Tax-Exempt Bank Loans (TEBL) vs.
Industrial Development Bonds (IDB)
Bankers and especially Chief Lending Officers are focused on increasing commercial loans
outstandings. Community Bankers sometimes find it difficult to compete with money center
banks with low cost deposits. The following is a program that can help community bankers as
well as regional bankers compete for manufacturing business clients.
The main questions we try to answer is whether there is a tool to compete for profitable, good
quality, manufacturing credits that use most banking services? Tax exempt bank loans – a
government-sponsored federal program encourages banks to offer lower interest rates on bank
loans for manufacturers. Simply telling manufacturers about this program could save
manufacturers MILLIONS of dollars and make it much more likely they’ll want to work with your
bank.
Most people who are familiar with tax exempt financing for manufacturers refer to it as Industrial
Development Bonds or IDBs. For a number of reasons that we discuss below, IDBs do not work
for manufacturers who are expanding and seeking financing for their projects. A useful
alternative to IDBs for manufacturers is a Tax-Exempt Bank Loan (TEBL)
The truth is in many cases a TEBL is the better option, and one that’s a win-win-win for
economic development organizations, lenders, and manufacturers.
Why a TEBL? Market Potential
In 2015 the U S Treasury allocated $37 Billion among all states divided up by population size. At
the same time, there was an additional $50 billion of unused allocation from previous 2 years so
a total of $87 billion of potentially low cost capital available. Pennsylvania received $1.3 billion in
allocation from the U S Treasury for 2015 and had unused allocation from previous years of
about $3.0 billion for a total of $4.3 Billion in usable allocation. Like most states, PA over the last
5 years has used very little of this allocation. In 2014 PA used only $29 million in allocation to
help manufacturers expand. See attached reports for both State and National statistics.
Why a TEBL?
In short, under a TEBL, a local community bank, regional bank, or money center bank funds the
loan for a manufacturer. The loan is tax exempt, meaning the bank does not have to pay federal
and in most cases state income tax on the interest earned.
Lenders can then pass on these tax savings in the form of an interest rate reduction to
manufacturers.
If you were trying to attract manufacturers to your bank and could offer them financing rates of
up to 40% less than other banks, would that make your job easier? Of course it would! The best
part is that your yield would remain the same as if you did not discount the rate by up to 40%!
Why not an IDB?
Under an IDB the Bond Market funds the debt. This bond can be taxable or tax exempt. Bond
Market transactions are actually more complicated and more costly than TEBLs. In a bond
offering you have to pay:
-
An underwriter
A trustee
A remarketing agent
A letter of credit bank (annual fee)
Upfront fees
The letter of credit cost alone can be 1.5% to 2.0% annually. That’s the same as a lender
offering an interest rate 1.5-2% higher than their competitors.
In a TEBL you do NOT need an underwriter, a trustee, a remarketing agent, or a letter of credit
bank. TEBLs are not as complicated as a bond deal since a TEBL is simply a commercial loan
with a tax-exempt interest rate. Bankers love getting the loan outstanding on the books.
The problem with letters of credit
Banks don’t like offering a letter of credit, a requirement of IDBs. As a bank the problem is the
fee they earn on a letter of credit is fairly low, while they are taking on ALL the credit risk. The
actual bond holder isn’t taking any of the credit risk.
Under recent regulations, banks now have to set aside reserves to cover these letters of credit –
another blow to a bank’s profitability for a letter of credit issuance.
Finally, banks make money converting deposits into loans. But a letter of credit just locks up a
bank’s cash, making it an unprofitable and unattractive option for them.
For all these reasons IDBs are increasingly unworkable to finance a manufacturers’ expansion.
Who’s Helping Manufacturers?
That’s the dilemma. No One Is! Most Capital Market Bankers know about tax exempt financing
but aren’t talking to manufacturers about it. Why? Because Capital Market Bankers like larger
loans, ($30 to $300 million) and by law a tax exempt loan to a manufacturer cannot exceed $10
million. On the other hand, most Commercial Lenders are very interested in loans of $10 million
or less. Unfortunately most commercial lenders are not aware that they can even offer a
manufacturer a tax exempt loan. The result is no one, neither the capital market bankers nor the
commercial lenders are telling the manufacturers about the opportunities available with tax
exempt financing.
The math of a tax-exempt bank loan
On a traditional commercial loan, a bank charges, say, 4% interest on that loan. On a
$1,000,000 loan for one year, the bank earns $40,000 in interest (of course a regular loan would
amortize over a much longer period, like 25 years). If they’re paying 35% in taxes, from that
$40,000 they pay $14,000 in taxes and keep $26,000 as Net Interest Earned.
With a TEBL, the bank doesn’t pay any income taxes on the interest they receive, so as long as
they can still make that $26,000, they’re just as happy. The manufacturer is MUCH happier as
they’re saving a lot of money. The interest rate they need to charge on that $1,000,000 to make
$26,000 is, of course, 2.6%. Because of the lower interest rate, the debt service coverage ratio
the bank uses improves and makes for a better credit quality.
Traditional
Commercial Loan
Tax Exempt
Bank Loan
Loan Amount
Interest Rate
Interest
Earned
$
1,000,000.00
4.00%
$ 1,000,000.00
2.60%
$
40,000.00
$
26,000.00
Taxes Paid
$
14,000.00
$
-
Net Profit
$
26,000.00
$
26,000.00
Manufacturer's
Savings
$
-
$
14,000.00
And remember, that’s only for a single year – which would never be the case with a
manufacturing loan like this. Over a typical 25 year loan period, a manufacturer who borrows
$10 million is looking at roughly $2.7 MILLION dollars in savings.
Why aren’t banks offering TEBLs?
If the bank makes the same amount of money and can offer a much more attractive interest rate
to a manufacturer, why aren’t they offering more of them?
Turns out most banks have no idea that the bank can offer a manufacturer a tax exempt loan.
In the meantime all of that tax exempt financing money goes unused. (See CDFA 2013 report
and PA DCED 2014 Allocation report) Manufacturers are forced to pay higher rates of interest
for no good reason. Banks and Economic Development organizations are losing out on an
exciting competitive advantage they could be using to attract new business.
What can we do?
Education is key. Starting at the state and local level including bankers associations and
economic development agencies. One to two hour workshops along with commercial bankers .
If the American Banker Association or a group of State Banking Associations started introducing
training programs for commercial lenders, the program would take off because it truly is a winwin for bankers and manufacturers.
TEBLs vs. IDBs (Summary)
Tax Exempt Bank Loan (TEBL)
Industrial Revenue Bond (IDB)
 Funded by commercial banks.
 Funded by Bond Market.
 Less complicated does not
 More complicated requires
require trustee,
trustee, remarketing agent, and
 Remarketing agent, underwriter.
underwriter.
 Lower transactional
 Higher transactional cost.
cost
.
 Capital Markets not interested
 Commercial bankers welcome
in smaller transactions, prefer
smaller transactions $750,000 to
transactions over $30 million.
$10 million.
 Bond market requires a letter of
 Banks no longer view letters of
credit or transaction will not
credit as
close.
 Profitable and would rather not
issue.
 New regulations require banks
to set aside reserves for letters
of credit.
 No national banking association
providing
 Education on TEBL for
Commercial lenders.