It could be said that if the credit markets were not so risk-averse right now, it would be an incredible time to issue debt for expansions, renovations, acquisitions or refinances. Construction costs remain low, and the 10-year treasury rate, an indicator of base interest rates with no risk pricing built in, has been hovering under 4 percent – compared with 6 percent in the late 1990s and 9 percent in the 1980s.

It appears that a “typical borrower” cannot take advantage of these low-cost opportunities to modernize a property, extend service lines or expand a facility because many financing options fell off the table as bond insurers and banks retreated in 2008 and 2009. Credit remains tight, and it seems that only the strongest borrowers can issue debt without enhancement or subsidy at a reasonable cost.

But several credit enhancement and financing options created or modified in the past two years have helped ensure key community resources could continue evolving despite the temporarily tough economy. Some allow borrowers to capitalize on local relationships; others allow them to rely on federal credit enhancement or subsidies in ways that weren’t possible before. Some work brilliantly for small projects that perhaps would not see any interest from a larger bank; others are being used for huge new facilities.

And some will expire after 2010, before many realize they exist. By looking both locally and federally for financing, providers may find more options available to them in 2010 than they did in 2008 or will in 2011.

Looking Locally: Federal Home Loan Bank
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 opened it up to non-housing borrowers 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. Some smaller banks cannot take on too much exposure to one particular borrower, making loans of over $15 million or so more difficult for one bank to handle on its own. In the case of a larger project, however, the borrower has the option to involve multiple local banks, so long as the banks will take a parity security position in the collateral. While some banks may be inhibited by market conditions and are holding back on lending to retain liquidity, many other local community banks still have considerable capacity to lend, and are willing to do so. According to the Federal Home Loan Bank of Pittsburgh, which has been aggregating these transactions, more than 100 non-housing FHLB LOC transactions totaling over $3 billion have been completed nationwide in the past year.

Looking Locally: Bank-qualified Bonds
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, though, this limit reverts to the pre-ARRA limit of $10 million.

Looking Federally: Build America Bonds
Build America Bonds (BABs) were also created by the American Recovery and Reinvestment Act. Public entities (e.g. municipal hospitals or retirement communities) that issue BABs are subsidized for 35% of their interest cost. This means that a county-owned retirement community that issued BAB debt with a 6.5% coupon would pay an effective rate of 4.2%.

BABs must be issued as taxable notes, and in 2009 and 2010 only public entities can use them, and only for new construction, acquisition or other capital expenditures – not for refinancing or working capital needs. The subsidy can be applied only to the interest coupon cost, not to any fees that are incorporated into the all-in rate.

BABs are set to expire after Dec. 31. The administration’s fiscal 2011 budget proposes opening them to nonprofits in 2011, but reducing the subsidy to 28%. Investors have a strong appetite for this structure, and BABs constitute about 20% of the municipal bonds market. As of Jan. 31, there had been 834 issuances in 47 states for a total of $70.8 billion, according to U.S. Treasury data collected from Bloomberg.

Conclusion
Affordable financing is available via these temporary options, via governmental financing programs and, to some borrowers, via conventional structures such as bank letters of credit or traditional unenhanced bonds. Those that do not take advantage in 2010, however, could be left in an unfriendly meantime if conventional financing options and the credit markets have not recovered more by the time these temporary options expire. Progress means remaining aware of opportunities, understanding each financing option’s impact on both the long- and short-term health of the organization, and being prudent in financing decisions.

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