Expiring Credit Enhancement Options: Federal Home Loan Bank (FHLB) Letters of Credit and Bank-Qualified Bonds

Affordable financing is available via these temporary options, each of which are set to expire at the end of 2010. By looking both locally and federally for financing, providers may find more options available to them in 2010 than they did in 2009 or will in 2011.

Borrowers that can issue tax-exempt bonds can supplant larger regional or national banks that aren’t lending or providing credit enhancement by combining local bank financing with Federal Home Loan Bank (FHLB) credit support to enhance the debt and reduce the interest rate. This opportunity already existed for housing borrowers, but Congressional legislation made it available to non-rated and low-investment grade hospitals, senior housing and care providers in June 2008. The non-housing permission expires after Dec. 31, 2010.

There are 12 Federal Home Loan Banks nationwide, each with its own credit rating of AA or AAA. The option provides a local-level financing solution on par with what can be offered by the country’s strongest investment-grade rated banks. Because many local banks do not maintain investment-grade ratings, they typically could not provide borrowers letter of credit (LOC) enhancement unless a larger national bank also participated, which can become expensive and dilute the local bank’s involvement in the community project.

The FHLB LOC wrap is a viable option for small-to-medium-sized projects, but it will be limited by the local bank’s capacity to lend. The 12 Federal Home Loan Banks lend and provide services to 8,100 local community banks and credit unions, which own the FHLBs as cooperatives. These local banks must be members of the FHLB system to borrow from the FHLB and to utilize financing options such as LOC wraps. Each of the FHLBs operates independently and has its own credit rating.

Click here to view a recent case study for the FHLB enhancement, and for additional details on the program.

When tax-exempt bonds are “bank-qualified,” banks can deduct 80% of their purchase and carrying costs, and can pass along the savings to borrowers by way of a reduced interest rate. This provides local banks the opportunity to get involved in a community project by purchasing the bonds directly, and it entices non-local banks to purchase bonds at lower rates because the purchases reduce the banks’ tax burdens.

Until recently, only $10 million in bonds could be designated bank-qualified by any single bond issuer (often the local municipality) in one year, limiting project sizes. But in 2009, the American Recovery and Reinvestment Act increased the amount of bank-qualified bonds that can be issued to $30 million and applied this new limit to the borrower, not the bond issuer. After December 2010, though, this limit reverts to the pre-ARRA limit of $10 million.

For more details on these expiring financial options and how they may work for your organization, click here.