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Recovery Zone: Bond Financing Under the Stimulus Law
THE FEDERAL RESPONSE TO THE RECESSION
The Stimulus legislation signed by the President on February 17, 2009 creates new categories of bonds available to local governments. These Bonds are authorized for issuance only in 2009 and 2010. Of particular interest to Georgia local governments are the new "Recovery Zone Economic Development Bonds" and "Recovery Zone Facility Bonds." Georgia has received a total amount of allocations (permissions to issue) of $335,785,000 of Recovery Zone Economic Development Bonds and $533,677,000 of Recovery Zone Facility Bonds. Most of the Georgia counties and the cities of Atlanta and Savannah (the counties and these two cities being referred to herein as "local governments") have received an individual allocation of these permissions to issue these bonds, and the amounts so allocated can be found here.
The Stimulus also has made tax-exempt financing more attractive to banks and other financial institutions through changes in the "bank qualification" and "de minimus" rules. These changes enhance the marketability of tax-exempt financing, which should make such financing more available, particularly from banks, and reduce the interest rates that apply.
All of these changes are designed to get money flowing to publicly-sponsored projects that will stimulate the economy.
RECOVERY ZONE BONDS
What Can Be a Recovery Zone? Georgia's local governments may issue Recovery Zone bonds for projects located in, or in some cases merely affecting, a "Recovery Zone." The designation of an area as a Recovery Zone can be made by each county commission or city council in any reasonable manner as it shall determine in good faith. Recovery Zones may include any area designated by the local government as having significant poverty, unemployment, high rate of home foreclosures or general distress (including by reason of the closure or realignment of military installations). Designated Empowerment Zones and Renewal Communities automatically are included as Recovery Zones.
Who Issues Recovery Zone Bonds? Although local governments have received the allocations to issue these Recovery Zone Bonds, the Bonds may be issued either by the local governments, or on behalf of the local governments by duly constituted authorities (such as building authorities or development authorities) if amounts are sub-allocated to projects sponsored by those authorities.
Governmental-Use Recovery Zone Economic Development Bonds. Recovery Zone Economic Development Bonds are available to finance a broad array of governmental-use projects that promote development or other economic activity in a Recovery Zone. For example, a project financed by a Recovery Zone Economic Development Bond could consist of capital expenditures for public infrastructure or construction of public facilities whether or not located in a Recovery Zone but that promote development or other economic activity in a Recovery Zone. Alternatively, Recovery Zone Economic Development Bonds may fund virtually any capital expenditures for governmental-use property in a Recovery Zone if the financed property promotes development or other economic activity. The expenditures financed must be new expenditures, or expenditures made after February 17, 2009 and after a declaration of official intent to finance made in compliance with the IRS's "reimbursement rules."
Recovery Zone Economic Development Bonds are a special category of "Build America Bonds" that carry an annual federal income tax credit of 45% of the interest paid on the bonds (rather than the 35% that applies to Build America Bonds generally). An investor in a Recovery Zone Economic Development Bond will pay income taxes on the interest that the financing earns. The local government will retain for itself the federal income tax credit on Recovery Zone Economic Development Bond financing that it enters into. A local government will receive the amount of the credit semi-annually as cash from the federal treasury. The cash refund will offset 45% of the interest that the local government pays.
Although these instruments are generally referred to as "bonds," the same rules can apply to loans or lease-purchases obtained from banks or other financing sources.
Private Activity Recovery Zone Facility Bonds. Tax-exempt Recovery Zone Facility Bonds may be issued to provide funds used principally (at least 95% of the net proceeds) for the construction, reconstruction, renovation or acquisition (not refinancing) of almost any private-use property substantially all of the use of which is in a Recovery Zone. The property financed with a Recovery Zone Facility Bond must be actively used in a business operating in the Recovery Zone (regardless of whether the property is privately-owned or governmentally-owned). The expenditures financed must be made after the designation of the Recovery Zone. The original use of the property financed in the Recovery Zone must commence with the borrower (existing property located in the Recovery Zone cannot be refinanced unless it is being renovated at a cost of at least 100% of its basis within two years).
Qualifying projects can include any type of property, except for residential property, golf courses, country clubs, massage parlors, hot-tub facilities, suntan facilities, racetracks, gambling facilities and liquor stores.
In effect, each local government will have the ability to determine what private projects will best aid in the alleviation of economic distress in its jurisdiction and to sub-allocate to such projects the authority granted to it to issue Recovery Zone Facility Bonds.
