Another option for private developers unable to issue tax-exempt bonds is to
issue variable rate debt. These bonds bear interest based on the one-month LIBOR
floating interest rate. Unlike a fixed-rate financing, variable rate bonds will
be secured by a letter of credit from a financial institution rated "A" or
higher. The letter of credit can be acquired for approximately 150 basis points
per year. In order to secure the letter of credit, there must be a minimum
of 1.40x annual debt service coverage for the life of the bonds. To add
security, a debt service reserve fund equal to between six months and one
year of debt service will be established. Although a combination of equity
and debt will be used, the attractive [debt-to equity?] loan-to-value ratios
of the variable rate issue enable the equity component to be reduced. To
mitigate the market risk of a variable rate issue, developers can engage
in an interest rate swap to secure a synthetic fixed interest rate. As with
the fixed rate financing, both the Production Tax Credit and MACRS accelerated
depreciation benefits are available to the equity investor.
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