Overview Of Private Activity Bond Financing And Incentives

SCOPE OF THIS OVERVIEW

This memorandum provides a brief explanation and overview of tax-exempt Private Activity Bond (formerly known as Industrial Development Bond) financing under the Internal Revenue Code of 1986, as amended (the "I.R.C."), including financing for manufacturing facilities, for Section 501(c)(3) non-profit organizations, for certain "exempt facilities" and in Enterprise Zones. This memorandum also describes "Taxable Bond" financing and other incentives for the location of industry, which have developed as an alternative to the more restrictive Private Activity Bond program. Details concerning "manufacturing small issues," "Section 501(c)(3) organizations," "exempt facilities" and "Taxable Bonds" appear in this memorandum. Bond financing for 501(c)(3) organizations, schools, hospitals and governmental facilities is specialized and we have separate Overviews on those subjects, available on request. The information provided may be useful in determining whether Bond financing or other incentives will be available in particular cases, how the transaction might be structured and proceed, what advantages exist, and what limitations are imposed. However, Bond Counsel should be consulted early to assist in determining whether a project qualifies and in assuring that the applicable legal requirements will be met.

BOND FINANCING

What is Bond Financing? Bond financing takes the form of loans, or some times leases or installment sales, from a local government entity, often a development authority or development corporation (the "Issuer"). State laws vary concerning Bonds, but they are available in most jurisdictions. The interest rate is low because Bonds issued by the Issuer can be qualified to pay tax-exempt interest to the investors under the I.R.C., and the low interest rate is passed on to the User. The money raised from the Bonds is reloaned by the Issuer to the User or used to acquire facilities to be leased or sold by the Issuer to the User. Bonds offer considerable flexibility in structuring terms, such as variable and fixed interest rates, prepayment and long and short maturities.

Why Use Bond Financing? Interest on a qualified Private Activity Bond is exempt from Federal income taxation (but, except for Bonds for Section 501(c)(3) organizations, is subject to alternative minimum tax) and, usually, income taxation in the state in which the Bonds are issued. The primary advantage of Private Activity Bond financing is that, due to the tax-exemption, typical borrowing rates are substantially lower than interest rates on conventional borrowings. A Taxable Bond does not satisfy the requirements for a Federally tax-exempt Private Activity Bond, but usually pays interest that is exempt from state income taxation in the state of issue and may confer other benefits. In some localities, ad valorem and sales tax exemptions may be utilized through Private Activity Bond or Taxable Bond financing. See "Taxable Bonds and Other Incentives" herein. Private Activity Bond issues usually are exempt from SEC and blue sky registration. A final important consideration is that the public involvement in the financing can generate substantial community interest in and support for the project financed (the "Project").

How are Bonds Repaid? Bond financing is normally backed solely by the User's credit and any credit enhancement that it furnishes, and sometimes by assets or other security that the User may pledge for this purpose. Users commonly utilize bank letters of credit or other forms of "credit enhancement" such as bond insurance to back Bonds issued for their facilities. Credit enhancement assures that the Bonds can be readily sold and obtain the lowest interest rates, as investors examine and rely upon the credit enhancer's financial strength and not the User's. The User's credit, financial position and operating history must be satisfactory to the credit enhancer, however, in order to obtain this type of financing.

Who Buys the Bonds? Bonds may be publicly sold or privately placed. Banks may choose to buy Bonds, although the I.R.S. results in increased rates on bank-held Private Activity Bonds (except some Section 501(c)(3) Bonds) (see "Bond Placement" herein). Bonds may also be sold to institutional investors and mutual funds, and sometimes individuals. Numerous banks and investment bankers offer Bond placement and underwriting services (see "Procedural Steps — Bond Placement" herein).

Contents of this Memorandum. The remainder of this memorandum will outline who may issue Private Activity Bonds and for what purposes, the limitations and requirements imposed by state and Federal law on Private Activity Bond financing, the typical structures for such transactions, the steps necessary to complete the same, Taxable Bond financing, tax and other incentives, and the role of Bond Counsel.

TYPES OF PROJECTS FINANCEABLE

Manufacturing and Processing Facilities. "Small Issue" Private Activity Bonds may be issued for property and facilities used in the manufacturing, production or processing of personal property, and on-site related and ancillary office and other space (no more than 25% of Bond proceeds may be applied to ancillary uses). At least 70% of the proceeds of "Small Issue Bonds" must be used to finance property directly utilized in the manufacture, production or processing of personal property (the directly-utilized property being referred to as "core manufacturing assets"). Items of property used in the storage or movement of raw materials and inventory, for example, are not core manufacturing assets, but often are functionally related to the manufacturing process. I.R.S. rules sometimes require companies desiring to use bonds for manufacturing facilities to exclude some such portions of their total capital projects from the financing to avoid exceeding the 25% limit on financed assets that are not core manufacturing assets and are only "ancillary." Investments in property used in functions such as storage, manufacturing offices, packaging, and shipping that are related functionally to the manufacture of goods on site and are subordinate (in the sense that the portion of the investment that these functions represent is smaller than the investment in the core manufacturing assets financed) are treated as "ancillary" costs subject to the 25% limit.

Raising of Capital Expenditure Limit to $20,000,000. The $10,000,000 capital expenditure limitation for tax-exempt "small issue" manufacturing facilities Bonds was raised to $20,000,000 effective for Bonds issued on and after January 1, 2007. Although the Bonds themselves may not exceed $10,000,000, the amount of permitted capital expenditure over the limitation period in the same jurisdiction is increased, allowing larger projects to qualify. Use of this form of very attractive tax-exempt financing for manufacturing had declined, since fewer manufacturers could stay within the capital expenditures limitation at a single location. The doubling of the limitation of $20,000,000 has sparked a renaissance of interest in these Bonds.

Section 501(c)(3) Non-Profit Organizations. Private Activity Bonds may be issued to finance Section 501(c)(3) non-profit organizations, such as schools, charities and certain healthcare facilities. Certain tax-exempt Private Activity Bonds for Section 501(c)(3) organizations can be designated as "qualified" for purchase by banks with full tax benefits.

"Exempt" Facilities. Private Activity Bonds also may be issued to provide certain qualifying projects, such as some multifamily rental housing projects, solid waste disposal facilities, hazardous waste facilities, water furnishing facilities, sewage facilities, certain local electric energy facilities, certain local heating or cooling facilities, airport and mass transportation facilities, public educational facilities, green building and sustainable design projects, and certain freight transfer facilities, all free from the Small Issue limitations. Included in this category are airport, dock, wharf and mass-commuting facilities, but although these facilities may be leased to private businesses, they must be owned by a governmental unit.

Redevelopment Projects. Pursuant to a redevelopment plan, an Issuer may issue tax-exempt qualified redevelopment bonds for the acquisition, clearing and refurbishing of real property in certain areas designated as blighted for resale at market value to private parties. The bonds must be secured primarily by taxes of general applicability, including increments of property taxes attributable to increases in valuation by reason of carrying out the redevelopment plan. Such bonds may take the form of "tax allocation bonds" or other tax-increment financing.

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