facilitate the implementation energy efficiency upgrades.²⁰

BetterBuildings Northwest Ohio

The Toledo-Lucas County Port Authority is a quasi-government entity involved in economic development.
The Northwest Ohio Bond Fund provides financing through the Port Authority for deferred maintenance and energy efficiency upgrades, such as improved lighting; more efficient heating, ventilation, and air conditioning (HVAC) systems; and better insulation. The program notes that most buildings can achieve a 20% energy savings with upgrades.

New York City Housing Development Corporation Sustainable Development Bonds

The New York City Housing Development Corporation offers Sustainable Development Bonds (SDBs) which are social investment bonds geared towards affordable housing and supporting low- and moderate-income (LMI) communities.
These bonds promote economic growth, environmental benefits, and neighborhood revitalization.
The SDB program must meet the Enterprise Green Communities Criteria, which is a green building framework specifically for affordable housing that includes energy resiliency. The criteria establish standards for improving operating energy, reducing water use, and ameliorating existing on-site hazards (e.g., lead).
The bonds allow people to invest directly in efforts to improve energy efficiency and resiliency.

New York State Energy Research and Development Authority (NYSERDA) Green Bonds: Green Jobs – Green New York Financing

NYSERDA issued multiple series of green bonds to finance residential solar and energy efficiency programs from 2018 to 2020.
Bonds were issued by NYSERDA to finance loans through the Green Jobs – Green New York Program.
The size of each bond issued ranged from about $15 million to $18 million.

Program Characteristics

Here are the typical characteristics of energy efficient mortgages.

Program types	Tax-exempt municipal bonds and green bonds
Target sectors	Public; Industrial; Nonprofit; Residential: Multifamily²¹
Potential funding sources	Municipal bond market
Security required of borrower	Credit rating and an ability to pay debt service obligations
Repayment mechanism	Semiannual interest payment and repayment of bond principal at maturity
Funding needs	Typically, sponsors must provide a moderate level of funding to make the program successful for their own municipal projects
Enabling legislation requirement	Not required

Reaching Underserved Communities and Addressing Consumer Protections

When developing a financing program, considering the needs of underserved communities early in the process can help decisionmakers create a comprehensive financing program and incorporate consumer protections. Decisionmakers can evaluate how and to what extent marginalized communities and considerations of equity have been included in the policymaking process for developing a financing program by considering the following questions:²²

Have marginalized communities participated meaningfully in the policymaking process?
Does the policy help address the impacts of inequality or inequity, or does it widen existing disparities?
What are the barriers to more equitable outcomes?
How will the policy increase or decrease economic, social, and health benefits for marginalized communities?
Does the policy make energy more accessible and affordable to marginalized communities?

Many of the financing programs covered in this Clean Energy Financing Toolkit for Decisionmakers resource can provide specific benefits to underserved communities through increasing access to clean energy (e.g., lower energy bills, upgraded equipment, improved comfort). However, financing programs that place additional debt on consumers could place LMI households at an increased risk if adequate consumer protections are not in place. For example, consumers could face penalties for failing to repay program funds, including having their power shut off, adverse credit scores, and in some instances losing their homes. Decisionmakers can implement consumer protection frameworks to address these concerns, including increasing awareness, analyzing the applicant’s ability to pay, and requiring disclosure of financing costs. Considerations for consumer protections are specific to each program.

Municipal and green bonds do not place any debt directly on residential consumers. The proceeds from bonds can lower upfront costs, which are often a barrier to LMI community participation, thus making LMI investments in energy efficiency and renewable energy systems more accessible.²³ In addition, municipal bonds can support LMI borrowers involved in industry and nonprofit sectors, such as small business owners and Minority, Women and Disadvantaged Business Enterprises. LMI communities can also benefit from tax-exempt bonds that are focused on implementing renewable energy and energy efficiency infrastructure in LMI multifamily housing and small businesses.

Roles and Responsibilities

Local governments and state agencies typically play a critical role in the implementation and operations of municipal and green bonds. To issue municipal bonds, local governments and state agencies must identify projects that should be included in a bond issuance package. Government staff must understand the clean energy project costs, anticipated savings, and benefits associated with implementation of the project. In addition, state and local governments that implement green bond programs may want to develop specific green bond frameworks to guide the issuance of use of proceeds bonds targeted at environmental or clean energy improvements and expected benefits. Following issuance of the bonds, government staff must track expenditures and provide reporting on bond-funded projects. The cost of issuance and retention of bond counsel are additional considerations, and may make issuance prohibitive for small municipalities.

