WASHINGTON - Premier Bank accelerated the payment of three black box bond issues last week after the letter of credit provider, Sumitomo Trust & Banking Co., declared defaults because the developers had failed to finance housing projects with the bond proceeds.
One of the developers, Dr. Robert C. Mohr, with Essex Downs Inc. in Utah sent Sumitomo a letter contesting the declaration of default and early payment of the $9.1 million bond issue that was to have financed the Fox Hollow apartments for the Ogden, Utah, Housing Authority. Essex Downs is currently in bankruptcy proceedings.
But Sumitomo and Premier Bank officials said Sumitomo had the authority to declare the defaults under its credit agreements with the developers. They said the bank also had the authority to direct the trustee to accelerate payment of the bonds under the bond indentures. Premier was trustee for the three issues.
The early redemptions effectively halt arbitrage earnings and therefore limit the potential tax liability for the three black box deals. The two other deals were a $25 million issue sold in June 1987 for Logansport, Ind., and a $20 million issue sold in April 1987 for Kokomo, Ind.
The Logansport and Kokomo issues have been under investigation by the Internal Revenue Service. It is unclear whether the IRS has been investigating the Fox Hollow issue. Ogden officials could not be reached for comment.
Market participants said these early redemptions appear to be the first for black box issues, dozens of which were sold in the mid- 1980s.
In most of these deals, some of which are under investigation by the internal Revenue Service for possible tax law violations, the projects were never financed with bond proceeds. But the bonds are still outstanding and could remain outstanding for seven to 10 years. The bond proceeds typically were used to purchase long-term investment contracts and were never available for the housing projects.
Sumitomo officials said yesterday they were asked to declare defaults for these three black box issues.
"We did this at the request of the issuers," said Bruce A. Ortwine, Sumitomo's senior vice president and general counsel. "We acted in good faith. The bondholders were made whole. "
Lawyers representing Logansport and Kokomo confirmed yesterday that city officials had been urging Sumitomo to find a way to redeem the bonds early because they were never used for housing and were under investigation by the IRS.
The Logansport and Kokomo issues had not been scheduled for redemption until 1997. The Fox Hollow issue was not to have been redeemed until 1996.
"The issuers were concerned that nothing was ever built. When they started getting attention from the IRS, they wanted to get the situation wrapped up," said one lawyer representing the two Indiana cities.
Sumitomo had provided direct-pay letters of credit for each of the three bond issues. Premier Bank had been drawing on the letters of credit to make the interest payments on the bonds, which ranged from 6.62% to 7.75%.
The letters of credit were backed by guaranteed investment contracts that paid interest at rates ranging from 6.89% to 8.16%. Sumitomo was able to obtain reimbursement from the GICS for the draws from the letters of credit.
When the bonds were redeemed on Friday, the bondholders were paid the full principal amount of the bonds and the interest that had accrued to date.
Sumitomo borrowed the money to pay the bonds, but will be reimbursed from the guaranteed investment contracts. The GICs will continue to remain outstanding and pay interest at rates ranging from 6.89% to 8.16% until 1996 or 1997.
The GIC providers are the Equitable Life Assurance Society of the United States for the Logansport issue, the Prudential Insurance Company of America for the Kokomo issue, and the Mutual Life Insurance Company of New York for the Fox Hollow issue.
In most of the black box deals that were sold in the mid-1980s, the letter of credit provider posted a direct-pay letter of credit for the mortgage note to the property. A mortgage broker was to arrange for participation interests in the mortgage note to be sold to investors. The proceeds from that sale were to be used to buy a guaranteed investment contract to back the direct-pay letter of credit.
But in many of the deals, the mortgage note was never sold to investors, and the bond proceeds were used instead to purchase the GIC.
Sumitomo officials said they were not aware that bond proceeds had been used to purchase the GICS in the three black box deals. They said they thought the money to purchase the GICs came from third-party investments.
The Logansport and Kokomo black box deals were underwritten by the now-defunct R.H. Moulton & Co. in Los Angeles. The bond counsel was Mitchell, Staser & Shaw in Evansville, Ind. The special tax counsel was Camfield & Christopher in Glendale, Calif. Bromley Capital Corp. was the mortgage broker.
The Fox Hollow deal was underwritten by the now-defunct Birr, Wilson & Co. in Los Angeles. Holme Roberts & Owen in Salt Lake City was bond counsel. Camfield & Christopher was special tax counsel.
Sumitomo officials said the bank has provided direct-pay letters of credit in other black box deals, but refused to disclose them.