CHICAGO — After a slow start, a federal program that allowed the nation’s Federal Home Loan Banks to guarantee non-housing related tax-exempt issues is picking up steam in the Midwest as local banks, borrowers, and underwriters see its value, local market participants say.
A recent notice from the Internal Revenue Service clarifying that the program applies to refunding bonds as well as new-money issuance, and the ongoing credit deterioration of some regional commercial banks, have helped stir interest in the program, according to market participants working on FHLB-backed deals.
Under the program, included in the Housing and Economic Recovery Act of 2008 enacted July 31, FHLBs were allowed to provide letters of credit for non-housing debt issuance through 2010. Previously, their backing was limited to tax-exempt housing projects. The FHLBs’ support is in effect a wrap on enhancement provided by a local bank that must post collateral.
Missouri-based Stern Brothers & Co. late last month closed on an $8.7 million floating-rate refunding transaction for Sienna Heights University in Adrian, Mich. The refunding included a letter of credit from two local community banks with guaranteeing LOC support from the Federal Home Loan Bank of Chicago, so the bonds ultimately carried the double-A rating of the Chicago FHLB.
The refunded 2006 debt was backed by an LOC from Fifth Third Bank. After a downgrade, the bonds failed at remarketing, driving up the university’s costs in excess of prime rate. The refunding is remarketed weekly and captured an initial rate of about 2% when issuance costs were included.
“This is an important financing tool that couldn’t have come at a better time, given the strain in the credit markets. It should help borrowers facing higher rate resets on their variable-rate bonds due to bank credit risk,” said Stern Brothers banker Bill Reisner, who worked on the deal with colleague Charlie Forrest. “The biggest issue is getting the word out. The time is definitely ripe.”
Stern Brothers is working on a handful of additional refunding transactions with borrowers in Illinois and Missouri. Reisner made a presentation on the topic at the Topeka Federal Home Loan Bank’s Annual Management Conference late last month.
While the borrower faces a shorter renewal term on its local bank coverage of three to five years, the FHLB wrap carries a 10-year renewal term. One drawback is that local banks are required to post approved collateral, which can limit the size of transactions they are able to support.
Of the 12 FHLBs, 10 carry top ratings from Standard & Poor’s. The Chicago and Seattle branches are rated AA and AA-plus, respectively. Moody’s Investors Service rates all of them Aaa. Nationally, there are 8,100 federal home loan member-lender banks.
The municipal debt enhancement program offers an attractive alternative to smaller, unrated borrowers struggling to find an affordable letter of credit. Often the floating-rate borrowing market remains the most affordable option over using a fixed-rate structure, but the costs for LOCs have skyrocketed due to the credit crunch and their availability has grown scarcer, especially for lower-rated credits.
Local market participants said that the Michigan university deal is one of the first in the Midwest to follow a $6.9 million sale last November led by Columbus-based underwriter Lancaster Pollard with support from the triple-A rated Indianapolis Federal Home Loan Bank. The bonds were issued on behalf of Swiss Village, a small, unrated continuing-care retirement community located in the town of Berne, Ind., with a population of 4,100. Two local Indianapolis FHLB lenders provided the first-tier LOC coverage.
Interest in the program was slow going, but market participants attributed that in part to concerns over whether refundings were eligible for the federal guarantee because of language in the law regarding “original issuance.” The IRS recently clarified that refundings are covered under that clause.
“We have definitely seen an uptick in requests for information,” said Barbara Watkins, associate general counsel for the Chicago FHLB, adding that the interest is coming from borrowers, local member banks, underwriters, and issuing agencies like the Illinois Finance Authority. “Word is definitely getting out. The process to put together an FHLB-backed deal can take two to three months.”
“Right now where we see the greatest need is in restructuring existing deals because of the credit deterioration,” said Stern president Terrence Finn.
In addition to lowering borrowers’ interest rates, Reisner and Forrest said the program offers a boon to local banks, allowing them to provide an additional service for their clients.
