June 23, 2022

Last week, the Federal Reserve raised interest rates by 0.75 percentage points, the largest interest rate increase since 1994, and indicated that it would continue increasing rates this year as it tries to slow the economy and fend off additional inflation, currently at a 40-year high. Last week’s increase represents the third time this year that the Fed has raised interest rates.

For issuers and borrowers of tax-exempt debt, rising interest rates have a direct impact on the reinvestment of tax-exempt debt proceeds invested in interest-bearing vehicles such as money market funds, local investment pools, and treasury securities and, therefore, on corresponding arbitrage rebate and yield restriction liabilities. Arbitrage rebate and yield restriction liabilities compare the yield on investments for a bond issue with the arbitrage yield for that same bond issue. Investment rates on typical investment funds have been rising sharply, which may bring overall investment yields on invested funds closer to or above the arbitrage yield, or allowable yield, for your tax-exempt debt. After more than a decade of extremely low interest rates and few positive arbitrage situations, the potential for positive arbitrage may catch issuers and borrowers off guard and unprepared.

To better position yourself for a positive arbitrage situation and potential arbitrage rebate or yield restriction payments which may arise, issuers and borrowers of tax-exempt debt should ensure that they are current on their arbitrage rebate analyses for bond issues that are actively invested. Further, available spending exceptions to arbitrage rebate should be monitored, and issuers should be cognizant of certain temporary periods allowable for yield restricted proceeds.

If your organization is in need of assistance with respect to arbitrage rebate or any other aspect of post-issuance tax compliance, please contact your BLX representative.

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