CDFA Spotlight: Composite Bonds Lower Borrower Fees By Stan Provus

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This article explores how composite bonds can lower borrower fees.

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With composite bonds, small and medium-sized Small Issue ( IDBs for manufacturers) and 501( c)(3) borrowers are grouped together into a single bond issuance in which up-front and annual costs are shared, making the financing more cost-effective regardless of the individual project size. Some issuers group together only Small Issue borrowers, while others include both Small Issue and 501(c)(3) borrowers in a single issuance. Savings are also realized by using highly standardized bond documentation. This document standardization, however, does not compromise flexibility in such areas as principal amortization. Although composite bond issues aggregate several projects together and are marketed jointly through a single Official Statement or Private Placement Memorandum, each project is assigned its own series of bonds -- there is no cross liability among projects or borrowers.

Composite bond programs in Pennsylvania (Pennsylvania Economic Development Financing Authority) and Florida (Florida Development Finance Corporation (FDFC), an operating affiliate of Enterprise Florida, Inc.) employ a two-tier bond structure. This article provides an overview of how the Florida program works. In the Florida program, the FDFC selected two lead banks (SunTrust and First Union) to act as the Master Letter of Credit Banks to provide a source of homogeneous credit enhancement for their composite issues. The Florida program uses a low-floater or weekly variable rate demand obligation interest rate structure. Only one of these banks, however, is selected to provide the Master or “Wrap” letters of credit for each composite issue. This selection is typically based on which of the two banks further supports a given issue by providing the greatest second tier of credit supports through “Participating Bank” letters of Credit (LOCs).

The majority of banks in the state can participate in the program by providing Participating Bank letters of credit. Participating Bank LOCs assume credit risk for projects they secure, while the Master Letter of Credit provider’s risk is limited to defaults by Participating Banks on their LOC obligations. The bond trustee will draw on the direct pay Master Letter of Credit to pay principal and interest for each series of bonds in Florida’s composite issues. The interest and principal draws must be reimbursed by the borrower or, if necessary, by the Participating Bank, who provides a standby LOC. Thus, the two-tier bond and cost structure.

The FDFC’s double-tier bond and cost structure is best illustrated by example. Assume a $6 million composite issue, under which there are six projects (projects A-F) of $1 million each. Projects A-C are supported by Participating Bank LOCs from SunTrust Bank. Projects D and E are supported by First Union LOCs and project F is secured by an LOC from another Participating Bank in the state. Since SunTrust brings the greatest volume ($3 million) of Participating Bank LOCs to this issue, SunTrust is selected to provide the Master Letter of Credit for the issue. Because SunTrust does not need to “wrap” its own Participating Bank LOCs, the structure for these three borrowers will be single tier. The structure for the other three borrowers will be double tier bonds—standby participating Bank LOCs wrapped by a SunTrust Master LOC.

In the Composite Bond double tier structure, single tier borrowers pay somewhat lower fees, since they do not have to pay any annual Master LOC fees. However, both single and double tier borrowers benefit from lower up-front (bond counsel, trustee, placement agent) fees as well as certain annual costs such as the annual trustee and remarketing agent fees. This cost reduction occurs as a result of “sharing” these costs and secondly, by aggressively negotiating these fees with industry providers. In this writer’s view, the Florida program can save the $1-$2 million borrower about 2%-2.5% on up-front fees compared to alternative stand-alone issues and several thousand a year on annual trustee and remarketing agent fees.

Composite bond structures give community or unrated banks the opportunity to participate in tax-exempt financing for their customers that would not otherwise be possible. The double-tier structure enables them to serve as Participating Bank LOC providers, while enabling their customers to access the lowest possible tax-exempt interest rates.

Issuers face several challenges putting together composite issues. Timing is one problem. It may take more time to put together composite issues because several projects must be ready to go at the same time to reach minimum volume size thresholds—the dollar amount at which composite issues become cost effective for borrowers relative to single project, stand-alone issues. Some issuers overcome this problem by advertising quarterly issuances throughout the year so borrowers coming in at the beginning of the cycle do not have to wait more than 12 weeks for funding. Others, such as the FDFC, have negotiated highly competitive fee structures that make composite issues as small as $4 million cost effective.

We would like to hear from our readers on topics that would be of interest for future articles. In addition, we welcome contributed articles from issuers and industry professionals. Please contact me at 501-760-6000 or provus@cdfa.net

This article is intended to provide accurate and authoritative information in regard to the subject matter covered. The author and CDFA are not herein engaged in rendering legal, accounting or other professional services, nor does it intend that the material included herein be relied upon to the exclusion of outside counsel. CDFA is not responsible for the accuracy of the information provided in this fact sheet. The information provided has been collected from a variety of sources. Those seeking to conduct complex financial deals using the tools mentioned in this document are encouraged to seek the advice of a skilled legal/consulting professional.