How U.S. and Foreign Firms Can Take Advantage of Private Activity Bonds for U.S. Projects

A form of financing known as private activity bonds (PABs) has long offered private companies a cost-effective, tax-incentivized alternative to commercial loans to finance large projects. Now, with a supportive policy environment driving a surge in construction and manufacturing, more and more companies are interested in PABs’ benefits—notably including foreign companies expanding in the U.S. Some foreign firms find it challenging to obtain credit for stateside projects if their banking relationships are primarily overseas. PABs offer flexible terms and lower interest rates than traditional commercial financing.

“Though private activity bonds have been around for a while, they’re piquing the interest of foreign-domiciled companies expanding in the U.S.,” says Aleks Granchalek, Managing Director, Public Finance for Fifth Third. “If you’re interested in growing here and you have capital needs, then you want to find a way to address them as inexpensively as possible.”

By gaining a deeper understanding of how PABs work and identifying the right situations for their use, foreign companies can effectively leverage this unique, cost-effective project financing option.

A Conducive Environment

There’s been an uptick in foreign investment in the U.S. over the past few years, especially in the manufacturing industry. According to the Bureau of Economic Analysis, foreign direct investment (FDI) into the U.S. increased by $227 billion to $5.39 trillion in 2023. FDI in manufacturing increased the most, growing by $58.6 billion to a total investment position of $2.22 trillion.

Part of what’s driving foreign investment is companies taking advantage of the Inflation Reduction Act legislation adopted in 2022 that provides tax incentives for clean energy projects, including producing solar panels, batteries, electric vehicles, carbon capture equipment, and many more clean energy technologies. The CHIPS and Science Act of 2022 also provides similar incentives for companies investing in semiconductor manufacturing in the U.S.

Both pieces of legislation allow foreign companies to benefit if they base their manufacturing operations in the U.S. With increased foreign interest in creating facilities in the U.S., there is an increased need for financing tools to support overseas companies’ expansion plans.

That’s where PABs have started to play a critical role.

Suneel Gill, Group Head of International Corporate Banking for Fifth Third, highlights one recent investment in which an overseas-domiciled company used a PAB to finance a clean energy project. “The bond offered a lower interest rate than a traditional commercial loan, and the business also received hundreds of millions in tax credits. The combination gave the company a huge advantage in terms of reducing the cost of its expansion and accelerating its return on investment,” said Gill.

Cost-Effective Capital

Like other municipal bonds, PABs are issued by a government entity. While municipal bonds often finance public projects like schools, parks, infrastructure, and public facilities, PABs fund private projects that have a public benefit. The bonds are often used for projects such as water and sewage facilities, water supply improvements, affordable housing, public transportation, airports, and seaports.

In addition, PABs can have a tax-exempt status for the bondholders if they’re financing qualified projects. These include airports, docks, and solid waste management facilities. Granchalek says, “The latter is one of the most common uses the bank sees for PABs. It’s not solid waste solely in terms of traditional waste management facilities. The category has a broader interpretation that refers more to managing waste processes or handling material that would otherwise be waste.” For example, Fifth Third has worked with companies that used tax-exempt PABs to finance facilities that handle scrap metal and other byproducts for steel manufacturing. Financing is primarily for production facilities and can’t be used for offices or corporate headquarter projects.

The tax exemption plays a key role because investors in PABs are more amenable to the lower yields when they can save on taxes. That means lower interest rates for PAB borrowers, which make the bonds so attractive. The bonds are also available to companies that have lower credit or lack investment grade.

The bank’s partnership with one manufacturing client illustrates how the cost-effectiveness of PABs works in the borrower’s favor and can even improve the ROI on projects. The company had limited interest from private lenders as it sought financing for an electric arc furnace modernization project. However, working in partnership with Fifth Third, the company obtained a tax-exempt PAB for $40 million with a 3.5% yield, fixed for 30 years. This was an estimated 175 basis points less than the available rate on corporate debt.

The Benefits of Private Activity Bonds

In addition to a lower cost of capital, PABs offer borrowers other benefits that merit examination, including:

Flexible bond structures. The bonds provide a flexible structure that can work to a borrower’s advantage. The bonds usually have a 30-year duration, but borrowers have a lot of say in how they structure the terms. For example, some PABs provide bullet maturity, which means that borrowers only make interest payments on the bond until it matures. At that point, they pay off the remaining principal in a single payment. Bullet maturity allows borrowers to put their cash to use over the life of the bond, though they do need to account for that final payment. Borrowers can also implement options to reset the rate or restructure the bond at specific periods, such as after 10 years. For instance, one company that worked with Fifth Third Bank used a PAB to finance a $600 million project. A piece of the company’s bond reset in four years, another piece reset in five years, and a third portion in seven years. The flexibility and lower rates help borrowers reach a return on investment in three or four years, instead of the usual seven or more with traditional project financing.

Longer MaturitiesThe 30-year life of PABs is another feature that borrowers may find appealing. The duration is often much longer than the term of a commercial loan and even many corporate bonds. It gives borrowers more time to pay off the debt, and along with the flexible structure, helps companies maintain cash flow as they’re beginning and sustaining capital projects. The long maturity is especially useful if the project requires a significant amount of upfront investment but doesn’t offer a return until years after the project is completed.

Improved Capital AccessPABs tend to attract attention in the market in smaller amounts, Gill says. That means borrowers may be able to use PABs to finance smaller projects than they initially expected. For example, borrowers may not pursue a corporate bond for less than $500 million or $1 billion because of the significant amount of work required to issue a security and the risk of not garnering enough interest. But investors lean toward PABs because of the tax incentives, making it more worthwhile to consider the bonds at lower amounts. In addition, PABs offer a financing option for borrowers with weaker credit. The bonds can be supported by standby letters of credit from a bank. “If there’s a borrower that’s not investment grade, then a bank can come alongside them, and the borrower will take on the bank’s ratings,” Gill says. Importantly, unrated and transactions not supported in this manner are also common in this market.

Pursuing a PAB

Understanding the details of PABs is a good first step for private entities, especially foreign companies that haven’t borrowed in the U.S. However, one of the challenges is that the PAB process is complex and lengthy—there are multiple stakeholders involved, and the bonds take several months or even up to a year to secure.

The lower cost of financing often makes the effort very worthwhile. Rather than approaching a local government to request a PAB, foreign companies should connect with an experienced lender with bond financing expertise that can provide guidance throughout the process and avoid any speed bumps or delays. PABs have proven a smart choice for many foreign companies pursuing expansion projects in the U.S.

Connect with a Fifth Third International Corporate Banking expert to learn more about private activity bonds.