There is a little-known financing product floating around that could provide significant debt service savings for your business. In finance jargon, it is commonly referred to as a “lower floater.”
A limited number of manufacturing and not-for-profit projects may qualify for tax-exempt lower floaters, but the uses are more limited and the restrictions far greater. For the majority of businesses that don’t qualify, however, there is another low-cost financing alternative that warrants serious consideration by business owners and CFOs — a taxable lower floater.
In the simplest sense, a taxable lower floater is a long-term loan with a short-term interest rate (historically ranging from 1.5 percent to 3 percent below prime). These loans are structured as “Adjustable Rate Taxable Securities,” which are secured by a letter of credit (LOC) from a rated bank and sold in the marketplace to institutional investors; the proceeds fund the loan to the borrower.
Annual letter of credit fees charged by a bank typically range between 3/4 percent and 2 percent of the outstanding loan amount, depending on the borrower’s credit quality. Lower floaters require additional documentation prepared by bond counsel to facilitate the securities offering and related matters.
There is always demand in the market for short-term investments to meet cash management needs of investors. The short-term liquidity of lower floaters (investors can “put” them back on seven-days’ notice) and the bank’s LOC as security create strong demand for these notes, which translates to lower interest rates, ultimately benefiting you, the borrower.
Most floaters are in a weekly interest rate mode, although the borrower can usually convert to longer terms if it desires. Taxable weekly floaters are typically priced at a small market spread over a benchmark rate, such as one month LIBOR (London Interbank Offering Rate) or 30-day commercial paper, and have recently been as low as 1.15 percent.
Even after factoring in associated financing costs of a floater, a borrower can still enjoy an all-in rate of 1 percent to 1.5 percent below prime.
If you have concerns about interest rates rising beyond a certain comfort level, you can protect yourself with an interest rate swap or cap, or just convert the weekly floater to a longer term. The borrower has the flexibility to make these decisions at any time it chooses, whether it’s two months after closing or five years.
Lower floaters can be utilized by any type and size of business. The funds can be used for new construction, renovation, acquisition of real estate, buildings, machinery or equipment, or even refinancing, and financings can be completed in approximately 45 to 60 days. Generally, $1 million is the minimum borrowing amount to be cost-effective. Transactions can be done for less, but a cost/benefit analysis should be carefully considered.
Standard loan terms (i.e. collateral, amortization, covenants, etc.) are negotiated between the borrower and the bank, just as with traditional loans, and are contained in a “Reimbursement Agreement” between the bank and the borrower. In this document, the borrower agrees to reimburse the bank for all payments of principal and interest on the notes to the investors. The amortization schedule is negotiated between the borrower and the bank, not dictated by the market.
Additional benefits include the flexibility to prepay any amount at any time without penalty and preserving confidentiality of borrowers’ financial information. Because the notes are secured by the bank’s LOC, borrowers can access the capital markets without having to disclose any information to the market.
Investors look to the credit quality of the LOC bank, not the underlying borrower. Financial information is shared only with the LOC bank.
If your business plans include borrowing in the not-too-distant future, you would be well-served to ask your banker or lawyer about the lower floater alternative. Although there are many factors besides cost to consider when borrowing, it can be a potentially significant one when comparing a lower floater to conventional bank loans.
Robert D. Swhier Jr. is a partner and the chair of the Public Finance Group. Swhier has received national recognition for his role as a pioneer of growth and development in Indiana. Reach him at (317) 684-5171 or [email protected]. Lynn M. Potosky is a public finance specialist and has experience in both law and investment banking firms. Reach her at (317) 684-5142 or [email protected].
