Industrial Revenue Bonds (“IRBs”) are typically structured with bullet long-term final maturities and may be issued as fixed or variable rate securities.
Fixed Rate Demand Bonds – Fixed rate demand bonds are priced solely based on the obligor’s credit quality and, as a result, require significant disclosure of the borrower’s financial condition. Borrowers with public debt ratings from S&P and/or Moody’s generally access the public market and do not include any financial covenants in the bond documents. Borrowers with no public debt ratings from S&P or Moody’s will pay a premium over rated paper, and depending on the financial strength of the borrower, may be required to incorporate financial covenants in the bond documents. Issues maturing in 10 years or less are generally non callable. Bonds with longer final maturities will generally be callable after 10 years at a premium of 2%, with the premium declining to par after 2 years. Tax calls and calamity calls are generally at par.
Variable Rate Demand Bonds – Floating rate bonds are usually structured as variable rate demand bonds (“Demand Bonds”). Investors in Demand Bonds may, upon a specified notice period, demand repayment of their investment at par plus accrued interest. A put may be funded by internal cash or alternatively, with a draw upon a direct pay letter of credit Borrowers rated lower than A-i/P-i generally use letters of credit for enhancement. Issues enhanced by letters of credit are rated on the credit quality of the letter of credit provider and the structure of the transaction.
Advantages of Fixed and Variable Rate Structures – Fixed rate bonds provide certainty for forecasting cash flows and eliminate interest rate risk. Generally, no credit enhancement is used and no renewal risk exists. Publicly issued bonds are sold without financial covenants.
Interest rates on Demand Bonds are more volatile than on fixed rate issues; however, over time, short-term instruments tend to be less expensive than long-term instruments. The differential between taxable and tax-exempt rates is most fully reflected in the short end of the yield curve, and Demand Bonds require less disclosure of borrower financial information than fixed rate issues if the bonds are supported by a letter of credit. For locking in intermediate term maturities, Demand Bonds can be swapped to fixed rates.
On the negative side, Demand Bonds supported by letters of credit will utilize credit capacity, and banks generally require financial convenants in the reimbursements agreement between the borrower and the bank. While generally only one year renewable letters of credit are required, borrowers will be subject to renewal risk.