Surprisingly, many qualified 501(c)(3) private and parochial schools are not aware they may issue debt at lower, tax-exempt interest rates. Additionally, many don’t realize how substantial the interest savings may be on a tax-exempt obligation, especially in the case of longer (e.g. 10 to 25-year) terms. Although tax-exempt debt has traditionally been issued most frequently by state and local governmental units for traditional government functions, certain “private” organizations, including private and parochial 501(c)(3) schools can take advantage of the same tax-exempt benefits. These benefits include not only the lower tax-exempt interest rates, but also longer financing terms, generally less and more flexible loan covenants, and in most instances, access to more competitive capital market participants.
Pursuant to applicable state and federal regulations, qualified nonprofit organizations (including private and parochial schools) can borrow on a tax-exempt basis by involving a state or local government unit which serves as a conduit issuing the debt on behalf of the nonprofit borrower. Using this structure to finance a new school construction or remodeling project, the conduit enters into a separate loan with the school, where the loan terms substantially mirror the terms of the conduit issuer’s tax-exempt obligation. Traditionally, the conduit’s debt is secured by the underlying real property and/or revenues generated by the school’s facility. At the end of the finance term, ownership of the real property being financed is transferred to the private school.
As an example, a preparatory academy in Keller, Texas recently completed a 25-year, $3.7 million conduit financing for a new facility. The conduit structure saved the school over $400,000 in interest costs over 25 years as compared to the cost of a taxable financing. In another situation, a charter school in Beaumont, Texas completed a similar tax-exempt conduit financing to include not only the $3.6 million construction cost of a new middle school, but also the refinancing of an existing $2.3 million taxable loan obligation. The combined $5.9 million conduit financing saved the school over $700,000 in interest costs over the 20-year term. These schools along with many other private, parochial and charter schools as well as private universities, have been taking advantage of the tax-exempt conduit debt market since 1986. It is worth emphasizing the flexibility of the conduit structure to provide “new money” to fund new construction projects and/or refinance existing debt at more favorable terms.
While the fact private and parochial schools can borrow at lower, tax-exempt rates is great news, the structure of the financings can be complex. Accordingly, issuers wanting to take advantage of these tax-exempt financings should consult Municipal Advisors or bond attorneys who are intimately familiar with the conduit borrowing authorities and Internal Revenue Code rules.