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COMMERCIAL FINANCE 701: Loans disguised as government bonds (BOANs)

Ben Williams and Molly Jeffcoat Moody

Molly Jeffcoat Moody and Ben Williams

EDITOR’S NOTE: Commercial Finance 701 is a continuing series on commercial loans written exclusively for the Mississippi Business Journal.  This series is geared to lenders, developers, investors and transactional attorneys.

Sir Thomas More, the obstinate attorney who — literally — lost his head over religion, is often misquoted as suggesting the profession of lawyers is “to disguise matters.” Though hardly descriptive of the overall Bar, we confess that finance attorneys occasionally dress commercial loans in government bond clothing.  This article sketchily addresses the reasons why a loan might masquerade as a government bond – something we will inventively call BOANs.

Our project is a to-be constructed $25,000,000 manufacturing facility in John Grisham’s fictional Ford County, Mississippi.  Ford County Bank is prepared to make a construction loan on the following terms: 1 percentorigination fee, 4.75 percent fixed rate, interest-only during construction followed by monthly P&I payments based on a 20-year amortization schedule, with a balloon payment in year seven.  The loan will be secured by a mortgage, security agreement and guaranty.

There are two main reasons this commercial loan might transmogrify into a BOAN:  the possibility of a sales tax and/or income tax exemption.

Sales Tax Exemption  

The purchase of goods, materials and personal property on this project would normally be taxed at rates between 1.5% and 7.0%.   Assuming approximately $12,500,000 of the project involves taxable purchases, a sales tax exemption might result in savings of over $400,000.

Tax-Exempt Interest Rates

If interest paid by the borrower to the bank were exempt from the bank’s taxable income, then the bank would be able to offer a lower interest rate.  Based on the assumption the proposed project might qualify for a tax exemption, Ford County Bank inexactly converted the 4.75% taxable interest rate to a 3.56 percent tax-exempt rate.  Over the life of the seven-year loan, using some reasonable assumptions about advance rates, the interest savings to the Borrower on a tax-exempt interest rate might be over $1,000,000.

How might a for-profit company take advantage of these exemptions and savings?  One recurring answer is a BOAN – a commercial loan disguised as a government bond.

The State of Mississippi

Although BOANs may be issued by various governmental bodies, the most frequent issuer of BOANs in Mississippi is the Mississippi Business Finance Corporation (MBFC).  This well-run state agency – with considerable experience, expertise and a proven track record – induces qualified projects that meet statutory qualifications.  Historically, the typical project was an industrial development – but the legislatively established rules have varied over the years.  These bonds are generally referred to as “revenue” or “conduit“ bonds and lack the full faith and credit of the government.


While state law controls the imposition of and exemption from sales and state income taxes, federal law governs exemptions from the corpulent federal income tax.  Congress routinely creates federal exemptions for “private activity bonds” to further national goals and appease powerful lobbies. Mississippians may remember the “GO Zone Act,” which was enacted to assist designated areas in the recovery from Hurricanes Katrina, Rita and Wilma. The private activity “GO Zone” bonds financed over $4.2 billion in wide-reaching Mississippi projects.

A BOAN is still a Loan

Since the government has no obligation to repay the BOAN, the bond purchaser (often a bank) needs the conventional assurances of repayment that would accompany a traditional loan – namely, collateral and guaranties. The loan will be enveloped into a bond structure containing the same guaranties, financial covenants, survey, title, ….

Are BOANs Bone-Headed?

All other things being equal, any borrower would seek these exemptions.  Alas, all things are never equal.  The BOAN structure is not a cheap vehicle, and to determine whether the project is worth the hassle and costs, the developer must engage in a complex, head-scratching, cost-benefit analysis involving copious assumptions to include (1) sales tax savings, (2) tax-exempt interest rate savings, (3) cost of transaction, and (4) the pain factor.

The BOAN will come with all the costs of a commercial loan plus a swarm of additional documents, opinions, fees, and parties.  BOANs might involve an Issuer, Underwriter, Financial Advisor, Trustee, Remarketing Agent, Letter of Credit Bank, Rating Agency – each with its own fee and legal counsel.  As an example of an added cost for our hypothetical $25MM project, the MBFC would charge a $25,000 issuer’s fee based on a scaled fee schedule.

And the pain.  Converting a commercial loan to a BOAN changes the timeline and adds exacting tasks. The governmental entity might meet once a month.  Once approved, the bonds have to be validated in Chancery Court – after publication in a newspaper.  Getting to a closing will likely take at least three months longer than a traditional loan closing.  Deal fatigue may set in.  The developer will have to extract all taxable purchases from the construction contract and purchase those materials directly (instead of the contractor making those purchases).  Itemizations beyond the normal construction draw process will be required to satisfy the Mississippi Department of Revenue.  There will be befuddling state and federal forms that the developer hadn’t even heard of before and ongoing reporting for tax-exempt debt.

Still, as the size of the project increases, the added BOAN costs begin to pale in comparison to the savings.  The more sophisticated and organized borrower can take the described annoyances in stride by assigning tasks to its in-house counsel and accounting department.

Expectedly, we have glossed over important topics. What projects qualify for tax benefits?   What happens at the end of the seven years?  Ad valorem taxes, MSRB, audits, CPCN, prepayment penalties, bank-qualified, private placement, letters of credit, inducement, defeasance, negative arbitrage, …

In summary, a BOAN is a creative, legal, financing vehicle that can result in considerable savings for qualified projects.  Determining whether a specific transaction is suitable for a BOAN requires a fact specific analysis.  You’ll probably need to talk to a commercial finance attorney and your CPA.

Vive la différence!

» Ben Williams and Molly Jeffcoat Moody are attorneys engaged in a commercial law practice at Watkins & Eager PLLC (www.watkinseager.com).   Ben is recognized by Chambers USA and Best Lawyers in America and was selected as Best Lawyer’s 2014 Commercial Finance Lawyer of the Year in Jackson, Mississippi.   Molly is recognized by Chambers USA in the area of Real Estate Law. 


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