California changed the payment schedule Friday on its $4 billion offering of revenue' anticipation warrants after a brouhaha arose over possible tax problems.
"Our plan was always to issue fully tax-free notes," state controller Gray Davis said through a spokeswoman. "This is a technical correction and is fully consistent with our original intentions."
Davis could not be reached for further comment.
Following inquiries from investors, California announced Friday morning that interest on all Series C and D warrants would be paid in two installments. The deal was priced on Wednesday.
The first payment would be made July 25, 1995 and the second would take place at maturity on April 25, 1996. Originally, the bonds only paid interest at maturity in 1996.
Sources familiar with the situation said Friday that the change in payment schedule was made to prevent the bonds from being subject to taxation under the market discount rule should interest rates rise.
According to one market source, the warrants were sold with a 5 3/4% coupon at a price of 101.468 to yield 4.84%. The Street assumed that because the warrants were sold at a premium they were protected from the market discount rule, unless the yield rose above 5 3/4%.
However, the Internal Revenue-Service requires that securities have to pay interest at least once a year, or be considered original-issue discount bonds.
Consequently, though the warrants looked like premium bonds, they could potentially have become market discount bonds, and taxable, if yields on the warrants rose above a certain level.
If the Raws were sold at a yield between 4.84% and 4.99%, the discount from the original-issue price would be subject to a capital gains tax. If the warrants were sold at a yield equal to 5% or higher, the discount would be taxed as ordinary income.
The fact that a security must pay a coupon at least once a year or become an original-discount bond "is not an esoteric tax point," a second market source said, but something all banking professionals should know.
Financial adviser Evensen Dodge Inc. could not be reached for comment late Friday. Orrick, Herrington & Sutcliffe served as bond counsel. Orrick Herrington referred all questions to the controller's office.
Turning to Friday's session, dollar bonds and high-grade issues both ended unchanged in light activity.
"It's so quiet I can't believe it," one source said, "This is one of the lightest. volume days we've had in a while.
The 30-year Treasury bond closed slightly less than 1/4 point lower to yield 7.55%, as no fresh news arose to inspire trading. The market was largely sidelined ahead of economic indicators to be released this week and new Treasury supply.
In debt futures trading on Friday, the September municipal contract settled up more than 1/8 point at 90 22/32s.
In other news, Standard & Poor's Blue List of municipal bonds rose $106.7 million on Friday to $1.70 billion.
The 30-day visible supply of municipal bonds for today totals $3.693 billion, down $143 million from Friday. That comprises $1.97 billion of competitive bonds, up $107.8 million from Friday, and $1.73 billion of negotiated bonds, down $251 million from Friday.