What is Conduit Issuer
A conduit issuer is an organization, usually a government agency, that issues municipal securities to raise capital for revenue-generating projects where the funds generated are used by a third party (known as the "conduit borrower") to make payments to investors. The conduit financing is typically backed by either the conduit borrower's credit or funds pledged toward the project by outside investors. If a project fails, and the security goes into default, it falls to the conduit borrower's financial obligation, not the conduit issuer.
BREAKING DOWN Conduit Issuer
Common types of conduit financing include industrial development revenue bonds (IDRBs), private activity bonds and housing revenue bonds (both for single-family and multifamily projects). Most conduit-issued securities are for projects to benefit the public at large (i.e. airports, docks, sewage facilities) or specific population segments (i.e. students, low-income home buyers, veterans).
Taxes, fees and revenues that secure bonds are collected by the conduit issuer from the borrower and then paid to the bondholders, but the conduit issuer is not usually responsible for repayment. Rather, it's the borrowing organization that must repay interest and principal on the bonds, unless stipulated otherwise in a written agreement. For instance, if a local non-profit hospital wants to build a new maternity center and uses conduit financing to fund the project, it is the hospital, not the conduit issuer, that is responsible for debt repayment.
Investing and conduit bonds
Investors in conduit bonds usually benefit from higher yields than general obligation municipal bonds, while enjoying the same federal tax-free interest income. If an investor lives in the same state where the bonds are issued, an investor may be exempt from state and local taxation on interest payments. But any tax-free benefits from municipal bond apply only to the interest income. Capital gains are till subject to the capital gains tax. Some municipal bonds may also be subject to the alternative minimum tax.
Risks for Conduit Issuers
Higher returns come with a higher risks, and since conduit bonds are not backed by the full faith and credit of the issuing government or agency, it's important for investors to understand they are investing in the project, not the conduit issuer. As such, a potential investor should engage in adequate due diligence to convince themselves that the endeavor has a reasonable chance of success. Even if a project has a compelling story and research indicates a high probability of success, the credit quality of the bond still matters. Ratings for a prospective bond investment can be checked with the three major bond rating agencies, which are Standard & Poor's, Moody's and Fitch.