WASHINGTON -- The Department of Housing and Urban and Development wants the Internal Revenue Service to issue a ruling allowing bonds to be refunded even though they already were redeemed last year when the Presidential Towers coplex in Chicago defaulted on its federally backed mortgage.
HUD underscored its "interest in the ruling request" in a recent letter to te IRS that also noted that if such a ruling were granted, HUD would "cooperate fully" with the refunding. The letter, which was sent to IRS lawyer David Selig, was signed by Albert B. Sullivan, deputy director of HUD's Office of Multifamily Housing Management.
The stakes are high for HUD, which wants the ruling because tax-exempt bonds would help limit potentially heavy losses from the default of the mortgage, the largest default in HUD's history.
The $171 million bond issue for Presidential Towers was sold by the city of Chicago in 1987 to refund construction loan notes that had been issued in 1983. But when the HUD-backed 1987 issue defaulted in 1990, HUD was forced to pay out roughly $163.7 million, which was used to redeem the remaining outstanding bonds, a HUD spokesman said.
IRS officials refused to comment on the Presidential Towers bonds but said generally that the agency is not likely to issue any rulings on refundings this year while it is in the midst of finalizing rules on refundings. Those rules, which will help clarify when bond issues are refundings, are expected to be issued next year.
The proposal to refund the already redeemed bonds is only one of several options that the developmer, Habitat Co., and HUD have been discussing as a means of limiting HUD's financial losses on the complex, informed sources said.
Under the proposal $70 million to $80 million of tax-exempt refunding bonds would be issued and the proceed would be used to pay HUD back for a portion of the money it paid out on the isurance claim.
The bond proceeds would be used to acquire the mortgage loan from HUD so that it could be help on behalf of bondholders and pledged to the payment of the bonds. The debt service on the bonds would be paid with revenues from the apartment complex.
HUD would then take out a second mortgage note from the developers for the remaining portion of the money it paid out on the insurance claim.
According to the sources, bond lawyers from the firm of Katten Muchin & Zavis in Chicago asked the IRS two months ago to issue a private letter ruling allowing the refunding on grounds that several private letter rulings published years ago permitted, under certain circumstances, a taxable refunding of tax-exempt debt and then a tax-exempt refunding of that taxable debt. The lawyers said the proposed refunding could be viewed in a similar light, except that, in this case, HUD provided the taxable financing by paying off the insurance claim, the source said.
Katten Muchin's lawyers would not comment on the proposal.
But sources familiar with the request said that the IRS officials told the bond lawyers they would not even consider the ruling request unless an issuer was interested in selling the bonds. The developer, Habitat Co., approached the Illinois Development Finance Authority, which agreed to consider the issue.
The authority had planned to discuss the possibility of adopting a resolution on the refunding bond issue today. But Ronald Bean, the authority's executive director, said yesterday that Habitat Co. had withdrawn it's application for the bond issue. Mr. Bean said he did not know why the application was withdrawn. But Douglas R. Woodworth, a spokesman for Habitat Co., said yesterday that the application was "premature" because discussions are still ongoing with HUD.
The withdrawal of the application came after Mr. Bean told reporters that, if the authority issued the refunding bonds, the developers would have to set aside some of the Presidential Towers apartments for low- and moderate-income residents. The 1987 bond were exempted from the tax law's 20% low- and moderate-income set-aside requirement by a special transition rule that was inserted into a federal tax bill by House Ways and Means Committee Chairman Dan Rostenkowski, D-Ill.
By refunding the bonds, the transition rule would still apply and the set-aside requirements would not have to be met. Parties to the proposal pointed out that meeting those requirements would mean less revenue coming into the financially strapped apartment complex.
"If there's an economic way to reduce the cost to the federal government of holding onto this property, the option should at least be looked at," said one party to the proposal who did not want to be identified.
Another option under consideration is foreclosure, in which HUD could be expected to lose a lot of money. An alternative could be to possible create a new first mortgage that could be insured and sold in the taxable market, and a second mortgage that would be held by HUD.
"Whether it's a refinancing or restructuring or something else, something will have to be done here. The problem will not go away," Mr. Bean said.