Page 14 - The EDGE Spring 2024 WEB

FINANCE

BY ALAN BOND AND SANDEE STALLINGS
Alan Bond Sandee Stallings
Rising Interest Rates and Yield Restriction

Since March 2022, the Federal Reserve has raised to similar, but not the same proceeds, and for
its benchmark rate 11 times in an effort to curb differing periods of time, it is possible for an issuer
inflation. For issuers and borrowers of tax-exempt or borrower to not have a positive arbitrage rebate
debt, rising interest rates have a direct impact on yet still incur a positive yield restriction liability.
the reinvestment of tax-exempt debt proceeds
The nuances noted above, coupled with the fact that
invested in interest-bearing vehicles such as money
yield restriction has not been a concern for issuers
market funds, local investment pools, and treasury
and borrowers for almost 15 years, make this area
securities and, therefore, on corresponding arbitrage
of tax compliance especially tricky to navigate.
rebate and yield restriction liabilities.
Additionally, increased IRS enforcement in this
Higher interest rates can be especially problematic area is expected. To help prepare for potential yield
for yield restriction compliance. reduction payments and IRS scrutiny, issuers and
borrowers of tax-exempt debt should ensure that
Yield restriction limits the investment yield on
they are current on their arbitrage rebate and yield
certain yield-restricted gross proceeds allocable to
restriction analyses, especially for bonds issued in
a bond issue, such as amounts remaining beyond
2019 – 2022.
applicable “temporary periods,” sinking funds,
and amounts in excess of what is considered a Alan Bond is Managing Director, BLX Group LLC.
“reasonably required reserve.” Instead of restricting
Sandee Stallings is Chief Operating Officer/Managing
the rate at which these amounts are invested,
Director, BLX Group LLC.
issuers and borrowers, in most instances, can make
a yield reduction payment (similar to an arbitrage
rebate payment) to reduce the overall yield on the
investments to the allowable yield.

Because yield restriction starts later in the life of a
bond issue and at the end of the various temporary
periods (3 years after the issue date of the bonds
for project funds is the most common), the potential
for a mismatch in rates is higher than for arbitrage
rebates. For example, suppose an issuer issued
bonds in 2021 at a very low rate, before the Fed
began raising interest rates, and has a large balance
still invested after the temporary period at high
investment rates. In that case, the issuer will likely
incur a yield restriction liability. Furthermore,
because arbitrage rebate and yield restriction apply

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14 THE EDGE SPRING 2024