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Bond Financing Basics for Housing and Redevelopment Authorities

Revenue bond financing is an important source of funds for the development of affordable housing. Many local housing and redevelopment authorities have successfully utilized bond financing to construct or rehabilitate housing for low- and moderate- income families.

Bond Financing Basics includes a description of the parties usually involved in a bond issue, the various documents that are typically used, an explanation of the process and some relevant aspects of federal tax law.

The following is based on material presented by John Wagner of the Kutak Rock Law Firm, Omaha, Nebraska at the NAHRO Annual Conference, October 7, 1996 in Orlando, Florida. This material is intended for informational purposes only. Housing and Redevelopment authorities interested in bond financing should contact appropriate counsel for specific legal advice.

 

Parties to a Bond Issue

Issuer This is the legal entity that is borrowing money by issuing bonds. Federal tax law defines an issuer as a state or political subdivision (which typically includes local housing authorities) or a legal entity acting as an "instrumentality" or "on behalf of" a state or a political subdivision.

Trustee The trustee is usually a commercial bank. Its purpose is to represent and protect the interest of the bondholders and this usually includes holding all funds and other security for the bonds.

Underwriter (Investment Banker) The underwriter is an investment banking organization that helps structure the bond issue and purchases and resells the bonds on behalf of the issuer.

Bond Counsel Bond counsel is a law firm with nationally recognized expertise in municipal bond transactions. Investors will not buy municipal bonds unless there is an opinion of a recognized law firm to the effect that the bonds are validly issued and the interest on the bonds is tax-exempt. Bond counsel also should be experienced with all aspects of structuring a financing and should advise the issuer and the underwriter on the legal aspects of the bond issue.

Borrower In conduit revenue bond financings, the Issuer issues the bonds not for its own use but to re-lend the bond proceeds to a private party which actually uses the proceeds, such as to finance an affordable housing project. The borrower can be a for-profit or a nonprofit entity. In affordable housing rental project financings, the borrower is often a limited partnership or limited liability company organized solely and only to own and operate the project. Most bond and mortgage guarantors (like FHA) require that the project owner be a "single asset" entity, meaning that the owner owns no projects other than the one being financed and conducts no business other than owning and operating the project being financed. This is generally desirable because it minimizes extraneous bankruptcy risks. In affordable housing projects, typically the developer is the general partner and 1% owner with the remaining 99% equity interest sold to the limited partners. This is particularly true in tax credit financings because the limited partners can utilize the tax credits only if they are legally a part owner of the facility.


Bond Issue Documents

Trust Indenture The contract between the bank, acting as Trustee for the bondholders and the Issuer which establishes the parameters for the bonds. The trust indenture is the most important of the bond documents and includes the form of the bonds. It has the following purposes:

  • sets forth the terms and provisions--maturities, interest rates and redemption rights--for the bonds;
  • sets forth the security for the bonds, which may include a project mortgage and a gross revenue pledge;
  • provides for procedures in the event of redemption and defeasance;
  • establishes the funds and accounts;
  • provides for permitted investments of moneys;
  • provides procedures for amending the Trust Indenture;
  • provides for the Trustee's duties and rights; and
  • establishes events of default and remedies.

The Issuer and the Trustee each are bound by the terms of the Trust Indenture. The Issuer promises to--

  • cause the principal and interest to be paid on the bonds;
  • be duly authorized to issue the bonds and preserve their existence;
  • comply with any tax covenants;
  • comply with the Trust Indenture; and
  • comply with the "program" covenants.

The Trustee has the following functions:

  • holds all money under the Trust Indenture;
  • pays principal and interest to bondholders; and
  • acts for the bondholders in the event of a default.

Financing Agreement The generic name for the agreement, in a revenue bond conduit financing, between the Issuer and the Borrower. It may be a loan agreement, lease-purchase agreement, installment sale agreement or even just a promissory note and mortgage. It generally includes the following:

  • terms and provisions for the effective loan of the bond proceeds;
  • the agreement of the Borrower to repay the loan in amounts and at times sufficient to enable the Issuer to repay the bonds;
  • security for the Borrowers's repayment obligations (usually a first mortgage on the project being financed, and often also some type of third-party insurance or guaranty such as FHA insurance);
  • the Borrower's representations and warranties;
  • maintaining, operating and insuring the project;
  • events of default by the Borrower, and remedies; and
  • the Borrower's prepayment rights.

Official Statement The Official Statement is dated the date the bonds are sold and contains the final terms of the bonds. Under federal securities laws, the Issuer (and the Borrower, if there is one) are obligated to disclose in this document all information that a "reasonable investor" would consider important in deciding whether to purchase a bond. A "Preliminary Official Statement" complete except for interest rates and maturities, is used to presell the bonds.

