Can Texas fund back school bond bank? IRS ruling sought by state review board.

DALLAS -- The Texas Bond Review Board has asked the state attorney general's office to seek a private letter ruling from the Internal Revenue Service on whether the state's Permanent School Fund can guarantee a controversial school bond bank program.

The board next month expects to accept proposals from prospective financial advisers for the $750 million bond program, which was designed two years ago to help Texas schools finance facilities. The plan has been opposed by Texas-based firms, which say it could take business away from them.

Tom Pollard, executive director of the review board, said the program could be operational by the end of fiscal 1992 if the IRS rules in its favor.

"I don't think we would move forward without a ruling," he said. "The bond bank program may be different depending on the outcome of the letter of ruling request."

The board, composed of the top five elected officials in Texas, has formally asked Assistant Attorney General Jim Thomassen to propose to the IRS two scenarios that would allow the Permanent School Fund to provide a triple-A rating for the proposed bond bank.

The IRS last year exempted the fund from restrictive arbitrage rebate regulations. The agency determined that the fund, a trust created in 1854, could be used to guarzntee up to 2.5 times its corpus -- or about $18 billion in debt.

Based on the size of the guarantee fund, both Moody's Investors Service and Standard & Poor's Corp. provide automatic triple-A ratings for all local school debt secured under the program. To date, that includes about $2.5 billion of bonds.

State officials earlier this year said they intended to ask the IRS to broaden the use of the fund to include the bond bank, saying it could allow for more cost-effective issuance by districts already benefiting from the triple-A guarantee.

Mr. Pollard said the IRS will be asked to decide if all debt sold by the bond bank can be backed by the Permanent School Fund. If not, the agency will be asked to decide whether issues already eligible for the guarantee can be pooled. Those not already eligible would not be backed by the fund.

Mr. Thomassen, the chief of the state's public finance section, declined to speculate on how the IRS might rule or how quickly it could reach a decision.

"The first step will be to enter into an agreement with the Bond Review Board on how we are going to do this," he said. "We have to do that because it's going to involve hiring outside counsel."

A formal agreement is needed to ensure that such expenses are paid by the Bond Review Board. Mr. Thomassen also could not say when proposals might be sought from Texas legal counsel.

Bond counsel that were interviewed speculated the state might hire the Houston law firm of Bracewell & Patterson. David Thompson, the former general counsel to the Texas Education Agency, is a partner in the firm. He worked for five years to win IRS approval to use the Permanent School Fund.

Even though the state is moving toward implementing the bond bank program two years after it was authorized, it is still not certain that the financing program will actually begin next year.

"The shifting tides of school finance and how they would impact facilities is why this program has been put on hold," Mr. Pollard said.

For seven years, the state has been struggling under cour orders to develop an equitable school finance system. A new wealth-sharing plan intended to shift hundreds of millions of dollars in tax welath from rich to poor districts was held constitutional earlier this month, but that ruling is being appealed.

Despite the delays, Texas-based brokerages have not changed their opposition to the bond bank. Many regional firms say they could lose scores of school district clients whose debt needs could be met by a bond bank.

When the state seeks proposals for a financial adviser to the bond bank, few -- if any -- Texas firms are expected to apply for the job. "You don't lobby against something and then turn around and run to help set it up," said a Dallas investment banker.

In fact, many have reasoned that if the state cannot use the Permanent School Fund to give the bond bank a triple-A rating, then many of the state's 1,054 districts might not use the program.

Also, because many school issues are bank-qualified, the firms say they could compete with the bank. However, state Treasurer Kay Bailey Hutchison and officials from other states have lobbied Congress to use its small issuer privilege in pooled financings.

The tax code allows bank to deduct 80% of the cost of purchasing and carrying bonds sold by any entity that expects to borrow less than $10 million per year. Under current law, issuers lose the bank-qualified benefit when they participate in pooled issuance, unless the pool authority expects to issue less than $10 million of bonds per year.

"I don't think Congress will go along with that," said a Houston financial adviser who opposes the program. "Even if the IRS goes along with what the state wants, we still think we can compete. Until something is decided, we just won't know how much we can compete."

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