WASHINGTON – The pending House tax bill is wreaking havoc with affordable multifamily housing and other tax-exempt private activity bonds issued to finance construction where bonds are drawn down in installments when they are needed, lawyers said.

Howard Zucker
Issuers may draw down their bonds for fear PABs will be terminated, said Howard Zucker with Hawkins, Delafield & Wood.

The bill is also causing problems for tax-exempt private activity commercial paper, which can be rolled over every few days, weeks or months, they said.

Draw-down bonds, which typically are privately placed, stretch out funding for construction projects if all of the bond proceeds are not needed at once. They allow issuers and borrowers to avoid negative arbitrage because the bonds are issued and paid for when drawn and don’t have to be invested at interest rates that are far lower than the bond rates.

Under the tax rules, for administrative purposes, such as PAB allocations and bond forms that must be filed, draw-down bonds are considered to be one issue and the issue date is the date of the first non-de minimis draw. But each subsequent draw is treated as a new bond with its own issue date because under IRS guidance, a bond is issued when money is actually paid for the bond.

Wade Norris. a founding partner at Norris George & Ostrow
Wade Norris. a founding partner at Norris George & Ostrow

If the House bill’s provision to terminate tax-exempt private activity bonds after Dec. 31 is in the final tax bill, issuers of tax-exempt draw- down PABs will not be able to draw them down in 2018 as tax-exempt. They will have to be taxable.

As a result, even before a final tax bill is passed, bond lawyers, municipal advisors, and their issuer clients that have outstanding draw-down bonds are rushing to fully fund their transactions, that is, draw down all the bonds by the end of the year, for fear that tax-exempt PABs will be terminated after that.

“Any issuer or borrower of tax-exempt private activity bonds that were issued on a draw down basis will have to fully fund the balance of their bonds before the end of the year in order for the as-yet undrawn bonds to be tax-exempt” if the Dec. 31 tax-exempt PAB termination provision is in the final tax bill, said R. Wade Norris, a founding partner at Norris, George & Ostrow based here.

Howard Zucker, a partner with Hawkins, Delafield & Wood, said, “If people have no clarity” about what’s going to happen in the final tax bill or if the final tax bill that is passed terminates tax-exempt PABs after Dec. 31, “it’s likely they will draw down the rest of their bonds,” he said.

Issuers “need to act very quickly,” said Norris, whose firm is involved in a lot affordable multifamily transactions involving draw-down bonds. “We’ve been riveted on this issue since H.R. 1 was passed by the House.”

Drawing down all the bonds before year end will be “a big cost to the issuers and borrowers,” Norris said, but the alternative – finding new draws of their bonds are taxable – may be worse, he said.

The cost to an issuer stems from the fact that drawing down the bonds all at once means bond proceeds will have to be invested for a time and because the investment rate will be much lower than the bond rate, the issuer will end up with negative arbitrage.

Norris also pointed that if borrowers fail to finance at least 50% of their affordable multifamily housing project costs with tax-exempt PABs, then the investors who purchased the 4% low income housing tax credits on the projects will lose over half the value of those tax credits.

An alert recently issued by Greenberg Traurig talked about the tax legislation’s impact on tax-exempt private activity commercial paper as well as draw-down bonds.

Tax-exempt commercial paper is short-term debt is used to finance short-term liabilities that pays tax-exempt interest to holders.

The alert – written by Rebecca Harrigal, Vanessa Lowry and Linda D’Onofrio – said that with private activity commercial paper, each “roll” of outstanding notes is treated as a refunding. Rolls that occur after Dec. 31 would be taxable if tax-exempt PABs were terminated on that date.

“Now might be a good time to consider refunding the outstanding paper on a fixed-rate basis,” they said in the alert.

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