Nonprofit organizations may be responsible for administering programs funded through municipal or green bonds.

Utilities do not have a significant role in the implementation or operations of municipal or green bonds.

Getting Started

State and local governments should consider these steps and best practices during the design, approval, issuance, and management of municipal and green bonds:

Create an action plan that describes goals, priorities, and constraints for issuing municipal bonds or green bonds for energy projects.
Determine legal, regulatory, and public review requirements for issuing municipal bonds or green bonds.
Define the type of projects that could receive funds, and develop an initial program budget, including capital costs plus bond issuance and administration costs.
Evaluate green bond guidance documents and standards and consider implementing best practices for ESG reporting.
Engage key stakeholders in the development of green bond programs.
Plan for the public approval process for new municipal bonds, which could add time, cost, and uncertainty.
Describe the program’s potential economic and environmental benefits to the community, relative to the costs.
Develop the ability to identify energy project opportunities and bundle smaller projects together to avoid high administrative costs.

Learn More

Learn more about bonding tools and leveraging bond financing to meet clean energy goals from the Department of Energy.
Learn more about tax-exempt municipal bonds from the Department of Energy.
Read the International Capital Market Association’s Green Bond Principles.
Read the Climate Bonds Initiative’s Taxonomy.

References and Footnotes

¹ In effect, the municipality is borrowing from the bondholder rather than a financial institution, at terms more favorable to the municipality and the bondholder.

² U.S. Department of Energy. n.d. Bonding Tools. U.S. Department of Energy.

³ U.S. Department of Energy. Tax-Exempt Bond Financing for Nonprofit Organizations and Industries.

⁴ U.S. Department of Energy. Tax-Exempt Bond Financing for Nonprofit Organizations and Industries.

⁵ U.S. Department of Energy. Tax-Exempt Bond Financing for Nonprofit Organizations and Industries.

⁶ U.S. Department of Energy. Tax-Exempt Bond Financing for Nonprofit Organizations and Industries.

⁷ U.S. Department of Energy. Public Bonding Options.

⁸ U.S. Department of Energy. Tax-Exempt Bond Financing for Nonprofit Organizations and Industries.

⁹ Environmental Defense Fund. n.d. Financing New Jersey’s Clean Energy Economy: Pathways for Leadership; Green City Bonds. n.d. How to Issue a Green Muni Bond: The Green Muni Bonds Playbook.

¹⁰ International Renewable Energy Agency. 2020. Renewable Energy Finance: Green Bonds.

¹¹ American Council for an Energy Efficient Economy. 2017. Green Bonds.

¹² Environmental Defense Fund. n.d. Financing New Jersey’s Clean Energy Economy: Pathways for Leadership.

¹³ The World Bank. 2018. The Pros and Cons of Green Bonds. 10.

¹⁴ International Capital Market Association. 2018. Green Bond Principals: Voluntary Process Guidelines for Issuing Green Bonds.

¹⁵ Bachelet, M.J., L. Becchetti, and S. Manfredonia. 2019. The Green Bonds Premium Puzzle: The Role of Issuer Characteristics and Third-Party Verification. Sustainability 11:4.

¹⁶ National Academies of Sciences, Engineering, and Medicine. 2021. Analysis of Green Bond Financing in the Public Transportation Industry. Washington, DC: The National Academies Press.

¹⁷ Climate Bond Initiative 2021. Record $269.5bn Green Issuance for 2020: Late Surge Sees Pandemic Year pip 2019 Total by $3bn.

¹⁸ Climate Bond Initiative 2021. Record $269.5bn Green Issuance for 2020: Late Surge Sees Pandemic Year pip 2019 Total by $3bn.

¹⁹ Vermont Municipal Bond Bank. 2020. 2020 Annual Report.

²⁰ Vermont Municipal Bond Bank. 2018. 2018 Annual Report.

²¹ U.S. Department of Energy. Tax-Exempt Bond Financing for Nonprofit Organizations and Industries.

²² Governments, agencies, and nonprofits have developed equity lenses and frameworks to ensure that issues of race and equity are incorporated throughout policy-making processes. These questions draw from the following frameworks: Institute for Energy Justice, “Section 2 – Energy Justice Scorecard”; City of Seattle, “Racial Equity Toolkit”; and Higher Education Coordinating Commission, “Oregon Equity Lens.”

²³ Orrick. n.d. Tax-Subsidized Financing Options for Energy Projects and Programs.