Sub-Allocations and Reallocation of Recovery Zone Bond Allocations. As described above, the local government to which an allocation has been given may sub-allocate the amounts to qualifying projects within or attributable to its jurisdiction as it sees fit. If a project or facility will be attributable to Recovery Zones in more than one jurisdiction, it may be possible for two or more local governments to "pool" allocations for that project or facility, although further guidance may be required on this point. In accordance with rules being developed by the Georgia State Financing and Investment Commission in conjunction with the Department of Community Affairs, local governments may waive any portion of the allocations they receive, in which event the amounts will be reallocated by the State in accordance with those rules.
Davis-Bacon Act. Federal Davis-Bacon Act wage standards apply to all projects financed with Recovery Zone Economic Development or Facility Bonds.
METHODS OF ISSUANCE OF RECOVERY ZONE BONDS
None of the changes worked in the Stimulus change Georgia law on how local governments and authorities incur debt and borrow. Local governments must pass a voter referendum to issue general obligation debt, although the authorization of debt can be included in a special purpose local option sales tax ("SPLOST") referendum. Local governments can issue revenue bonds for particular types of undertakings without a referendum under provisions of Georgia law, and sometimes can finance their projects through revenue bonds issued by an appropriate authority. A referendum is not required for revenue bonds. The other principal form of financing used by local governments is multiyear lease-purchase financing, which can either be placed or negotiated privately with a bank or other financing institution, or sold in the public debt markets as certificates of participation. Lease-purchase financing involves having facilities or equipment constructed or acquired for the local government and leased to the local government with an option to purchase. The lease terms reflect an underlying financing, and the local government purchases the financed property through the course of annually appropriating its lease payments.
Any of these principal types of financing -- general obligation debt, revenue bonds or lease-purchase financing -- can be used to issue "Recovery Zone Bonds," and can either be sold in the public debt markets or be placed or negotiated with banks or other financing institutions. As a result, all of these forms of financing are affected by the provisions of the Stimulus that will whet the appetite of banks to extend such financing.
ENHANCED MARKETABILITY OF PUBLIC FINANCING
Changes made by the Stimulus improve the tax treatment banks receive when they make tax-exempt loans, whether for Recovery Zone projects or otherwise. Under prior law, banks could not deduct for federal income purposes any of their costs allocated to funding tax-exempt bonds or loans, unless a limited exception applied. Although the interest earned by a bank on a financing to a local government was exempt from federal income, the bank could not offer as low an interest rate as the tax-exemption would seem to dictate because of the lost deduction for the bank's cost of obtaining the funds for the loan. There has long been an exception of this loss-of-deduction rule for loans or bonds that meet the requirements for treatment as "qualified tax-exempt obligations," generally referred to "bank-qualified" obligations. This exception applied when the financing was obtained by a "small issuer," for example a local government that, together with the authorities organized under it, did not expect to issue more than $10 million of governmental or nonprofit 501(c)(3) financing during calendar year in which the financing was closed. Local governments not involved in the closing of more than $10 million of such financing in a particular year could place their financing with a bank, either through the private placement of bonds or a tax-exempt loan, without entering the often more costly bond market. If the financing was "bank qualified," then a bank could deduct 80% of the allocated cost of funding the financing and banks, as a result, could offer attractive tax-exempt interest rates.
The Stimulus increases this $10 million limit on bank qualification to $30 million for financing closed during 2009 and 2010. Moreover, this $30 million limit is applied separately to 501(c)(3) nonprofit organizations that may use bonds or loans issued by a local government authority, rather than attributing such amounts to the local government. As a result, local governments should have much greater access to tax-exempt bank-qualified financing.
An additional change -- the extension of the de minimus rule to banks -- may provide the equivalent of bank-qualified financing even to local governments that would exceed the expanded $30 million limit for bank-qualified financing. The de minimus rule now allows banks to deduct 80% of their allocated costs of funding new governmental and private activity tax-exempt financings closed in 2009 and 2010, so long as the total of such financings that the bank places on its books closed in those two years does not exceed 2% of the bank's total assets.
The effect of these rules will be to greatly enhance the ability of banks to provide bond financing for public financing in all categories, and to improve the interest rates that they can offer.
The changes to federal laws that have been passed in an effort to address the current nationwide economic difficulties provide greater access to local governments for financing and present new tools and choices. These federal efforts should result in broader and more varied markets for local government debt, more interest on the part of banks in extending such financing, and lower total borrowing costs for local governments.
In particular, the local governments that have received allocations for Recovery Zone Bonds will be well served to locate appropriate governmental-use and private-use projects, and issue this alternative debt in 2009 or 2010, before the program expires.
If we can assist you in these matters, you may contact:
James P. Monacell 404-815-3555
Andrew Patterson 404-815-3708
Benjamin J. Brooks 404-815-3705
Drew M. Slone 404-815-3706