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Loosening the Usury Cap

DALLAS - A state constitutional cap on the amount of bond interest that Arkansas state and local governments can pay is curtailing their ability to issue debt.

A provision in the state constitution limits the interest rate on local capital improvement bonds, which are usually supported by sales tax revenues, to no more than 200 basis points above the discount rate of the Federal Reserve Bank of St. Louis.

All other bonds supported by tax revenue, including general obligation debt and road bonds that rely on gasoline tax revenues, can carry an interest rate of no more than 500 basis points above the federal discount rate.

The rate charged by the Federal Reserve to its member banks has been at 0.5% since December. That requires an interest rate of no more than 2.5% on local capital improvement bonds from Arkansas issuers, and no more than 5.5% for all other state and municipal debt.

"It's a real problem," said Edmond Hurst, senior managing director in the Little Rock office of Crews & Associates Inc. "Municipal financing is still getting done in Arkansas, but only general obligation issues that are rated A or higher."

Arkansas' two U.S. senators have tried to pass a federal exemption to the state constitution, similar to legislation that removed the state's usury limit on bank loans and home mortgages, but have not been successful.

Sen. Blanche Lincoln sponsored legislation in Congress to provide an exemption to override the state usury provision in 2001, 2003, and 2006, but the bills never made it out of committee.

A spokeswoman for Lincoln said the prevailing mood in Congress is that the usury cap is a state issue that should be resolved at the state level.

Without federal intervention, Hurst said, neither the Arkansas state nor local governments will be able issue the new taxable Build America Bonds without exceeding the constitutional cap.

The constitution cannot be amended to take out the usury cap until the general election in November 2010. A bill that would have allowed legislators to amend the constitution without approval from the voters died in the General Assembly this year.

"Those [BAB] bonds have to be issued by 2010, and we cannot make that deadline unless we get a federal exemption," he said. "Hopefully, common sense will prevail and that will happen."

Hartsill Ragon 3d, bond counsel and partner in Gill Elrod Ragon Owen & Sherman PA, said bond activity in Arkansas is unlikely to revive until either the federal discount rate rises or the usury limits are removed.

"It's real tough, and getting more difficult," he said. "There's nothing much going on. We have a lot of demand for proceeds, but at this point we can't sell any BABs or economic development bonds."

Issuers in the state are unlikely to challenge the usury cap in federal court, Ragon said.

Many small issuers rely on revenue bonds, often issued as unrated taxable debt, for economic development efforts, Hurst said, and those cannot be issued in today's marketplace at rates beneath the constitutional cap.

"Anything taxable cannot be done in this environment, especially if it is nonrated," he said. "How in the world can we keep something like that below 5.5%? The answer is, we can't."

Arkansas issuers sold $678 million of revenue-supported debt in 2008, according to information from Thomson Reuters, and $466 million of GO debt.

Communities that voted to impose sales and use taxes for economic development bonds now cannot move forward on those projects, Hurst said.

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