Recent Legislation Permits the Federal Home Loan Bank to Guarantee Tax-Exempt Bonds

On July 30, 2008, President Bush signed into law the Housing and Economic Recovery Act of 2008 (the "Act").  The Act amends several federal tax laws applicable to tax-exempt bonds, including the laws regarding the tax-exempt status of bonds guaranteed by a Federal Home Loan Bank.  Previously, the interest on most bonds guaranteed by a Federal Home Loan Bank was not exempt from taxation.  However, under the Act, the guarantee from a Federal Home Loan Bank no longer disqualifies bonds from being eligible for treatment as tax-exempt bonds.  Ice Miller LLP would like to share how we believe this new development could positively impact member banks that have not been highly rated and borrowers who have relationships with such banks.

How the Act Affects You

As you are likely aware, various governmental issuers support economic development and charitable organizations by loaning the proceeds of their tax-exempt bonds to qualified borrowers, including 501(c)(3) organizations and manufacturers.  In these "conduit bond" transactions, the borrower serves as the underlying source of repayment for the bonds, and, in turn, the rating on the bonds hinges upon the borrower's creditworthiness.  Because many 501(c)(3) organizations and smaller businesses are not highly rated entities, these borrowers will often boost the rating on the bonds by securing the bonds with a letter of credit of a highly rated bank.  The rating of the letter of credit bank becomes the basis for the rating on the bonds, and the borrower achieves an increase in the marketability of the bonds and a decrease in their costs of borrowing. As a consequence, many smaller member banks are not able to provide this credit enhancement without the guarantee of the member bank's credit by a Federal Home Loan Bank.  Previously, the Federal Home Loan Bank's guarantee was only permitted with respect to multi-family housing bonds.

The new amendment generally provides that a Federal Home Loan Bank's guarantee does not disqualify a bond from tax exemption. This will allow member banks with lower ratings to use the guarantee of the Federal Home Loan Bank for any tax-exempt bonds.  In doing so, the bank essentially replaces its rating with the Aaa/AA+ rating of the Federal Home Loan Bank.  The result will be lower overall cost of borrowing.  Smaller member b anks are now able to compete with larger banks due to the ability to offer highly-rated credit enhancement via a Federal Home Loan Bank guarantee on many types of projects like economic development. 

Requirements

The Federal Home Loan Bank of Chicago provides letters of credit for the following types of transactions:

• Housing Projects, including multifamily homes, assisted living facilities and nursing homes.  The Federal Home Loan Bank does not have any income-level or location requirements for housing projects.
  
  
• Economic Development Projects , including commercial, industrial, manufacturing, social service, and public facility projects and activities, as well as public or private infrastructure projects, such as roads, utilities, and sewers.  These projects must benefit targeted beneficiaries, which are determined by the geographical area in which a project is located ("Geographically Defined Beneficiaries") or by the individuals who benefit from a project as employees or service recipients ("Individual Beneficiaries").  Eligible Geographically Defined Beneficiaries include, for example, neighborhoods with a median income at or below a targeted income level, rural or urban Empowerment Zones or rural or urban Enterprise Communities.  Eligible Individual Beneficiaries include individuals and families of a targeted income level that will benefit from the jobs created, or the services provided, by the project.  Certain small businesses are also considered targeted beneficiaries.

Illinois banks must be or become a member of the Federal Home Loan Bank of Chicago to be eligible for a Federal Home Loan Bank of Chicago letter of credit. 

Ice Miller LLP is a full service law firm with offices in Chicago and DuPage County, Illinois; Indianapolis, Indiana; and Washington, D.C.  For additional information, please contact James Snyder (james.snyder@icemiller.com; 312-726-7127) or David Hight (david.hight@icemiller.com; 312-726-6721).

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice.  The reader must consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.