Conduit Financing?

Conduit financing is a means for private companies, nonprofit organizations (NPO), and public entities to raise capital via tax-exempt municipal bonds to fund large-scale projects that typically benefit the general public. Such projects include hospitals, airports, industrial and housing projects, public facilities, and schools.

Municipal bonds are a form of revenue bonds known as conduit bonds and represent a public-private partnership.

How Conduit Financing Works

When a conduit bond is issued, the entities that receive the funds from the issue are known as the conduit borrowers and are responsible for the interest and principal payments to the bondholders. In most cases, the conduit issuer is not responsible for repayment.

The project's revenues secure the bond debt, and the debt finances and cash flow from the revenue-generating project are used to pay the bondholders. The conduit issuer collects revenues that secure these bonds from the borrower and then delivers them to the bondholders.

The borrowing organization must repay interest and principal on the bonds unless stipulated otherwise in a written agreement. For instance, if a local nonprofit hospital wants to build a new maternity?center and uses conduit financing to fund the project, the hospital, not the conduit issuer, is responsible for debt repayment.

Common types of conduit financing include?industrial development revenue bonds (IDRBs), private activity bonds (PABs), and housing revenue bonds—both for single-family and multifamily projects. Most conduit-issued securities are for projects that benefit the public, such as airports, docks, sewage facilities, or specific population segments, including students, low-income homebuyers, and veterans.

Risks of Conduit Financing

The risks of conduit financing are higher as the full faith of the issuer does not back the bond. Municipal assets or taxes do not support municipal bonds.

The investors of the bonds are investing in the project, as opposed to the credit standing of the bond issuer. As such, they are exposed to the risks that come with developing a new project.

It is essential, therefore, that investors are clear on all details of the project being financed. That includes costs, time of completion, default risk, and future revenue generation, all of which can typically be found in the project's prospectus.

Benefits of Conduit Financing

Because the risk of a conduit bond is higher, the yield on the bond is usually higher as well, particularly when compared to traditional municipal bonds. Furthermore, as with other municipal bonds, it is simpler for an investor to transfer ownership and offload the inherent risk in conduit financing compared to the corporate bond market.

Another advantage that conduit bonds hold over corporate bonds is that they are usually not taxed at the federal level on interest income. Investors might also be exempt from state taxation on interest payments if they live in the state where the bond is issued or if a U.S. territory issues it.

There is, however, no special treatment for capital gains. Conduit bond investors are still liable to pay taxes on the growth in value of their investments when they sell up like everybody else.