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Stimulating Boon for Small Colleges

Stimulating Boon for Small Colleges
February 2, 2009

WASHINGTON -- The federal legislation designed to stimulate the moribund U.S. economy is so filled with programs and provisions for different segments of American society that if you turn a page, you're likely to come across one that you haven't noticed before. Colleges and students would benefit from many aspects of the bills that are working their way through the House and Senate, many of which are so big (like $39 billion in funds designed to restore state budget cuts for public colleges and schools) and so obvious (between $3.5 billion and $6 billion for construction projects at postsecondary institutions) that they've been well-documented.

But a comparatively little noticed tax provision in both the Senate and House measures could make it significantly easier for small private colleges to raise money to build or renovate facilities, buy equipment, or refinance debt. It would temporarily alter a change made in the 1986 tax reform law that essentially closed one avenue that private nonprofit entities had previously used to finance construction and other projects -- a change that state bonding authorities have been fighting to undo for two decades.

Based on its title, the provision would, at face value, appear to have little to do with higher education: "De minimis safe harbor exception for tax-exempt interest expense of financial institutions and modification of small issuer exception to tax-exempt interest expense allocation rules for financial institutions."

But here's why a change in the federal tax code in how banks can deduct interest on money that they borrow could ease the flow of financing to private nonprofit colleges:

Before 1986, it was common for small colleges, nonprofit hospitals and municipalities, typically working through the facilities financing agencies in their states, to borrow money for facilities and other needs from local banks. The banks -- in most cases financial institutions that worked closely with the colleges in their areas and had an incentive to help them -- would borrow money from larger financial institutions to make the tax-exempt loans to the colleges or hospitals; the banks were able to deduct from their federal tax bills not only the interest payments they received from the nonprofit borrowers, but also the interest they themselves paid on the money they had borrowed. (With us so far?)

But as part of 1986's wide-ranging reform of the federal tax code, members of Congress, viewing the deduction of both kinds of of interest as a form of "double dipping," generally barred banks from deducting interest payments or carrying costs on money they borrowed. There was one exception: Banks could deduct up to 80 percent of such costs when the loans they made were to an entity that issued less than $10 million in bonds in a year. What that meant was that the state facilities authorities, every one of which issues more than $10 million in bonds to its various constituents, essentially lost access to one common way of raising money for colleges and other entities.

Without that route, colleges and other nonprofit entities have had to depend on the public markets (if their offerings are large enough or attractive enough to appeal to investors), with the attendant insurance underwriting costs, or to pay significantly more to cover the interest costs of the banks they were borrowing from. And with the recent tightening of the credit markets and the availability of loan funds generally, such funds have in many cases become either prohibitively expensive or altogether unavailable for less-wealthy institutions.

State agencies and cities have been working to change the tax law almost ever since 1986, to no avail, said Chuck Samuels, a tax lawyer at the firm Mintz Levin who represents the National Association of Health and Educational Facilities Finance Authorities. It appears to have taken a crisis -- and "an incredible stimulus package" -- to persuade Congress to act, Samuels said.

Both the Senate (see page 71 of the bill) and House versions of the stimulus legislation would make two changes in the federal tax code that could greatly increase the availability of bank funds to colleges for building projects. In combination, the annual dollar limit on borrowing would rise to $30 million from $10 million, but more importantly, the dollar limit would apply not to the issuer of the bonds but to the borrower itself.

In other words, where banks now cannot deduct interest on funds they borrow to lend money to any state agency that itself issues more than $10 million in bonds a year, they would under this legislation be able to deduct the interest on any funds that flow as long as the ultimate recipient of the money --
an individual college, for instance -- does not borrow more than $30 million in a year.

"This provision would allow us to once again offer as an alternative financing structure the ability for our colleges to go to local or regional banks, rather than to the public market -- in other words, to do direct or private placement rather than public placement, which requires an underwriter," said Larry Nines, executive director of the Wisconsin Health and Educational Facilities Authority.

"This is aimed at trying to get some relatively small but immediate capital into colleges," said Samuels, the Washington lawyer. "It should be especially important for private nonprofit colleges, giving them small amounts of loans without huge expenses, so they can do basic kinds of capital investments, repairs, renovations."

As hopeful as Samuels and others are that the banking provision will "incentivize banks to start de-icing a little bit so more money will flow" to colleges and other needy entities, he and others warn that this change in the tax code won't be a magic bullet unless broader changes take place in the economy.

"We're definitely excited about this, but we have to underpromise and overdeliver," said Nines. "Banks aren't making a lot of loans right now, and while this will be an incentive," they may remain cautious unless and until the overall financial picture changes.

That's what the rest of the economic stimulus proposal is for.

 

 

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