Losing interest

How would you like to get a notice from your bank indicating that the interest rate on the financing used to add on to your building, purchase that new piece of equipment or build your new plant has dropped to 1.2 percent or 1.4 percent this week?

Businesses that have taken advantage of tax-exempt bond or taxable note financing have received that type of notice recently, as interest rates reach historic lows.

Although these are not the best of economic times, for businesses with a long-term view, it is a great time to borrow money to acquire, build, or expand.

Low-interest rate, tax-exempt bonds can be used to finance certain “privately-owned” capital projects. Among the most common type of tax-exempt bonds are Industrial Development Revenue Bonds (IDRBs or IRBs) for manufacturing/processing companies, and 501 (C)(3) bonds for nonprofit entities having 501 (C)(3) determination letters from the IRS. Additionally, companies that do not qualify for tax-exempt bonds can access the low interest rate capital market using Taxable Adjustable Rate Notes (TARNS).

Typically, these types of tax-exempt bonds or taxable notes are issued as variable rate demand obligations (lower floaters). The interest rate changes weekly and obligations can be pre-paid without penalty. Interest rate swaps may be utilized to convert the variable rate into a fixed rate, and interest rate caps can be utilized to minimize the risk associated with a variable interest rate.

The obligations are secured by a bank letter of credit. Generally, the weekly variable rate letter of credit-enhanced bonds or notes is best used for longer-term asset acquisitions such as land, buildings, additions or equipment. They are usually cost-effective for minimum amounts of $1.3 million, with maturities ranging from seven to 30 years.

For a bank to issue the letter of credit as credit enhancement for the bonds or notes, collateral is required, such as real estate mortgages, security interests in equipment, guaranties or pledges.

Tax-exempt bonds are typically issued by governmental entities such as counties, cities or port authorities. Once they are issued, the issuer usually has no continuing involvement in the project, having merely acted as a conduit for this type of financing.

Even if a company does not qualify for tax-exempt financing, it may qualify to issue taxable notes. None of the Internal Revenue Code requirements for tax-exempt bonds or Ohio prevailing wage law requirements apply to taxable notes.

The company itself is the issuer of the notes, not a governmental entity.

The recent weekly variable rates for credit-enhanced bonds secured by one local bank are 1.2 percent for 501(C)(3) bonds, 1.3 percent for manufacturing/processing companies, and 1.4 percent for the taxable notes for any borrower for any purpose.

In assessing the actual cost of bonds or notes to businesses, factor in issuance costs (underwriters fees, bond counsel fees, etc.) and annual maintenance costs (letter of credit fee, trustee fee, etc.) to get the “all-in” rate. Depending on the principal amount of bonds or notes issued, and the specific issuance costs and maintenance fees, the “all-in” cost could be anywhere from 1 percent to 2 percent higher than the interest rate alone.

However, this rate is still usually lower than most competing types of capital financing. Thus, although the economic news is not very good, savvy business owners may have the chance of a lifetime to obtain favorable interest rates for capital projects. Jay P. Porter is a partner with Brouse McDowell. Reach him at (330) 535-5711 or at [email protected]