WASHINGTON — A consulting firm has warned the Treasury Department that interim guidance it released in March might force small school districts to obtain Cusip numbers for their tax-credit bonds even if the issuer has no intention of ever stripping the tax credit from the bonds and selling it separately.
An official with the firm also said yesterday that while issuers now can offer school tax-credit bonds as taxable debt for which the issuer receives a direct federal interest-cost subsidy, the fact that those payments can be offset is keeping some districts from jumping into the market.
St. Louis-based North by Northwest Capital informed Internal Revenue Service officials in a comment letter that the notice outlining the stripping process needs clarification to ensure it does not force issuers and community banks entering into small negotiated deals to take burdensome steps intended to boost the broader tax-credit bond market.
The need for clarity stems “from the differences between straightforward, small tax-credit loans negotiated directly between a school district and a bank, and complex, broadly distributed tax-credit bonds underwritten by Wall Street and broker dealers,” the firm wrote in its letter, dated May 17 but not released publicly until last week.
“These loans are made by strong community banks which are long-term lenders, support the local school districts, and have no interest in selling/trading the issues .... As such these loans are generally done in the least cost method and are not assigned a Cusip.”
The firm followed up on its original letter with a few more comments in a second letter, dated May 20.
North by Northwest principals Thomas J. Murphy and Thomas A. Westrup wrote that the Treasury notice, as written, could require issuers of all tax-credit bonds to obtain a Cusip for the bonds, regardless of whether the credits ever would be stripped. They said the notice should be modified to make clear that only strippable issues require a Cusip, protecting smaller issuers from this “unnecessary burden.”
Along similar lines, small school districts are “ill equipped” to meet the new reporting requirements for strippable bonds, which require issuers to file information returns with the IRS annually and with the credit recipient quarterly. The IRS should clarify whether small districts not seeking strippable deals need to meet this new obligation as well, Murphy and Westrup wrote.
Stripping guidance was at one point a very high priority for the muni market, as participants hoped it would boost tax-credit bonds by broadening the market of potential investors. The tax-credit bond market had struggled to gain traction over the years, even as Congress authorized increasing amounts of bond authority for various types of projects.
But the call for stripping guidance waned after President Obama in March signed a law allowing issuers of the most popular tax-credit bonds to opt for a direct subsidy from the federal government instead of offering investors a federal tax credit. Market participants generally believed that issuers would almost exclusively choose the simpler direct-pay option.
However, Westrup, North by Northwest’s executive director, said concerns over the IRS’ ability to reduce or stop a payment to “offset” outstanding taxes the issuer owes the federal government is making some districts slow to embrace direct-pay bonds.
While the offset concern has been discussed mainly in terms of Build America Bonds, that same issue applies to other direct-pay bonds. The IRS and Treasury regard the subsidy payments as tax refunds, which makes them subject to offsets.
The concerns are “very chilling on that version of it,” Westrup said, adding that disrupted payments would be particularly tough for districts struggling with budgetary issues. “What does the school district do when they come up to their interest payment date and that money doesn’t flow in?” he asked. “They’re in tough times and it becomes very difficult.”