Federal Tax Credit Bonds in 10 Easy Minutes Session A2: New Trends in Financing AASHTO Annual Meetin

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Federal Tax Credit Bonds--in 10 Easy
Minutes !!!Session A2 New Trends in
Financing AASHTO Annual Meeting September 30,
2007David Seltzer
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• The 64 billion Question How to augment
  traditional sources to fund large capital
  projects?

? More Direct Federal Grants? Problem
Inadequate obligation authority. ? Low
interest SIB Loans? Problem Requires
Capitalization Grants. ? Federal credit
program (with loans at Treasury rate)?
Problem Not deep enough PV subsidy (15). ?
Tax-Exempt Private Activity Bonds? Problem
Not deep enough PV subsidy (15) ?
Investment Tax Credit for Project Sponsors?
Problem Thin and illiquid market high return
required.
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A newly-emerging approach Tax Credit Bonds

• A Tax Credit Bond (TCB) is a hybrid debt
  instrument
• Cash Return of Principal at maturity (balloon
  payment), payable by the project sponsors
  revenue commitments
• Non-Cash Return through Tax Credits annual (or
  quarterly), provided by the Government in lieu
  of interest payments

Principal Repayment
Annual Tax Credits
Key Point Investors receive tax credits instead
of cash interest payments,greatly reducing the
borrowers annual cost.
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General Features of Tax Credit Bonds

• Investors receive quarterly Federal tax credits
  in lieu of cash interest
• 0 borrowing for rail project sponsors.
• Bond term matches assets economic life
• A 25-year term produces an effective federal
  subsidy of 75 (in present value terms).
• States need to identify revenue stream to make
  annual deposits sufficient to repay bond
  principal at maturity
• Represents a 25 local match in present value
  terms.
• Bonds are not backed by U.S. Treasury
• They are limited obligations of the issuer backed
  by the pledge of accumulated sinking fund
  investments.
• Fractional budgetary scoring
  
• Scored cost is 30 - 40 of principal amount.

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Tax Credit Bond Mechanics
Investor Perspective (25-year 10 million TCB
with 5.5 credit rate) rounded for simplicity
Bond Principal 10 million repaid at
maturity (NPV 2.5 million)
25-Year Tax Credit Stream annual credits
550,000 (NPV 7.5 million)
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Tax Credit Bond Mechanics
Project Sponsor Perspective (25-year 10 million
TCB with 5.5 SF investment rate)(rounded for
simplicity)
Bond Proceeds 10 million received at issuance
25-Year Matching Contributions annual sinking
fund deposits 195,000 (NPV 2.5 million)
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How does the Issuer repay the Bond at maturity?
Sinking Fund Growth (25-year 1 billion TCB with
195,000 annual deposits earning 5.5)
Cumulative Earnings 5.12 million
Cumulative Deposits 4.88 million
Annual Deposits of 195,000 /year
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Comparison with Conventional Financing

• The Tax Credit Bond approach can reduce debt
  service costs to nearly one-quarter that of
  conventional tax-exempt financing.

Assumptions ? 10 million project ?
25-year level debt service repayment stream
? 4.5 tax-exempt borrowing rate 5.5 tax
credit rate ? 5.5 sinking fund
reinvestment rate
Annual Debt Service
Tax-Exempt Bond annual debt service payments
675k
Annual Savings
Tax Credit Bond annual sinking fund contributions
195k
2008
2033
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Establishing a Central National Issuer Pros
Cons

• Advantages
• Broaden the universe of investors speed market
  development.
• Minimize credit risk through nationwide
  diversification.
• Reduce transaction costs through uniformity
  volume.
• Facilitate Federal Oversight.
• Disadvantages
• If the issuer looks too much like a federal
  entity, borrowing will be scored at 100 as
  federal spending.
• Heightens Treasury concerns about implied Federal
  guarantees.
• Some loss of state/local autonomy.

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Long-Term Tax Credit Bond PrecedentsQZABs and
CREBs

• Qualified Zone Academy Bonds (QZABs)
• Authorized at 400 million/year since 1998 (3.2
  billion to date).
• To subsidize improvements to public schools in
  lower-income communities.
• Allocated by formula among the states
  approximately 2.0 billion issued to date.
• The Administration supports reauthorization
  through 2007 (another 800 million).
• Clean Renewable Energy Bonds (CREBs)
• Authorized in the 2005 energy bill at 800
  million during 2006-2007.
• To help non-profit utilities finance renewable
  energy projects.
• QZABS and CREBs both involve local issuers

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Federal Policy Advantages of TCBs as a form of
Public Subsidy

• Provides Deep Capital Subsidy The 75 P.V.
  Benefit approaches subsidy level of traditional
  grant programs.
• Avoids Direct Federal Spending Uses the
  Internal Revenue Code, not General Fund or
  Highway Trust Fund, to subsidize the capital
  costs.
• Limited Federal Staffing Needs Simpler to
  administer than a grant program.
• No Federal Liability Investors in the bonds
  will bear any risk of default, not the U.S.
  Treasury.
• Budget Leveraging Each 1 billion of investment
  (and the resulting public benefits) has a
  budgetary cost of 350 million (tax
  expenditures).