The Internal Revenue Service is sending out questionnaires to 300 issuers asking about their advance-refunding procedures and post-issuance compliance.
The eight-page, seven-part questionnaire digs into all aspects of an issuer’s advance refunding policies, asking how it decides to do an advance refunding, how it complies with arbitrage restrictions and how it picks a guaranteed investment contract, or GIC, provider.
The surveys are being sent to 269 governmental entities and 31 nonprofit organizations that issued advance refunding bonds between July 1, 2009, and June 30, 2010. During that period, there were $23.5 billion of advance refunding bonds sold in 445 transactions, according to Thomson Reuters.
The questionnaire is part of the IRS’ “ongoing efforts to promote voluntary compliance with federal tax requirements applicable to advance refunding bond issuers and conduit borrowers,” Steven Chamberlin, manager of the IRS’ tax exempt bonds compliance and program management, said in a cover letter.
The questionnaire first asks issuers to describe how they find bonds that would qualify for an advance refunding, and whether the issuer consults with an outside party for advice. It asks if any approval from government officials or elected leaders is needed. It also asks the issuer to include any written internal procedures for its advance refundings.
The questionnaire asks if the issuer has procedures in place to review data related to arbitrage yield restriction. If so, it asks the issuer to explain how it would implement the procedures.
The arbitrage section also asks about purchases of state and local government series securities, or SLGs, which are issued by the Treasury Department for issuers to purchase for advance refunding escrows to ensure they don’t violate arbitrage restrictions.
The IRS wants to know why the issuer would decide to purchase SLGS for advance refunding escrows. SLGs are Treasury securities that are specially tailored to match the maturities of the issuer’s bonds. If the issuer is planning to invest in a GIC, the IRS wants to know if it would choose a GIC provider based on a request-for-proposal process, a recommendation, or through internal guidelines or some other way.
The SLGS window was closed earlier this month by the Treasury to help keep the government under its statutory debt limit.
Several questions revolve around record keeping: Does the issuer keep minutes from any meetings held among officials to decide if an advance refunding is a good deal? Does the issuer keep written correspondences with parties associated with its bond financings?
Advance refundings can be used by issuers to save money on debt service. Issuers with outstanding high-coupon bonds can issue lower-coupon bonds and use the proceeds to purchase Treasuries or SLGs to put into escrow so that they can be used to refund or redeem the previously issued bonds at the call dates.
Advance refundings do not work to an issuer’s advantage as far as cost savings when Treasury yields are less than those of comparable muni bonds. During the financial crisis, the ratio of muni yields to Treasuries jumped above 100%. Typically, the ratio stays below 100% because the interest on munis is tax exempt.
The muni-to-Treasury ratio fell below 100% for about 10 months, from September to the last days of June, during the IRS’ query period for the questionnaire, according to Thomson Reuters.
The Government Finance Officers Association in 1995 published a “best practices” document on advance refundings that recommends issuers sell refunding bonds if the savings are at least 3% to 5% of the present value of the bonds outstanding.
The document is to be reviewed and possibly updated by GFOA’s debt committee this summer. Any revisions would be sent to the executive board this fall for final approval, said Susan Gaffney, director of the group’s federal liaison center.
