It’s Time to Consider Private Activity Bonds

As interest rates have climbed over the past two years, companies want options to save on their interest rate costs as they look for ways to invest in their operations. One option is to use a private activity bond—in particular, the tax-exempt industrial revenue bond, or IRB—for new equipment financing.

Compared to a conventional loan, companies may be able to save an average of 20% on interest rate costs. And in a higher interest rate environment, that benefit is much more pronounced. Even if the Federal Reserve begins to decrease rates, it’s unlikely interest rates will reach near-zero levels anytime soon.

Not all banks choose to establish the internal capabilities to offer IRBs. But against the current interest rate backdrop, an IRB can remain a viable solution for qualified businesses for years to come.

Tax-exempt IRBs are debt instruments issued by various governmental units to assist manufacturing companies in financing new capital equipment. Because the governmental authority acts as the “issuer” of the tax-exempt bonds, the interest paid on the financing is not subject to federal (and, in some cases, state) income taxes.

Even though IRBs are issued through local, county, regional or state municipalities, the local government entity does not provide the financing. The government simply serves as a conduit in the financing process to provide the tax benefit.

Instead, your bank serves as the lender and handles all the documentation, booking, funding and servicing. Through its involvement, the bank is able to pass through tax benefits in the form of a reduced interest rate, typically 15% to 25% lower.

Also, IRB financing is structured as a loan. And like a conventional loan, your banker can customize an IRB to your specific needs.

IRBs come with the following eligibility requirements:

• 

  IRBs are intended for new capital equipment acquisitions and not for refinancing of existing equipment.

• 

  The funds must be used by a manufacturer of tangible goods. That is, the company must add value or alter raw materials as part of a finished product manufacturing.

• 

  The size of the tax-exempt bond cannot exceed $10 million. A bank can, however, potentially fund amounts in excess of $10 million as a conventional taxable loan.

• 

  The manufacturing company's capital expenditures cannot be greater than $20 million in the three years prior and three years after the bond date in the jurisdiction where the project is located (this amount excludes tax leases).

With government entities involved, your bankers and advisers will handle all the logistics of working with the municipalities.

Because government entities are part of the approval process, it can take a bit longer to close than a conventional financing deal, and there are some added costs involved. But any incremental time necessary to complete the closing process is more than offset by the interest rate savings.

When we discuss IRBs with clients, a key question often emerges: How can I improve my chances to qualify for an IRB? Because multiple levels of local government can approve and issue an IRB, your bank can seek approval from the authority that has the best understanding and appreciation for your project.

Also, while eligibility specifies manufacturers of tangible goods, keep in mind that “manufacturing” is a broad term and can include everything from industrial manufacturing to food processing.

For companies that are looking to acquire new equipment for manufacturing projects over the next three years, the benefits are well worth exploring.

In an interest rate environment that will likely remain elevated, a tax-exempt IRB is well worth considering for your upcoming capital equipment financing needs. Learn more about the Equipment Finance team and our capabilities.