WASHINGTON - Bonds from mid-1980s black box and collapsible escrow deals that have been or may be declared taxable by the Internal Revenue Service are trading at a premium because their coupons are high compared with today's rates, traders said this week.
The coupons on many of those deals ranged from 6.75% to 8.00% when they were first issued or remarketed to public investors in 1985 and 1986, the traders said. That compares with yields this week of 3.40% to 3.75% for taxable securities with comparable maturities, they said.
The investor who is buying these bonds "doesn't care whether they stay tax free or not, he's buying the yield," which has been running 150 to 160 basis points above the yields of comparable taxable securities, said David Owens, a vice president and manager of the municipal department at Marcus, Stowell & Beye Inc. in Fort Lauderdale, Fla.
"It's a no-lose situation," said Mr. Owens, whose firm is one of the biggest traders of these bonds among the handful of firms around the nation that trade them. "Even if they become taxable" and the IRS taxes the investor's interest earnings, "the investor still will come out good" because their yield is above taxable market yields, he said.
Earlier this month, Mr. Owens was offering $250,000 of the Springfield, Mo., Industrial Development Authority's $10 million Glenstone Business Park black box issue at a yield of 5% and a premium of 103% of the par amount. The offering of the bonds, due December 1993 and originally sold at par with a coupon of 7.75%, came about a week after it was reported that the IRS was taking steps toward taxing the holders of the bonds.
Mr. Owens said he figures his firm has traded a total of about $50 million of various black box bonds during the last four years, recently mostly to investors interested in taxable investments.
It's just a bonus if they don't become taxable" because then the investor "got away with" a better-than-taxable rate for a bond whose interest earnings were never taxed, said Tom Lundon, a vice president at Wolfe & Hurst Bond Brokers Inc., a broker's broker in Jersey City, N.J. "But it's very likely that they'll be taxed so everyone anticipates that. "
Mr. Lundon said Galveston, Tex., County Housing Finance Corp. sold a $13 million black box issue for the Huntcliff apartments, one of at least two dozen deals closed without cash by Matthews & Wright Inc. in late 1985, with a coupon of about 7.75%. Those bonds are currently being offered at a yield of 5% and at a price of about 103% of the principal amount of the bonds. That compared yesterday to a yield of 3.40% for Treasuries with a comparable maturity of Dec. 1, 1993.
The Huntcliff bonds are selling at a premium even though the IRS sent Galveston County Housing Finance Corp. a notice in August 1991 saying that the bonds were not tax exempt and that the IRS would try to tax the bondholders if the issuer did not move toward negotiation of a closing agreement. In a closing agreement, the issuer pays the IRS compensation for lost arbitrage or back taxes in return for the IRS' agreeing not to tax the bondholders.
These issues are attractive, not only because their coupons are high compared with today's market, but also because they were structured so that the the bonds remain outstanding for years, even though the proceeds were not used for projects and the bondholders are likely to be paid in full. Many of the deals were backed with guaranteed investment contracts that cannot be broken and are to remain outstanding until the end of 1993.
The Huntcliff issue, for example, is backed by a guaranteed investment contract from Crown Life Insurance Co. in Toronto, which currently has an AA- rating from Standard & Poor's Corp.
"Part of the attraction is that they're solely supported by Crown Life, a good company, and for 14 months out it's not a big risk" that Crown Life will have such financial problems that it cannot honor the terms of the GIC, said Mr. Lundon.
The traders of these bonds, however, were not happy when Sumitomo Trust & Banking Co. last month declared defaults and asked Premier Bank to accelerate payment of four black box issues sold for issuers in Utah, Indiana, and Florida. "That caught us a little by surprise," said Mr. Lundon. "Most people thought those bonds would be noncallable to maturity." he said.
Many traders, however, shy away from the questionable mid-1980s deals.
"I don't like doing them, personally," said Jon Tuft, an assistant vice president at Stifel, Nicolaus & Co. "It's too much of a headache and too much explanation to the retail customer."
Traders of these bonds, he said, often get calls from investors who are panicked about a story in the press or a notice from the trustee bank about IRS enforcement action.
"It's not really great for the industry to have to explain how these bonds could become taxable," Mr. Tuft added.
