For almost a decade, business owners have benefited greatly from the low interest rate environment. With rates on the rise in 2022, the cost of future financing is weighing on their minds. While the last couple of years have presented a multitude of challenges for most businesses, many have now adapted to the “new normal” operating environment and are thriving because of gained efficiencies and new growth opportunities.
Private business owners and their finance teams are leaning into growth by investing in capital expansion projects and are evaluating the best manner to fund these initiatives. For manufacturing companies, there exists a compelling option to finance these capital expenditures with favorable structures and lock in attractive long-term fixed rates before rates rise too significantly.
Industrial revenue bonds (IRBs) are a creative tool in the marketplace available to manufacturing companies for domestic capital expenditures. These tax-exempt bonds are issued through state or regional development authorities and provide long-term, low interest rate financing for certain capital expenditures. Permitted projects include the construction or purchase of a new facility, expansion of an existing facility, purchase of new machinery and equipment or ongoing maintenance capital expenditures up to $10 million per location. A portion of bond proceeds may even be used for related costs, such as land acquisition, real estate development and legal and development authority fees.
IRBs offer fixed or floating interest rates, which are lower than more traditional sources – often by 100 basis points (bps) or more. As an illustrative example, a $10 million IRB amortized over 10 years would provide approximately $1 million in interest savings compared with a conventional loan. A borrower generally has 18 months from approval by a development authority to formally close on the bond and has the remaining calendar year to spend the proceeds.
There are a few caveats to consider when contemplating the use of an IRB as a financing option. Tax code qualifications and restrictions include:
- Qualifying costs: At least 95% of the bond proceeds must be spent on qualifying costs, which are generally capital expenditures, such as land, building and equipment and other depreciable property.
- Issuance costs: No more than 2% of the bond proceeds can be spent on issuance costs (placement fees, legal fees and other issuance costs).
- Maturity: The average maturity of the bonds cannot exceed 120% of the average economic life of the facilities financed.
- Land: No more than 25% of the bond proceeds can be used to acquire land.
- Acquisition of used property: The acquisition of used property cannot be financed. One exception is used real estate, which can be financed if at least 15% of the portion of the bond amount used to purchase the used facilities is spent on their rehabilitation.
- No working capital or inventory: Bond proceeds cannot be used to finance working capital or inventory.
- Straight line depreciation: IRS guidelines require straight line depreciation for assets financed with the proceeds of tax-exempt financing. (Consult your tax advisor for more information.) The interest savings usually dwarf the benefit of accelerated depreciation.
- $20 million limitation: The capital expenditures for the project, when added to capital expenditures in the three years immediately preceding and following the closing of the financing of the project in the jurisdiction where the project is located, cannot exceed $20 million.
- $40 million aggregate limitation: A company may not be the beneficiary of more than $40 million of tax-exempt financing regardless of the location of the projects during a three-year period after the facility being financed is placed in service.
Overall, IRBs are a low-cost method to fund significant capital projects. With rates already on the rise with the Federal Open Market Committee having raised the fed funds rate 225 bps so far in 2022 and projecting more hikes through the remainder of the year and into 2023, locking in still relatively attractive long-term rates should be a top priority if funding expenditures with debt.
Unlike most publicly traded banks, Brown Brothers Harriman offers IRBs directly to manufacturing companies by underwriting and holding the IRB directly, substantially reducing costs to borrowers and maintaining a simple borrowing structure. Our Corporate Advisory & Banking team, which has extensive experience underwriting IRBs, works closely with clients throughout the process and can structure standalone financing designed to complement a company’s existing banking arrangements. To learn more or discuss any needs your company may have regarding this form of financing, please do not hesitate to contact us.