Navigating Yield Spread Limitations to Issuer Fees in Bond Transactions with Related Parties

Issuers typically apply fees from bond transactions to administrative and program expenses — but also use these to fund other programs operated by the Issuer. However, the presence of certain related parties in a transaction may significantly constrain the fees an issuer can generate from that transaction.

We’ll explore the challenges that arise when a bondholder and project owner are related, as well as creative solutions to help maximize what the issuer can earn in these transactions. Let’s dive in.

Challenges of Fee Constraints

In transactions without related parties, usual issuer fees will typically fall within an allowable 1.5% “yield spread” (i.e., the spread between the bond yield and loan yield). However, Treasury regulations require that transactions involving certain related parties must adhere to a lower allowable yield spread of 0.125%. This limitation reduces the total amount of fees an issuer can realize; and violation of the spread limitation could result in penalties, fines imposed by the Treasury and/or the obligation to remit excess fees to the Treasury or return to the borrower.

How CSG Advisors Helps Issuers Analyze The Impact of Related-Party Constraints

We help our clients navigate the challenges of transactions involving related parties. We work with clients, first, to identify the transactions where related parties are of concern, quantify the likely financial impact of the related party to Issuer fee expectations, identify structuring strategies that eliminate the related party consideration, and, when warranted, help the Issuer retain the maximum allowable total fees in consideration of the applicable yield spread limitation.

Issuer Yield Spread Analysis

CSG Advisors, in collaboration with the Issuer and bond counsel, gather relevant information on the project (such as the proposed bond structure, interest rates, draw schedules, and repayment terms) and calculate the amount of upfront and annual fees allowable that are payable within the applicable yield spread. The analysis takes into consideration, the time value of cashflows throughout the bond, from issuance to maturity, timing of bond issuance and redemption; and Amounts classified as original issue discount (OID) for tax purposes.

The initial yield can serve as a reference point, in some situations for allowable subsequent fee adjustments.

Potential Reimbursement of Administrative Costs

In a circumstance where related parties remain and the 0.125% yield spread limitation is in effect, an issue might want to recover certain “qualified administrative costs” outside of the yield spread limit. This very challenging approach requires, throughout the life of the bond issue, a significant commitment to documentation and record-keeping, in order to demonstrate (conservatively), upon audit, that such reimbursed expenses are attributable to the specific bond issue. An approach to recovering qualified administrative costs might include:

• Limit total remittances, including fee within the applicable yield spread plus recovery of qualified administrative costs, to the amount the Issuer would have expected to receive in the absence of related parties;
• Require the lender/bond purchaser to underwrite the full issuer fee (as if related parties did not affect the yield spread limitation);
• On or about project completion, revise the yield analysis to reflect actual bond draws etc, in order to establish the highest amount ongoing fee that be paid within the applicable yield spread limit – and establish the maximum qualified administrative costs to be recovered outside of the yield spread limit. This approach is particularly purposeful where the bond issue is a “draw-down” issue that may require using worst-case funding timing for yield calculation purposes. The revised analysis would use actuals, and would create a more favorable determination of fee and be recovered within the yield spread limitation.

Contributor: John Hamilton