Office Space Gets Tight (2)

WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK.  FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON

With the help of Matt, the head of the Blogtropolis Development Agency, we are able to secure two older buildings which the City owns and intends to demolish.  This will provide us with the necessary land on which to build our new one story office building.  We propose to finance the land purchase from the City at a reduced cost and the building construction with a $2,040,000 Industrial Revenue Bond (IRB) to be issued by the City.  We want the bonds to bear interest at a fixed rate of 4% per annum and have a term of twenty-five years.  We would like to pay interest only for the first five years of the term of the IRB and then payments of the principal and interest amortized over the remaining twenty years.  Although simple in concept, the details of the transaction are complicated.  We need $2,000,000 for our project.  The extra $40,000 is for the costs of issuing the bonds, legal fees, trustee fees and other closing costs.  Matt thinks we can find investors willing to buy IRB bonds on these terms.

The IRB is a municipal bond issued by the City of Blogtropolis.  The first decision to be made is whether the IRB will be issued in a public offering or a private placement.  If the IRB will be issued to the public, the costs of issuance increase sharply.  If we can find a small number of "accredited investors" as defined in the securities laws to buy the IRB bonds, the costs will be much lower.  Here is a link to the definition of an "accredited investor" under the Securities & Exchange Commission rules.  Matt supplies us with a list of banks and insurance companies which have purchased Blogtropolis IRB issues in the past.  Matt explains to us that the City will play no role in setting the terms of the IRB issue.  We must contact the potential investors to negotiate the terms of the IRB to be issued by the City for the benefit of BBE.  Simply put, the investors loan money to BBE using Blogtropolis as a conduit to provide tax exempt status for the interest they will earn on their investment in the IRB.

Alice, our President, and Mary Jo, our Chief Financial Officer (CFO), meet with representatives of a number of banks and insurance companies to see if there is any interest in purchasing the Blogtropolis IRB to finance our project.  After many meetings, they locate three insurance companies and two banks interested in buying the bonds.  Because BBE is a small privately held company, it has no credit rating from any of the rating agencies.  Rating agencies, such as Moody's, study companies and their securities and issue ratings on their financial strength and credit worthiness.  Since they have no credit information on BBE to justify an unsecured loan, they insist that the bonds be secured by a mortgage on the land and building.  The property will serve as collateral for the bonds.  We agree that for the first five years, BBE will pay interest only on the bonds on a quarterly basis.  We will make quarterly principal and interest payments in order to retire the bonds (pay them completely) during the following twenty years of the twenty-five year life of the bonds.  Each of the investors will put in $408,000.  They will share equally in the payments and the mortgage collateral.  All of details relating to the purchase of the bonds by our investors from the City will be provided in a rather lengthy document called an Indenture.  Five bonds will be issued under this IRB, each in a denomination of $408,000, one for each investor.

After further negotiations, we reach agreement with the investors on the final terms for the bonds.  Other than an increase in the interest rate and the granting of a mortgage on the property, we get most of our financial terms.  The IRB will bear interest at a fixed rate of 5.5% per annum and have a term of twenty-five years.  BBE will pay quarterly payments of interest only for the first five years.  Thereafter, the company will make payments of accrued interest and a principal payment of $25,500 every quarter.  The annual principal payments of $102,000 will completely pay off the $2,040,000 by the maturity of the IRB, twenty-five years hence.  All of these terms will be included in the promissory note representing the loan from Blogtropolis to BBE and also in the bonds issued by the City to the investors.  Additional terms will be contained in the mortgage, the document which grants a lien to the lender on the property.  In the event of a default in payment by BBE, the mortgage can be foreclosed and sold by the lender to recoup the loan made to BBE.  BBE will be legally liable for any deficiency if the sale of the property is not enough to pay off the loan balance.

In bond issues of this type, one of the most important parties is the bond trustee.   A bond trustee is a third party, usually a corporate trust company, designated to act on behalf of the bond holders.  The City issues its bonds in order to raise the money to loan to BBE.  The bonds are held by the bond trustee until sold.  At the closing, the investors pay their money to the bond trustee, who then delivers the bonds to them.  The money is then lent to BBE on the basis of the loan documents between the City and BBE.  Those loan documents will be assigned to the bond trustee so that the bond trustee steps into the shoes of the City as BBE's lender.  All payments are made by BBE to the bond trustee who, in turn, makes the quarterly payments to the bond holders.  If there is a default, the bond trustee would take all necessary collection action, including a foreclosure of the mortgage on BBE's property.  The duties of the bond trustee are contained in a document called a Trust Indenture.  The terms of the Trust Indenture also include the assignment of all of the loan documents between the City and BBE to the bond trustee.  Because we are constructing a building, the bond trustee will hold the bond proceeds and pay them to BBE as the construction progresses.

We finally get to the closing on the Blogtropolis Industrial Revenue Bond (Best Blogs Ever, Inc. Project-2013).  The conference table at the lawyer's office is covered with stacks of documents, each to be signed by all of the parties.  Once we have closed and the bond trustee has the $2,040,000 on deposit, we buy the land from the City and start construction.  The construction project is completed on time and on budget.  All of BBE's employees are now working on the same floor in the same building.  Operations are much smoother now.

We will return to the story of BBE in the next blog.

Comments are always welcome.