Common reserve bond funds spurring investment

Bond issuers are branching out into establishing common reserve bond funds to spur economic growth and generate income.

"The whole goal of the bond fund was, 'how can we further extend economic development,' said Craig Teamer, director of finance and special projects for the Toledo-Lucas County Port Authority.

"If you're looking to amplify some additional investment in economic development, a bond fund could be considered, and it could be a revenue stream. There are fees that come with that."

The comments came during a webinar produced by the Council of Development Finance Agencies that sheds light on a tool that could come in handy for some issuers.

The Port Authority runs the Port of Toledo and two local airports. It started a bond fund in 1988 that now carries an A rating from S&P Global Ratings and finances projects ranging from $2 million to $25 million. The port also administers SBA loan programs for the state.

About 40% of its loans are tailored to tax-exempt entities including hospitals, nonprofits, water and sewer projects, roads and bridges. The port also issues its own credits for airport and seaport projects.

Evidence of any national trends that mimic what's happening in Ohio are unclear, but the current economic conditions suggest a fertile environment for setting up a common reserve fund.

"In light of the recent interest rate and tight lending environment, it has been absolutely essential in assisting projects get across the finish line," said Philip Angelo, director of public finance for Huntington Capital Markets.

Even as the federal reserve ratchets down its rates, the higher numbers have issuers dusting off old techniques for cashing in, including arbitrage tactics.

Arbitrage allows issuers to take advantage of the difference between the rates of the issuance of bonds at a lower tax-exempt rate and investment of the proceeds in obligations that pay higher taxable rates.

Arbitrage is closely scrutinized by the Internal Revenue Service which raises risk for the issuer. Establishing a common reserve fund can also be fraught with financial peril.

"In order to achieve an investment grade credit rated fund, an issuer will need to make a significant investment of both time and funds," said Colin Kalvas, partner at Bricker Graydon

"That investment will include marshalling the necessary reserves, engaging the right outside partners and professionals, getting the necessary approvals, and structuring the program."

To avoid taking on too much risk the port steers around some deals. "No speculative real estate," said Teamer. "That includes retail, hotels and multi-tenant real estate projects."

Common reserve funds easily fit into capital stacks for certain projects and can be perceived as competition for banks.

"We're very intentional that when we present that we are not competing against banks," said Teamer. "We are trying to see how we can complement the commercial lenders or other entities out there."

Issuers performing financing like banks are advised to mimic their behavior when it comes to collateral, including getting first lien priority on property as well as doing plenty of due diligence.

"In a typical commercial lending transaction, a bank is going to want to run some traps on who it is that they're giving money to," said Kalvas. "If you're operating one of these credit enhanced common bond programs, you'll want to do a similar type of diligence on your borrower."

Kalvas recommends examining federal income tax filings if available, background checks and a litigation search.

Jumping through the hoops can help issuers who are focused on spurring regional development that is currently being blocked by higher interest rates.

"Development finance agencies are created to help spur investment and growth, particularly where more traditional sources of capital are not available," said Kalvas. "Common reserve bond fund programs can provide capital to worthy projects that keep economies running."