3.3.9 Conduit Revenue Bonds

“Conduit financings” involve bonds issued by governmental entities to finance projects for nongovernmental borrowers. Federal tax exemption requires issuance of the bonds by a state or a political subdivision of a state. Bonds must satisfy the requirements in the Internal Revenue Code for tax exempt “private activity bonds.” Although a number of local governmental entities may provide conduit financing, most conduit revenue bonds are issued by JPAs or by State financing authorities.

Conduit revenue bonds are issued primarily to finance the following:

Infrastructure qualifying as exempt facilities
Small manufacturing facilities
Hospitals and other nonprofit health care facilities
Educational facilities
Multifamily housing developments serving low income tenants

Conduit financing is also provided for cultural, recreational, and other nonprofit organizations. The specifics of what can be financed with conduit revenue bonds and much of the process are dictated by the federal tax law requirements. See Section 4.7, Qualified Private Activity Bonds. The benefits of conduit financing are generally more pronounced in higher interest rate environments, where the interest rate difference between taxable and tax exempt debt is greater.

Conduit revenue bonds are generally issued by a public agency under an indenture or trust agreement between the issuer and a trustee and the bond proceeds are loaned to a private borrower. The private borrower makes loan repayments that match the debt service on the bonds. The loan repayments constitute the “revenues” securing the bonds and the public agency is obligated to pay debt service on the bonds only to the extent it receives the payments. In theory, the private entity makes loan payments to the public agency, which in turn makes payments on the bonds to the trustee who makes payments to bondholders. In practice, the private entity borrower makes payments directly to the trustee. Figure 3-5 diagrams the flow of funds in a typical Conduit Revenue Bond.