The Treasury Department formally liberalized its position on interest calculations for single-family mortgage revenue bonds Friday by releasing final regulations that favor issuers and aid transactions that may still be under audit.
The final regulations, which take effect today, appear to apply to the eight single-family mortgage bond issues that were under audit as of April 2002 by the Internal Revenue Services tax-exempt bond enforcement division.
Mark Scott, director of the IRS tax-exempt bond office, declined to say if those bond issues are still under audit, but indicated that the circumstances addressed in the regulations are no longer relevant in those audits.
The new ruling, which finalizes proposed regulations issued Nov. 4, 2003, allows issuers of single-family tax-exempt mortgage bonds to leave out the portion of interest payments used to pay mortgage guarantee fees when calculating the effective rate of interest on the mortgage loans to determine if they have violated arbitrage restrictions.
The regulations were the first issued under the Tax Reform Act of 1986 that addresses mortgage revenue bonds. The rule also changes the existing regulations on pooled mortgage insurance.
Although the municipal bond market was overjoyed when the proposal was originally unveiled because it reversed an unpopular technical advice memorandum, its reaction to finalization will probably be more muted given that the new rule merely affirms the proposed rule, Frederic L. Ballard Jr., a partner with Ballard Spahr Andrews & Ingersoll LLP here, said Friday.
The IRS liberalized the regulations, which means they can now be applied to bonds issued subject to the pre-1986 tax code, Ballard explained. A key difference was that the proposed regulations had applied only to bonds issued under the code as modified in 1986, he said.
The new rules mark a shift in the agencys interpretation of current regulations, which the IRS outlined in a technical advice memorandum written in December 2002. The memo, which was made public in April 2003, said that an unidentified issuer of single-family mortgage bonds must include the portion of interest payments used to pay mortgage guarantee fees to Ginnie Mae when calculating the effective rate of interest on the mortgage loans.
Based on that ruling, issuers would have to recalculate their mortgage yield to see if they have violated arbitrage restrictions. Under Section 143(g) of the IRS tax code, the effective rate of mortgage interest cannot exceed the bond yield by more than 1.125 percentage points. In other words, the issuer is allowed to earn 1.125 percentage points above the bond yield, and any earnings above that ceiling are deemed impermissible arbitrage.
For example, an issuer could have been in trouble under the TAM if it paid 6% on a tax-exempt bond issue and charged 7.13% for a mortgage based on those proceeds, but used six basis points of the interest rates on the mortgage to pay for the guarantee to Ginnie Mae or other mortgage insurers such as Fannie Mae and Freddie Mac.
Under the TAM, the effective rate would have been 7.13%, which would exceed the allowed spread of 1.125 percentage points. But under the new final regulations, the effective rate would be 7.07%, which is comfortably under the allowable spread, Ballard said.
