Update on the Tribal Bonds Provisions in the Recovery Act
On February 17, 2009, President Obama signed into law the American Recovery and Reinvestment Act of 2009 (ARRA), which allows Indian tribal governments to issue Tribal Economic Development Bonds, Build America Bonds, and Qualified School Construction Bonds. It also raised the annual dollar limitation on so-called “bank qualified debt.” All four provisions present attractive project financing opportunities for Indian tribes, although some are only available this year. What follows is an overview of these provisions, an update on the latest allocations, and a reminder about applicable deadlines.
Tribal Economic Development Bond
Under ARRA, Indian tribal governments are allowed to issue economic development bonds without having to satisfy the “essential governmental function” test, which had previously limited issuance of tribal tax-exempt bonds to functions customarily performed by state and local governments. However, this new bond issuing authority is not unlimited. ARRA contained a $2 billion aggregate volume cap that was allocated among tribal governments applying for bond authority in two tranches.
The first tranche was announced on September 15, 2009. The first $1 billion in bonding authority was allocated to 58 different projects maintained by at least 45 Indian tribes. The projects varied, and included financing for facilities such as the following:
- tourism facilities, such as hotels and RV parks
- commercial retail facilities
- low-income housing
The dollar amounts of bonding authority ranged from slightly less than $1 million to $22.5 million. (The allocation schedule can be found at http://www.irs.gov/pub/irs-tege/tedb_allocation_schedule-2.pdf.) Bonding authority allocated during the first tranche needs to be utilized on or before December 31, 2010.
The second tranche was announced on February 11, 2010. This $1 billion in bonding authority was allocated to 76 different projects benefiting at least 66 Indian tribes. Again, the size of the projects varied considerably, as the amounts of bonding authority ranged from $1.8 million to $30 million. (The allocation schedule can be found at http://www.irs.gov/pub/irs-tege/tedb_allocation_schedule_2nd_round.pdf.) Tribes can use second-round bonding authority anytime between now and December 31, 2011.
In addition, the Tribal Economic Development Bond provision required the Treasury Department to conduct a study on the effects of these bonds, including whether the generally applicable limitations on tribal financing should be eliminated permanently, and to report back to Congress within one year of the date of enactment. The legislation was enacted on February 17, 2009. Indian advocacy groups, such as the National Congress of American Indians, have initiated discussions with White House and Treasury staff with respect to the study. In addition, an Advisory Committee to TE/GE Division of the IRS is gathering data from Indian tribal governments to inform Treasury regarding this study. Although the study was originally due on February 17, 2010, Treasury does not appear close to issuing it, so there is still time to register tribal input.
Build America Bonds
Whether or not your tribe received a Tribal Economic Development Bond allocation, it may be eligible to issue Build America Bonds (BABs). BABs are a new class of debt created by ARRA. These bonds offer governments the unique opportunity of being able to issue taxable bonds at the lower tax-exempt bond rates. The lower rates are available because the government issuing the bond is able to pass along a federal income tax credit equal to 35 percent of the interest on the bond to the investor. Alternatively, the government issuing a BAB can elect to receive a payment from the federal government in an amount equal to 35 percent of the interest paid, instead of passing the tax credit to the investor. An added benefit of electing to receive a payment from the federal government is that there are no restrictions on how the amounts are used; these amounts can be spent freely.
BABs have a few limitations, however. If your tribe did not receive a Tribal Economic Development Bond allocation, the BAB would need to satisfy the “essential governmental function” test; alternatively, if you are combining a TEDB allocation with a BAB, it does not need to satisfy this test. In either case, BABs cannot be private activity bonds (meaning the facilities financed with bond proceeds may not be used by private parties), and can be used only for new projects. Under ARRA, BABs must be issued on or before December 1, 2011 (although Congress is considering legislation to extend the deadline).
Bank Qualified Debt
Bank qualified (BQ) tax-exempt debt is attractive to banks because in addition to the tax-exemption on such debt, they may deduct 80 percent of the interest expense incurred to invest in BQ debt. BQ debt is attractive to governmental borrowers because the transactional costs associated with a bank loan are generally much lower than those associated with a bond offering.
Prior to ARRA, governments (including tribes) could issue only $10 million of tax-exempt BQ debt in a calendar year. ARRA increased the $10 million threshold to $30 million with respect to debt issued in 2010. Once issued, the favorable tax status of the debt remains in place until the loan is repaid – although the threshold will return to the lower level in 2011 on new debt incurred (unless Congress acts to extend this provision).
Unlike BABs, the new BQ debt threshold applies to both refinancing and new projects. As a result, customers of a bank that have incurred non-BQ debt due to the application of the $10 million limit may be able to modify or refinance that debt on more favorable terms. Like BABs, BQ debt can be utilized by a tribe whether or not it received a Tribal Economic Development Bond allocation. The only difference is that a TEDB allocation will allow the tribe to finance projects that do not meet the essential government function test.
Finally, a tribe could theoretically do a financing that combines BQ debt and BAB financing. This combination allows a tribe to borrow, in the same calendar year, $30 million of tax-exempt BQ debt, and to issue an unlimited amount of additional BABs (subject of course to creditors willingness to lend or underwrite) with an effective tax-exempt borrowing cost.
Qualified School Construction Bonds
ARRA created a new category of tax-credit bonds1 for the construction, rehabilitation or repair of public school facilities, or for the acquisition of land on which a public school facility will be constructed. The provision also contained a special authorization for the issuance of $400 million of qualified school construction bonds by Indian tribal governments for schools funded by the Bureau of Indian Affairs. The bonding authority has been split between two tranches: $200 million in 2009 and $200 million in 2010. The application deadline for the second tranche is March 15, 2010, so there is still time to submit an application. For further information, please visit http://www.bia.gov/WhoWeAre/AS-IA/OFECR/index.htm.
Next Steps for Tribes Receiving an Allocation
Contrary to a popular misconception, receiving an allocation of Tribal Economic Development Bond authority is no guarantee that a tribe will be able to successfully secure tax-exempt financing, which is highly dependent on the willingness of banks to lend and/or underwriters to structure a bond offering for the benefit of a particular tribal borrower. Thus, the first step in utilizing an allocation is to make contact with financial institutions and acquaint them with the project to be financed (as well as the tribal borrower’s financial condition). Financial institutions will be looking to determine whether the tribal borrower has the means to pay back the debt (both principal and interest). If repayment is contingent on revenues from the financed project, expect close scrutiny in the current credit climate.
Other critical steps include ensuring that the tribe’s financial audits are completed and that the governance structure is both functional and transparent. A legal infrastructure, e.g., tribal codes, also needs to be in place.
Outside legal counsel with experience in tribal financings can help in a number of ways, including the following:
- structuring the economic development enterprise with due regard to sovereign immunity, tax, governance and financing considerations
- rendering legal opinions and bond tax opinions in connection with the financing
- preparing and/or reviewing the financing documents
- resolving environmental and tribal land-related concerns
- navigating regulatory issues that may impact the financing, such as federal and state gaming regulation
- ensuring compliance with all aspects of security laws
- interacting with rating agencies and credit enhancers
- assisting the tribe’s CFO in managing the relationship with the bond underwriter and other financial institutions
- where needed, assisting with Code drafting and other legal infrastructure necessary to a successful transaction
1 Generally, tax-credit bonds provide the bondholders/investors with a tax credit in lieu of interest, resulting in an interest-free loan to the issuer/borrower. However, tax-credit bonds are only “interest free” if the holder believes that the tax credit is sufficient to compensate for the borrower’s use of money and the risk that the underlying principal will not be repaid.