Purchase Contract This is the agreement between the Issuer and the Underwriter in which the Issuer agrees to sell the bonds to the Underwriter and the Underwriter agrees to purchase the bonds from the Issuer at a specified purchase price, typically principal plus accrued interest from the date of the bonds to the date of closing. The Purchase Contract sets forth the terms and conditions under which the Underwriter will purchase the bonds. These provisions include provisions for various documents and opinions to be provided by parties to the financing at the closing, including any expected bond rating.

The Bonds The bonds are interest-bearing promises to pay a specified sum of money on a specific date to the bondholder. The form of the bond is contained in the Indenture. Each bond is signed by the facsimile signatures of Issuer officials and is manually signed, or "authenticated," by the Trustee. A Letter of Representations is executed by the Issuer, the Trustee and the Depository Trust Company (DTC) which sets forth each of their responsibilities with respect to the bonds.

In many financings, there may be the following additional documents:

  • Credit Enhancement Agreement This is the document by which a third party insures or guarantees either the bonds or the Borrower's mortgage repayment obligation. Often there are two documents, the guaranty or insurance agreement, which runs to the Trustee, and the agreement of the Borrower to repay the insurer/guarantor.
  • Disclosure Agreement In this agreement, the Issuer, or the Borrower in a conduit financing, agrees to provide ongoing disclosure as required by S.E.C. Rule 15c2-12.
  • Investment Agreement Also sometimes called a "guaranteed investment agreement" or "GIC" this is the agreement between the Issuer/Trustee and a financial institution in which Indenture moneys are invested at a fixed rate and term, subject to withdrawal at any time without penalty when needed by the Trustee or Issuer.
  • Regulatory Agreement Also sometimes called a "land use agreement" used in rental housing revenue bond conduit issues, this is an agreement executed by the Borrower and recorded with the mortgage to ensure compliance with federal tax law requirements, principally addressing the income limits for tenants.


The Process: Steps and Timetable

This is a general description of the steps and timetable in a typical simple revenue bond financing. In many cases, the process requires a longer period of time than described here.

Step 1 The officers of the Issuer (and the Borrower, if there is one) preliminarily discuss the proposed bond financing. Other parties who will participate are consulted, including Bond Counsel, an Underwriter and sometimes Underwriter's Counsel. If the bonds will be sold to the highest bidding underwriter through a "public sale," the Issuer usually employs a Financial Advisor to arrange the bond sale instead of an underwriter. At this time, Bond Counsel determines whether and to what extent the financing is affected by state and federal laws and what, if any, approvals are necessary. If required, the Issuer applies to the State for a private bond authority allocation.

Step 2 The Issuer adopts a resolution stating its general intention to proceed with the bond financing and formally hire Bond Counsel and the Underwriter; the Issuer also details any additional requirements it may have. If a project is being financed for a Borrower, construction of the project may then begin. First drafts of the basic bond documents are distributed by Bond Counsel. Bond Counsel conducts its review of whether the project satisfies applicable federal tax rules. If a Credit Enhancer is involved, it distributes its requirements and documents.

Step 3 Comments on the first drafts of the basic documents are received from the parties involved. Second drafts marked to show changes from the previous draft are distributed, by the appropriate parties, reflecting negotiated business issues, as well as the first draft of the Preliminary Official Statement.

Step 4 Comments on the second drafts of the basic documents are circulated. Revised drafts are again distributed. The Preliminary Official Statement is revised. Comments on the revised documents are received and revised drafts are again distributed until an substantial consensus is reached on all provisions.

Step 5 Once the basic financing structure and documents are agreed upon and any State private activity bond cap allocation is received, the Issuer holds a public hearing (after at least 14 days' notice) with respect to the issuance of the bonds. Then the Underwriter (or Financial Advisor, in the case of a public sale) makes a public distribution of the Preliminary Official Statement to prospective investors. Final drafts of the documents and the Issuer's bond resolution are prepared.

Step 6 The Issuer adopts the bond resolution, in which it agrees to sell the bonds to the Underwriter, approves the documents and authorizes execution of the bonds. The Purchase Agreement is signed. The Final Official Statement is printed. Bond Counsel circulates drafts of closing documents. All parties complete and assemble the remaining documents for the closing.

Step 7 About two to three weeks later, the preclosing and closing occur, which are the final meetings of all parties. At this time, all of the documents are executed and delivered. Bond Counsel delivers its opinion that the bonds are valid and the interest on them is exempt from federal income taxes. The Issuer delivers the bonds to the Underwriter, and the Underwriter transfers money to the Trustee to pay for the project and various costs.

Copyright 1997 - 1998 - 1999 - 2000
Affordable Housing and HOME
National Association of Housing and Redevelopment Officials (NAHRO)
630 Eye Street, NW
Washington, DC 20001-3736
Telephone: (202) 289-3500
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