The Build America Bond Program provides new opportunities for financing. Eichner & Norris PLLC, a law firm from Washington DC describes the potential as follows:
In the current credit enhancement environment, many housing borrowers have been turning more often to mortgage insurance provided by the various Federal Housing Administration (FHA) programs, including Sections 223(f), 221(d)(4), 221(d)(3) and 232 of the National Housing Act. Hospital borrowers have frequently been using mortgage insurance provided by FHA under Section 242 to provide credit support for their borrowings. Governmental entities that own apartment projects have often used an FHA-insured mortgage loan, wrapped with securities from the Government National Mortgage Association (GNMA), to secure a tax-exempt bond issue, resulting in a lower interest rate.
Recently, housing and hospital borrowers have abandoned the tax-exempt market and instead have opted to sell their FHA-insured mortgages wrapped with securities from GNMA in the taxable market. This has allowed them to avoid the significant upfront financing costs of a traditional tax-exempt bond financing, “negative arbitrage,” caused by short-term investment rates substantially lower than long-term tax-exempt bond coupons and other structural problems in rating tax-exempt bonds backed by FHA insurance, while simultaneously financing at relatively attractive taxable rates.
The American Recovery and Reinvestment ACT of 2009 (ARRA) introduced Build America Bonds (BABs), which creates a new opportunity for governmental hospital and housing borrowers to achieve even greater borrowing cost savings than under a tax-exempt only financing through the issuance of taxable Build America Bonds, backed by a pass-through certificate or credit enhancement issued by GNMA.
THE BUILD AMERICA BOND OPPORTUNITY
One type of BAB that was introduced by ARRA permits issuers of governmental bonds to elect to have interest on their bonds included in gross income for federal income tax purposes and, in return, receive, contemporaneously with the payments of interest on the taxable bonds from the U.S. Treasury, 35% of the interest payable on the BAB. These BABs, called “direct subsidy BABs,” are limited to new construction or acquisition financings. The IRS issued Notice 2009-26 in April to provide guidance on how the payment of this refundable credit will be implemented. Neither private activity bonds, nor qualified 501(c)(3) bonds, are eligible to elect to be treated as BABs. In addition, ARRA currently requires that BABs must be issued by December 31, 2010 to be eligible for the subsidy.
HOUSING BABS FOR NEW CONSTRUCTION AND ACQUISITIONS
We are working with several governmental borrowers who are looking at issuing BABs to finance the construction or acquisition and rehabilitation of apartment buildings that they will own and securing the BABs with FHA mortgage insurance and GNMA securities. Using BABs with credit enhancement from Freddie Mac or Fannie Mae also is possible. After application of the subsidy payments on the BABs, these taxable bonds can be structured to provide the Issuer, without any additional upfront costs, a lower net effective cost of borrowing, an effective cost of funds to the Issuer that is at a lower net rate than available in the tax-exempt market that would otherwise be produced through traditional tax-exempt bond financing.
SAVINGS ESTIMATES ON HOUSING BABS IN TODAY’S MARKETPLACE
In the current market, using BABs secured by agency-backed securities for housing may provide a significant economic advantage as summarized below:
FHA 221(d)(4)/GNMA EXECUTION
TAXABLE BABs ISSUE
Est. Rate 6.75%
(less BAB subsidy) (2.36)%
Net Interest Cost 4.39%
FHA 223(f)/GNMA EXECUTION
TAXABLE BABs ISSUE
Est. Bond Coupon 5.20%
(less BAB subsidy) (1.82)%
Net Interest Cost 3.38%
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