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IRS Audits $375M of Pa. Issuer

WASHINGTON — The Internal Revenue Service is examining $375 million of local government revenue bonds that were issued by the Delaware Valley Regional Finance Authority in 2002 to fund a revolving loan program for local governments and school districts in four Pennsylvania counties. Representatives of the authority disclosed the audit in a material event notice filed Wednesday with the nationally recognized repositories, saying the agency appears to have selected the bonds randomly for examination. “The IRS routinely examines municipal debt issuances to determine compliance with the federal tax requirements,” the IRS letter stated. “I can only assume it’s a random audit,” said Lucien B. Calhoun, president of Calhoun, Baker Inc. in Flourtown, Pa., the administrator of the authority’s revolving loan program. “There isn’t any indication from the service that they have any problems with our structure or the authority or anything else.” “Strictly speaking, this doesn’t rise to the dignity of an event notice, but just because there is so much trading of our bonds, we want to make sure that everybody has the same information about the authority, that information about the audit wouldn’t be used perversely,” Calhoun said. The agency has about $310 million of seven-day variable-rate demand obligations outstanding in the market, and its other bonds are traded actively in the secondary market, he said. Market sources noted that the 2002 transaction contains many elements that are currently under focus by the IRS, including pooled bonds, guaranteed investment contracts, interest rate swaps under which bonds that are swapped from fixed to variable rate, and a broker-dealer that serves as both underwriter and swap counterparty. But Calhoun said that the IRS in 2004 audited an almost identical bond transaction done by the authority in 1997 and concluded that there should be no change to the tax status of the bonds. “We received a no-action letter,” he said. The authority was created in 1985 to issue debt and provide loans to local borrowers, mostly within Bucks, Chester, Delaware, and Montgomery counties in Pennsylvania. Occasionally it will originate loans outside of the counties. Calhoun said the authority has sold roughly seven bond issues, has about $1.2 billion of bonds outstanding, and has originated about 350 loans totaling about $2.3 billion to more than 200 local governments and school districts since it was created. The proceeds of the 2002 bonds were all used to originate loans the first year after the bonds were issued, he said. The authority, he added, usually originates loans equal to about three times the par amount of the bond issues. The 2002 transaction involved $375 million of fixed-rate bonds that were swapped to a variable rate. Calhoun said the swap allows the program to stay viable when interest rates drop. Local governments can either borrow money at a variable rate or arrange for the authority to swap the bonds back to fixed rate. The proceeds to be used for loans are put into a guaranteed investment contract, which can be drawn down when the loans are originated. The lead underwriters on the deal were Salomon Smith Barney, now Citi, and Merrill Lynch & Co., which served as swap counterparty at issuance and in any swaps done after the bonds are issued. Co-underwriters were the now defunct Dolphin & Bradbury Inc., the current target of several enforcement cases and lawsuits that are unrelated to these bonds, First American Municipals Inc., and Janney Montgomery Scott LLC. Bond counsel was Blank Rome Comisky & McCauley, now Blank Rome LLP. Underwriters’ counsel was Conrad, O’Brien, Gellman & Rohn PC and Clifford Chance Rogers & Wells LLP, now Clifford Chance U.S. LLP. Carmen P. Belefonte in Media, Pa. was counsel to the authority.

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