Obliging the Issuers.

• Author: Marlowe, Justin

At a glance, U.S. Steel Corporation, Penn Hills Charter School of Entrepreneurship, and the Little Sisters of the Poor don't have much in common. One is the second-largest steel company in the United States. One is a charter school with a curriculum that brings business and economics to life for K-8 students. The other is a group of nuns who run nursing homes. Their missions don't seem to overlap. And yet, all three have upgraded their buildings and equipment with low-cost financing made available through the Allegheny County, Pennsylvania, Industrial Development Authority (IDA),In other words, taxpayers in greater Pittsburgh have supported all three, directly or indirectly.

IDA acts as a "conduit." It borrows money and then lends that money to for-profit companies, healthcare organizations, cultural institutions, and other entities that contribute to the region's economic development. The benefiting entity then repays the IDA, who then repays the bonds. A properly executed conduit transaction is a win-win. An economic development project with tangible public benefits that might not otherwise pencil out is made possible through access to affordable, often tax-exempt financing.

That's why it's concerning, but not entirely surprising, that conduit financings have once again drawn the attention of regulators and the ratings agencies. This fresh round of scrutiny is both a challenge and an opportunity for state and local finance professionals.

Conduit bonds are part of a broader economic development toolkit made possible by the municipal bond market. That toolkit includes lease revenue bonds, "63-20" bonds, private activity bonds, and certain types of municipal securitizations, among many others. These tools all follow from the same basic strategy where a state or local government borrows money on behalf of a third party "obligor." Core to this approach is that the borrowing government is not a "real party in interest." In other words, investors who buy the conduit bonds are repaid only if the obligor makes its payments. This ensures that the financing doesn't directly affect the borrowing government's balance sheet.

Conduit financings have a long and colorful history. Throughout the early 1980s small municipalities flooded the municipal market with hundreds of millions of dollars of industrial revenue bonds (IRB)-a conduit financing on behalf of a for-profit entity. Congress's desire to curb such abuse of IRBs helped set in motion a much...