WASHINGTON — The National Association of Bond Lawyers yesterday joined the growing chorus of muni market groups pushing for an extension beyond the end of 2010 of two provisions in last year’s $787 billion American Recovery and Reinvestment Act allowing banks to purchase tax-exempt bonds from issuers that otherwise might not have access to the market.
NABL recommended that Congress extend an ARRA provision that increased the small-issuer limit for bank-qualified bonds as well as a provision that extended the 2% de minimis rule for financial institutions to banks. Both provisions “have accomplished their goals and could have a continued beneficial impact” beyond their Dec. 31 sunset dates, NABL said in a
The advisory was prepared in response to requests from NABL members and other muni market participants, the bond attorneys group said.
The NABL advisory comes as many other market groups, including the National Association of Health and Educational Facilities Finance Authorities, also are encouraging Congress to extend the provisions.
Though lawmakers are reportedly receptive, none have introduced such legislation, yet.
Specifically, the bank-qualified provision increased to $30 million from $10 million the small-issuer limit for bank-qualified bonds so that banks can now deduct 80% of the costs of buying and carrying tax-exempt bonds sold by issuers whose annual bond issuance is less than $30 million. In addition, the stimulus law allowed for the $30 million limit to be applied to individual borrowers participating in conduit deals, rather than the conduit issuer.
Congress also modified the 2% de minimis rule for financial institutions to include banks that invest in tax-exempt bonds so they can deduct 80% of the cost of buying and carrying tax-exempt bonds, to the extent that their tax-exempt holdings do not exceed 2% of their assets. The idea was to encourage them to purchase tax-exempt munis.
While the provisions may appear duplicative, NABL noted that the de minimis provision is important partly because it allows banks to purchase bonds that may not be BQ eligible.
No estimates of bank purchases of tax-exempt bonds under the de minimis extension were immediately available. However, the total number of bank-qualified designated debt skyrocketed last year to just under $40 billion across 6,005 issuances, compared to $15.3 billion across 4,195 issuances in 2008, according to Thomson Reuters.
Michelle Barstad, executive director of the Montana Facility Finance Authority, said that the bank-qualified bond changes were crucial in the majority of the authority’s projects last year, including a $610,000 transaction for the Rimrock Foundation, which runs an addiction treatment center in Billings.
Barstad said that Rimrock was able to get a 4.75% interest rate on the bonds it sold to a local bank, far below the prevailing commercial loans of between 6.5% and 7%. She said that local banks want to help local foundations, but they have to be responsible to their shareholders and cannot offer below-market rates without the tax exemption.
“It is a way for the facility to get a project done at a great rate and to get the local participation of the bank that they do business with,” Barstad said. “Typically you don’t see those kinds of interest rates unless you’re in the market, and you don’t get in the market unless you’re in the millions of dollars.”
Linda Schakel, a partner at Ballard Spahr LLP here who helped author the NABL advisory, said that $5 million is the level at which a transaction generally becomes cost efficient in the public markets, a figure that only grows with time.
Certainly, she said, $10 million in 1986 could help a small issuer finance a couple of school buildings, “but not now.”
Though NABL’s advisory does not specifically call for the provisions to be extended permanently, Schakel said that making the changes permanent would provide for a more stable market.
“Particularly when you go to refinance and you know that it’s always going to be there, you have more flexibility in structuring the transactions,” she said, referring to the bank-qualified bond changes.
NABL’s advisory provides detailed the history of the bank-qualified limits, beginning with the 1986 Tax Act that changed the Internal Revenue Code in a way that made it less financially attractive for a bank to be a direct purchaser of tax-exempt bonds for its own portfolio.
However, in response to concerns about the impact of harsher interest expense deduction rules on smaller localities that had traditionally depended on financial institutions to buy their tax-exempt bonds, Congress included an exception that would allow an issuer whose annual issuance did not exceed $10 million of bonds to designate those bonds as bank-qualified debt, NABL said.
NABL noted that prior to the ARRA, the $10 million limit had not changed for 23 years and had not been indexed for inflation, “so it became increasingly harder for governmental issuers to finance their own governmental projects in a cost-effective manner through local banks.”
After the 1986 Tax Act many banks provided credit support in the form of letters of credit to wrap variable-rate bonds that were expected to provide a lower cost of capital than a taxable rate banks were otherwise able to offer. But the transactions greatly increased in complexity and brought the bond offerings “into the public offering arena with its attendant securities laws and tax information reporting regimes,” NABL said.
And while few nonprofit conduit borrowers could have foreseen the problems in the variable-rate market — such as the downgrading and decreasing number of banks providing letters of credit during the financial crisis — current credit conditions have made entering the public markets with such variable-rate structures uneconomical if not impossible for these issuers, NABL said.
