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Tax-Credit Bonds

Tax-Credit Stripping Looms

WASHINGTON — Guggenheim Partners LLC wants to be the first in the municipal market to “strip” the tax credit from tax-credit bonds and isn’t waiting for the Treasury Department to issue guidance on the matter.

The global, privately held financial services firm, which is based in New York and Chicago and has more than $100 billion of assets under management, is the largest buyer of qualified school construction bonds in the municipal market. As of Sept. 21, the firm had purchased $272 million of QSCBs.

Guggenheim officials told The Bond Buyer this week that they are exploring how to separate the credit and principal from bonds the firm purchased last week from the Los Angeles Unified School District and hope to complete that transaction by the end of the year.

The district sold $318.8 million of QSCBs on Oct. 1, the largest issue of its kind thus far. Guggenheim purchased a significant amount of the debt, and wants to strip and retain all or a portion of the tax credits from the bonds while selling the principal to other investors.

“We feel very comfortable with the structure of the [LAUSD] deal, and we think we have an opportunity to actually strip the principal and sell it,” said Scott Minerd, Guggenheim’s chief investment officer. The firm has identified buyers interested in just the principal, which would essentially function like a zero-coupon bond if stripped from the tax credit.

Minerd declined to identify potential investors, but market participants say they could include pension funds or other investors seeking long-term investments.

Even though the federal government authorized stripping for tax-credit bonds in the farm bill enacted during the summer of 2008, market participants have not yet attempted it because they have been waiting for guidance from the Treasury.

Treasury officials say the stripping rules are a high priority, but concede that the long list of technical issues make it a slow-moving project.

But the straightforward structure of the Los Angeles school deal makes Guggenheim confident it can handle the stripping, and attract investors who are willing to buy the principal without the tax credit. “The LAUSD deal is a good deal because the structure is very clean,” Minerd said. “It’s a large, identifiable credit, which makes it easier to talk to potential buyers.”

Minerd said the firm is currently working its way through a “long laundry list of issues,” such as how a client should account for the credits.

“There must be realistically ... 20 or 30 little technical things that you need to address to actually affect the transaction,” he said.

Minerd said Guggenheim’s effort to strip the tax credits from the bonds could help the Treasury with drafting its guidance by identifying issues that arise and need to be addressed.

“It’s a good pilot deal to try to run through all the hurdles and figure out what all of the potential issues are,” he said. “We think going through this transaction before the regulations are done will help us identify any other issues or weaknesses that we see.”

Minerd added that every tax-credit bond the firm has bought is a candidate for stripping, but that most of the other tax-credit bonds it has purchased will not be stripped until the Treasury issues rules because their structures are more complex.

Muni market participants claim that stripping will expand the market for tax-credit bonds, which has struggled to gain traction over the years.

But a Treasury official recently cautioned against expecting too much from stripping.

Speaking during a teleconference sponsored by the American Bar Association’s sections on taxation and state and local government law, John J. Cross 3d, the Treasury Department’s associate tax legislative counsel, said that stripping “has been oversold as a panacea to the development of that market.”

“I think it will help, but people should not expect that market to develop overnight, even with the ability to strip,” he said.

While the Treasury is working on stripping guidance, the project “has huge challenges for IRS administrative information reporting and tracking,” Cross said.

Minerd agreed that stripping will not solve all of the problems with the tax-credit bond market, but said it would significantly increase how much Guggenheim would be willing to invest in the tax-credit bond market. Currently, the firm’s “appetite” for the bonds is about $2 billion, but it could grow to $5 billion if stripping emerges as a viable option, Minerd said.

“It’s not a panacea from the standpoint of solving all the issues that surround these securities, but it does go a long way toward increasing the size of the investor universe,” he said.

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