The Retama Development Corp. has agreed to pay the Internal Revenue Service an unspecified amount and convert $30.425 million of tax-exempt bonds into taxable debt to ensure $160.3 million of bonds it issued in 1993 and 1997 will remain tax-exempt.
The Selma, Tex.-based nonprofit corporation disclosed its closing agreement with the IRS in a material event notice filed Tuesday with the Municipal Securities Rulemaking Board's Electronic Municipal Market Access, or EMMA, system.
The IRS had alleged that some of the bonds were taxable due to alleged arbitrage play under which some risky and speculative bonds issued to finance a racetrack defaulted within three years of issuance and were then backed by Treasuries and resold as triple-A securities.
In its notice, Retama said the owners of the 1997 bonds to be converted have consented to the conversion, and that it has directed the trustee to issue new taxable bonds to obtain a new Cusip number for them. Certain provisions of the bond indenture that will be affected by the conversion have been waived, according to the notice.
The bonds that fell under IRS scrutiny included $57.54 million of special facilities revenue bonds and $39.275 million of special facilities revenue notes, both sold in 1993, as well as $93.925 million of special facilities revenue refunding bonds sold in 1997. In December 2004, the IRS issued a preliminary adverse determination letter that concluded the bonds may have involved improper defeasance and refunding measures, according to the material event notice Retama filed at the time.
The preliminary adverse determination letter said the IRS was concerned about "issues arising from the refunding and defeasance of the ... bonds following the issuer's bankruptcy," according to the 2004 notice. "The issuer has been advised that the preliminary adverse determinations are based on a number of inaccuracies as to factual matters as well as legal conclusions, and it is working with the Internal Revenue Service and other interested parties in an effort to resolve these matters."
Retama Development, a nonprofit organization set up by Selma to construct and equip the racetrack, sought bankruptcy protection in 1996 after its first horse racing season failed to produce the revenue needed to cover debt service.
One area of focus in the IRS audit seemed to be $39.27 million of special facilities subordinated revenue notes the issuer sold in 1993. The notes had high yields due to their speculative and risky nature, and were to be backed with revenue from the racetrack project, but the debt defaulted when Retama filed for bankruptcy in 1996.
In 1997, the issuer did a $22.66 million remarketing of the bonds, purchasing Treasury securities for the escrow to back the bonds, which were then rated triple-A by Moody's Investors Service and Standard & Poor's. The reoffering yields ranged from 5.70% to 5.85% and were much lower than the yields of the original bonds. The IRS appeared to contend that the remarketing was actually a refunding, or a new issue, that violated arbitrage restrictions because the investment yield of the Treasuries was much higher than the yields of the refunding bonds.
A 1994 IRS revenue ruling cracked down on bond deals involving bogus insurance or some sort of security to generate arbitrage profits. Ruling 94-42 specifies that debt service payments are taxable in deals in which the original bonds were never intended to be backed by the full faith and credit of the issuer and the security was added later.
Fulbright & Jaworski LLP was bond counsel on both deals and Kinsell, Newcomb & De Dios Inc., then known as Kinsell, O'Neal, Newcomb & De Dios, served as remarketing agent for the 1997 deal.
Officials with Retama did not return calls for comment yesterday.
