WASHINGTON - Two more California school districts have disclosed that the Internal Revenue Service has preliminarily determined that their bonds are taxable, the latest in a series of school district deals put together by California underwriter Kinsell, Newcomb & De Dios Inc. that have come under the agency's scrutiny.
In material event notices sent to nationally recognized securities information repositories late Friday, the Centinela Valley Union High School District and the Pomona Unified School District disclosed that $39.2 million of 2004 general obligation refunding bonds and $24.1 million of 2001 GO refunding bonds, respectively, have been preliminarily determined to be taxable by the IRS.
The two deals are among 26 transactions totaling about $800 million that were sold from 1993 to 2003, with Kinsell Newcomb as underwriter and Best Best & Krieger LLP as bond counsel.
The transactions were part of a forward-refunding program developed by Kinsell Newcomb in the early 1990s for California school districts with outstanding debt that carried fairly low interest rates. Under the program, a district like Pomona would enter into a forward agreement to sell advance refunding bonds at a future date and use those proceeds to defease the outstanding bonds to their maturity dates.
A third party agent would take bids on Treasury securities for the escrow, but Kinsell always won the bid. The firm also canvassed at least three potential purchasers of the bonds to establish the bonds' issue price. At the forward delivery date, six to 15 months later, the firm would purchase the refunding bonds from the district and sell them to the public at prevailing market rates, which typically were higher due to interest rate movements during the forward period.
However, the issuers said in the notices that the IRS contends the escrow securities were not purchased at a fair-market value and that the yields on the bonds were computed based on an incorrect issue price, resulting in bond yields that were below the yields of the escrow securities. As a result, the IRS has preliminarily concluded that the bonds are considered arbitrage bonds and are taxable.
J. Jeffrey Kinsell, president of the underwriting firm, said in a December interview that the IRS simply does not understand the transactions.
"Ultimately, at the end of the day, I think it's that they are deals that had lots of moving parts," he said. "Usually, lack of understanding creates a doubt."
Nevertheless, he is pursuing a settlement with the agency, claiming the audits are hurting the school districts and investors.
Kinsell said yesterday that settlement talks with the IRS are "increasing in frequency and substance, and my guess is that we'll have something done soon." He declined to elaborate on a timeline for the settlement.
He also said that the fact that the IRS continues to send out preliminary adverse notices on the deals is not reflective of any new issues or problems with the deals or settlement discussions.
"I have no idea why they continue to spend their time on it. We get the message," Kinsell said.