WASHINGTON - The National Association of Bond Lawyers, in a letter sent to the Treasury Department this week, said certain existing tax-exempt bond issuance rules - especially related to refundings and restructurings of issues that include swaps or other financial products - are posing problems for issuers trying to function in the tumultuous market.
The association is seeking either clarification or guidance to help issuers navigate the crisis.
In the 12-page letter sent Monday, the group outlined several areas where, due to unexpected and unprecedented market events, issuers are in situations where previous rules and regulations do not seem to adequately apply, or are having an unintended impact.
"This is a list of a number of really common issues that we're seeing now," said Perry Israel, who has his own law firm in Sacramento and was part of the working group that drafted NABL's letter. "These are things nobody expected would ever happen, and have effectively become commonplace in the last six months."
"The purpose of the letter was to offer the Treasury our solutions to a number of technical questions that have arisen in the current bond market relating to refundings and restructurings of bond issues with swaps or other financial products," said Frederic Ballard, Jr., a partner at Ballard Spahr Andrews & Ingersoll LLP, who was also part of the group.
Treasury officials invited NABL members to air their concerns stemming from the financial crisis during NABL's annual Bond Attorneys' Workshop in Chicago last month. NABL officials said yesterday they have not yet received an official response from Treasury on the letter.
A number of NABL's requests involve questions surrounding qualified hedges and swap agreements, many of which have arisen since the bankruptcy of Lehman Brothers.
Among other items, NABL encouraged Treasury to extend the reach of a provision it offered in its March notice on reissuance to its regulations. That provision states that a modification to a qualified hedge will not terminate the hedge if the change is not expected to change the yield on the bonds by more than 25 basis points and any hedge payments are taken into account in determining yield on the hedged bonds for arbitrage purposes. NABL said in its letter the principle of the notice should be extended to apply specifically to assignments, including assignments of contracts that do not have language permitting an assignment.
NABL also suggested to Treasury that if a variable-rate bond issue with an integrated qualified hedge has a failed remarketing and is subsequently put to a letter-of-credit bank until markets stabilize, the hedge should not be disqualified due to the interest rate mode conversion, as normally dictated in the tax rules, "due to events beyond an issuer's control."
Many issuers involved in Lehman swap agreements now are making termination payments to the firm to exit the agreement, and NABL asked Treasury in the letter to clarify that issuers can finance such payments with tax-exempt bond proceeds.
The downgrades to bond insurers also drove NABL to ask Treasury to modify the tax rules to permit issuers to finance a debt service reserve fund with proceeds derived from a tax-exempt bond issue. Insurer downgrades have forced many issuers to abandon surety bonds that previously financed reserve funds, instead filling those funds with cash, but the tax code "seems to prevent issuers from doing a stand-alone bond issue to fund the debt service reserve fund," due to the 10% limit placed on using proceeds to fund a reserve.
Israel said the extreme market conditions are driving the need for relief on this issue.
"In a situation where there's a financial crisis and you need to fund a reserve fund because a surety bond has gone away, you ought to be able to issue a bond issue just to finance a reserve fund," he said.
NABL also asked Treasury to clarify that when an issuer purchases and holds its variable-rate or auction-rate bonds, or short-term commercial paper due to adverse market conditions, the interest rate of those bonds during that time should be ignored for purposes of calculating the bond yield.
Due to current poor market conditions, some issuers are finding that they are unable to go ahead with planned bond refunding issues, and instead are hoping to use endowment funds or cash reserves to retire bonds that were originally intended to be refunded, and then reimburse that equity with a new issue as soon as market conditions improve. NABL asked Treasury to clarify that an issuer can adopt this approach so long as the issuer declares its intent to issue bonds no later than 60 days after retiring the original debt.
And finally, NABL weighed in on Treasury's recent move to temporarily provide a $50 billion insurance program to both taxable and tax-exempt money market funds. The tax code states that tax-exempt debt cannot be federally guaranteed, but Treasury clarified that the tax-exempt funds will not run afoul of this rule last month.
However, NABL asked Treasury in its letter to provide guidance stating that the federal guarantee will not adversely affect the tax status of tax-exempt bonds the proceeds of which are invested in money market funds participating in the insurance program. NABL argued that since the insurance program only covers investments made prior to September 19, 2008, "there is little or no opportunity for issuers to take improper advantage of such relief."