Introduction to Tax-Exempt 501(c)(3)
Bonds
William P. Scott, Esq.
Nixon Peabody LLP
Introduction to Tax-Exempt 501(c)(3) Bonds
• Legal Basis
– State Law authorizing issuance
• State Tax Exemption – Kentucky v. Davis case
– Section 145 of Internal Revenue Code
• 95% Test (no activities producing UBIT)
Introduction to Tax-Exempt 501(c)(3) Bonds
• Bond Financing Documents
– Trust Indenture
• Form of Bond
– Redemption Provisions
• Grant of Security
• Trustee-held Funds
– Purposes: e.g. construction, debt service and reserves
– Investment of Funds
• Defaults and Remedies
• Defeasance (i.e. refunding)
Introduction to Tax-Exempt 501(c)(3) Bonds
• Bond Interest Rates
– Fixed Rate
– Variable Rate Demand Bonds
• Weekly or Daily rate changes
• Optional Tender by Bondholders
– Commercial Paper (or Flexible) Rates
• Interest pricing on each individual bond
– Multi-Annual or Term Rate
– Mandatory Tenders of Bonds (when they occur)
– Role of Remarketing Agent or Auction Agent
Introduction to Tax-Exempt 501(c)(3) Bonds
• Bond Interest Rates (cont’d)
– Auction Rate (more to come in panel discussion)
• Auction Process
• Credit Enhancement
– Letter of Credit
• Confirming letter of credit
– Bond Insurance
• Rating downgrades
• Liquidity Facility
– Standby Bond Purchase Agreement
– Used when Credit Enhancer doesn’t cover tendered bonds
– Relationship between Credit and Liquidity Providers
Introduction to Tax-Exempt 501(c)(3) Bonds
• Interest Rate Swaps
– Purpose
– Documentation
– Termination Payments
• Mark-to-market effect on financial statements
– Effect on financial covenants
• Entering into swap
• Financial ratio covenants
– Insurance of Swap
Introduction to Tax-Exempt 501(c)(3) Bonds
• Financing Agreement with Borrower
– May be loan, lease or sale agreement
– In Mass., is combined with Trust Indenture
• and called a Loan and Trust Agreement
– Borrower agrees to pay debt service on Bonds
Introduction to Tax-Exempt 501(c)(3) Bonds
• Master Trust Indenture
– Purposes:
• Repeat borrowings with parity security
• Pooling credit strength of Obligated Group
– Joint and several liability
– The Obligated Group uses the Master Indenture to issue
Notes and Guaranties
– In a bond financing, the Note (or Guaranty) goes to the
Bond Trustee under the Bond Indenture.
Introduction to Tax-Exempt 501(c)(3) Bonds
• Timing of a Bond Transaction
– Selection of Financing Team
•
•
•
•
•
•
•
Underwriter
Financial Advisor?
Borrower Counsel
Bond Counsel
Selection of Issuer?
Credit Enhancement?
Trustee
Introduction to Tax-Exempt 501(c)(3) Bonds
• Timing of a Bond Transaction (cont’d)
– Determination of Financing Structure
• Security and covenants
–
–
–
–
Due Diligence
TEFRA Approval (Public Hearing, Elected Official signs)
Borrower’s board approval
Preliminary Official Statement (POS)
• Inclusion of financial statements, agreed-upon procedures ltr.
Introduction to Tax-Exempt 501(c)(3) Bonds
• Timing of a Bond Transaction (cont’d)
–
–
–
–
–
Marketing of Bonds
Bond Purchase Agreement (Issuer Approval)
Final Official Statement
Closing
Post-closing
• Reporting required under financing documents
• Continuing Disclosure – SEC Rule 15c2-12
• Arbitrage Rebate (unless exempt)