CHICAGO -- Columbus, Ohio, added a rarely used call provision to its tax-exempt $27.12 million general obligation issue priced yesterday to attempt to overcome market concerns about the tax status of the bonds.
Dan Rohr, a managing director at Banc One Capital Corp., the book-running manager, said yesterday that the provision allows for calling the bonds at par "upon a final determination of taxability."
The provision would take effect if the Internal Revenue Service determines the controversial bond deal taxable and after Columbus has exhausted all legal remedies to maintain the tax-exempt status of the bonds, Rohr said.
Legal sources called the inclusion of such a provision in a GO bond issue rare.
"I certainly have not seen a general obligation bond with a specified call for lost tax exemption," said one bond attorney.
Rohr said the decision to include the provision was made Tuesday after "the market reacted adversely" to an article in The Bond Buyer on concerns voiced by federal and legal sources over the deal.
Federal officials and some lawyers said the deal could run afoul of 1986 tax law changes enacted to prohibit tax-exempt bond proceeds from being directly or indirectly used for pension funds and invested on an unrestricted basis.
Columbus plans to use proceeds from the bond issue to pay off a $26.93 million liability to the Ohio Police and Firemen's Disability and Pension Fund. The deal became possible earlier this year when the Ohio Legislature passed a bill enabling Ohio municipalities to prepay in a lump sum the $360 million of total liability they owe to the fund. The fund, meanwhile, was empowered to discount the liability in return for the lump sum payment.
Columbus, which owed the fund about $41.4 million, was the first Ohio city to apply for a discount, which the fund set at $26.93 million in October. The city has structured the deal as a refunding to refinance the state loan that set up the pension fund in the 1960s. Once the city pays off the loan to the fund, the bond proceeds will be treated as spent and be freely invested by the fund at a yield high enough to make up for the discount.
David Rogers, an attorney with Arter & Hadden, the special tax counsel for the deal, said yesterday that his firm is prepared to deliver an opinion that "the interest on the bonds is excluded from gross income."
Hugh Dorrian, Columbus' auditor, said yesterday he first opposed the inclusion of the tax call provision in the deal because he felt it would indirectly signal that the city had no faith in the tax position.
"I have a lot of faith in Arter & Hadden's position," Dorrian said. "I've been through an awful lot of bond deals in my career, and I feel pretty comfortable with this one."
He said he "finally yielded" to Banc One's contention that the provision was needed for marketing purposes.
"If it saves a few basis points, I said let's put it in there," Dorrian said.
Rohr said that without the provision, the market would have demanded a higher interest rate on the bonds.
The firm tentatively priced serial bonds with yields ranging from 3.45% in 1995 to 5.30% in 2007. A 2013 term was priced with a coupon of 5.35% for a return of 5.50%, and a 2019 term, containing $10 million of the loan, was priced as 5.40s to yield 5.55%.
The bonds are rated AA-plus by Standard & Poor's Corp. and Aa1 by Moody's Investors Service.
Rohr said he is confident the tax call provision will never be used. But numerous municipal market players yesterday voiced concern over the lack of call protection. "It's difficult to sell bonds to an investor that could be called away," said one market player. "Call protection is a critical factor, and there can be a litany of woes when a deal runs afoul of the IRS."
One legal source said the IRS's approach over the last 20 years has been to threaten to pull the tax exemption from a bond issue and then settle with the issuer without changing the tax status on the bonds.
Dorrian said he sent the IRS, at its request this week, an eight-page memorandum Arter & Hadden prepared defending its position on the tax-exempt status of the bonds.