Bank Qualified Bonds (aka Small Issuer Exception) Overview
What are bank-qualified bonds?
Bank-qualified bonds were created in 1986 to encourage banks to invest in tax-exempt bonds from smaller, less-frequent municipal bond issuers, and to provide municipalities with access to the lower cost borrowing that they need in order to provide services and invest in schools, roads, bridges and other projects. Governments issuing $10 million or less in bonds per calendar year can designate those bonds as bank-qualified, which allows them to by-pass the traditional underwriting system and sell their tax-exempt bonds directly to local banks.
Selling bank-qualified bonds directly to banks decreases debt issuance costs for governments by an estimated 25 – 40 basis points (bps) for several reasons – (1) Smaller, less-frequent issuers do not have to pay higher yields to investors due to investor unfamiliarity with the issuer’s jurisdiction and (2) Bank-qualified debt issuers do not have to pay transaction costs associated with traditional bond sales. A 25 – 40 bps cost savings on a 15-year, $10 million bond at current interest rates ranges from $232,000 to $370,000. This is a substantial savings!
In the late 2000s, the limit was temporarily increased, which created a market for thousands of small borrowings that stimulated the economy as well as cash strapped small governments and nonprofits. Then in the 116th Session of Congress, House Committee on Ways & Means members Terri Sewell (D-AL) and Tom Reed (R-NY) introduced H.R. 3967, the Municipal Bond Market Support Act of 2019, a bill that offers a proven incentive for local banks to purchase the tax-exempt debt of small local governments and borrowers such as small colleges, health care facilities and other charities. Governments issuing $10 million or less in bonds (a limit that has not changed since 1986) per calendar year can have those bonds designated (or qualified 501(c)(3) bonds) as bank-qualified, which allows them to bypass the traditional underwriting system and sell their tax-exempt bonds directly to local banks at a cost savings for taxpayers.
In the 117th Session Congresswoman Sewell introduced H.R. 2634, the Local Infrastructure Financing Tools (LIFT) Act that includes - among other bond provisions - an increase to the small issuer exception to $30M and permanently pegs future increases to inflation. The provision was included in the House-considered version of the Build Back Better Act, which ultimately was not taken up by the Senate.
Modernize bond provisions by increasing the maximum allowed bond issuance of bank eligible bonds to $30 million.
Proposed Legislative Change
- Increase the maximum allowed bond issuance of “bank eligible" bonds to $30 million from the current level of $10 million. Set in 1986, the limit should be increased and then tied to inflation in future years.
- Permanently modify the small issuer exception to tax-exempt interest expense allocation rules for financial institutions (Section 265(b)(3)). The provision should be modified to apply to governmental issuers and the borrowing organizations separately regardless of the issuer and permit the 501(c)(3) organization to provide the designation.
Why should you support increasing the cap on bank qualified bonds?
Since bank-qualified bonds were created in 1986, the program’s $10 million cap has not kept pace with inflation or the cost of labor, land and materials associated with most public infrastructure projects. Increasing the cap to $30 million not only brings the program into the modern age but also enables governments to increase the amount of bank-qualified bonds they can issue and realize corresponding cost savings. For example, a 25 – 40 bps cost savings on a 15-year, $30 million bond at current interest rates ranges from $696,000 to $1.1 million.
Access state profiles of bank-qualified bond issuance from 2008-2018.
The date range of the data is intentional given the cap was temporarily increased in the late 2000's, which demonstrated a substantial appetite for small borrowings.