DALLAS -- Fayetteville, Ark., officials are strongly considering accelerating payment on $33 million in defaulted bonds because a traditional defeasance could require the city to use over $1 million of nonbond funds.

"We have enough money in existing funds to do the acceleration," said Mary Ella Earle, a spokeswoman for Arvest Trust Co., the trustee for the deal. "We think we would have a shortfall if we did a defeasance."

Llama Co. of Fayetteville, the underwriter of the 1990 deal, is calculating how much money would be needed to cure the default through acceleration or defeasance, according to city officials and Arvest Trust.

Under the terms of most indentures, the payment of bonds can be accelerated and paid in full in the event of a default. In a defeasance, the payment to bondholders is secured by structuring a portfolio of government securities to match the existing maturity schedule of municipal bonds.

A defeasance can be financially more advantageous for bondholders, particularly if the outstanding debt is high-coupon. However, the Fayetteville deal is lower coupon because it is triple-A rated and insured by Capital Guaranty Insurance Co.

At a May 5 meeting at the Fayetteville Hilton, about 25 bondholders voted in favor of an acceleration.

"It's up to the bondholders and the insurance company," said Ben Mayes, director of administrative services for Fayetteville. "It's not really the city's call."

However, the city council must vote on what action to take, although the credit enhancement agreement with Capital Guaranty gives the San Francisco-based insurer the final say. Officials said the acceleration could take place later this summer.

"We'd like to see the acceleration for economic reasons," said Michael Gallagher, senior vice president at Capital Guaranty, who says it does not expect to pay a claim to remedy the default. "That's what we've asked for."

While Llama Co. has not completed its analysis, a spokesman at the firm said the city would have to contribute up to $1.5 million of its own funds to complete a traditional defeasance even though an estimated $32 million of bond funds is still held by the trustee.

Arvest froze proceeds from the sale of the 20-year serials after local taxpayers filed suit in October 1991 challenging the legality of a one-cent sales tax designated to retire the bonds. In January, the Arkansas Supreme Court ruled that the tax could not legally secure the bonds because the planned use of money varied from the legal authorization granted by voters in a 1988 referendum. The ruling triggered a default.

Despite the default and the court fight that ensued, bondholders have not missed a payment. Last week, Arvest distributed an estimated $1.08 million for the scheduled May 15 debt service payment.

The plan to defease or accelerate payment on the bonds follows a late April settlement between the city and taxpayers in which both sides agreed that bond funds would not be subject to claims for refunds from the illegally collected sales tax.

City officials have estimated that as much as $11 million in sales tax was illegally collected, and they have agreed to refund the money to any business or individual that can prove they are owed the tax. Because proving the tax was paid will require documentation, Fayetteville officials have estimated that only about $4 million may have to be repaid.

Taxpayers have four months beginning June 1 to present their claims.

To repay the money, the city will receive some $2 million in sales taxes that had been transferred to the trustee before the state Supreme Court made its ruling. Potentially, Fayetteville may have to use other general fund monies to settle claims.

The city could use surplus bond funds to pay claims. Earle and others interviewed said that by accelerating payment on the defaulted issue, Fayetteville could see a windfall from leftover proceeds. Officials could not estimate how much might be available, though one source predicted it could exceed $1 million.

If any money is left over, Mayes said, the city council might opt to use it for capital improvements that were to be funded with the 1990 issue. "We would probably just hold onto that money until the claims were paid," he said.

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