WASHINGTON -- State and local issuers may try to advance refund so-called multipurpose bond issues before Aug. 15, when arbitrage rules containing more restrictive provisions and a possible glitch take effect, bond lawyers and investment bankers said last week.
"This is one area in which I think we're going to see more transactions being done before the new rules kick in," said an investment banker who asked not to be identified.
While some bond lawyers and underwriters predicted issuers will try to rush advance refundings of multipurpose issues to market to beat the new arbitrage rules, others said they do not see any rush right now and that the refundings that are being done were spurred by low interest rates, not changes in rules.
The final arbitrage rules, which do not go into effect until Aug. 15 for issuers that chose to continue using the existing rules, drop a provision from the previously issued refunding rules that gave issuers more flexibility, and hence greater interest rate savings, in determining how a multipurpose issue could be divided up so that some of the bonds can be refunded.
Bond issues are multipurpose when they include both refunding bonds and new-money bonds, or when they include bonds that were issued for several projects.
The new rules, in what some bond lawyers say is a glitch, also contain a restriction that had been included in, then dropped from, earlier refunding rules that limited issuers from going back more than one generation of multipurpose issues to refund bonds that otherwise could not be refunded under the tax law limits.
The new arbitrage rule restrictions revolve around arbitrage-related refunding rules that the Internal Revenue Service issued last year. Those rules allowed an issuer to treat the different portions of a multipurpose issue as separate issues so that some of the bonds could be advance refunded even if the entire multipurpose issue could not.
An issuer that sold a bond issue containing refunding and new-money bonds could use the multipurpose rules to refund the new-money bond portion of the issue, even if the refunding bond portion could not be refunded again because of the tax law limits on the number of times bonds can be advance refunded.
Under the Tax Reform Act of 1986, private-activity bonds cannot be advance refunded. Governmental and 501(c)(3) bonds can only be advance refunded once if they were issued after Dec. 31, 1985, and twice if they were issued on or before that date.
The 1992 refunding rules gave issuers two methods for dividing up their multipurpose issues, but the new arbitrage rules drop one of these.
The new rules eliminate the so-called 90% average weighted maturity test, under which, the average weighted maturity of the refunding bonds could not be less than 90% of the average weighted maturity of the bonds being refunded.
Market participants liked this method of dividing up their multipurpose issues because it gave them the flexibility to refund a greater percentage of high-coupon bonds so they could achieve a greater interest rate savings.
The new rules, instead, keep the pro-rata method that was in the 1992 refunding rules and add other options for dividing up multipurpose issues.
But the new options generally are not be as favorable as the 90% average weighted maturity method, bond lawyers said.
In the pro-rata method, each of the remaining outstanding bonds in the multipurpose issue is divided up to reflect the percentages of the new-money and refunding portions of the issue. So if 50% of the multipurpose bonds were new money and 50% were refunding, each set of bonds with the same maturities and interest rates in the issue would be divided up by the same percentage.
Another option is the so-called "mirror method," under which the debt service for the new refunding bonds must mirror the debt service of the refunding bonds in the multipurpose issue. Under this option, if the refunding bonds in the multipurpose issue had a level debt service, the new refunding bonds must also have level debt service.
A third option in the new rules allows an issuer to divide up a multipurpose issue, based on the economic lives of the various projects that were financed. For example, if the new-money part of a multipurpose issue financed a building with a 30-year economic life and the refunding portion refunded bonds that had been used to finance equipment that only had an economic life of five years left, it would be reasonable for the issuer to refund the higher coupon bonds because the new-money portion of the issue was used for a longer-term project.
The rules also allow issuers to use other "reasonable" methods if the first three would have been prohibited by state laws or bond documents as of July 1, 1993, when the new arbitrage rules generally took effect.
The other restriction that bond lawyers are calling a glitch revolves around a so-called one-generation rule that the IRS included in the refunding rules issued in 1992. That rule said that issuers could only go back one generation of multipurpose bond issues in dividing them up for refunding purposes.
Last September, however, the IRS published a correction to those rules saying that the one-generation restriction applied only for transferred proceeds purposes and not to the refunding limits. In other words, an issuer could not go back more than one generation of a multipurpose issue to get more favorable transferred proceeds treatment, but it could go back to refund bonds that otherwise could not be refunded under the tax law's refunding limits.
The new arbitrage rules contain the old one-generation rule and fail to carry the correction. Treasury and IRS officials said they are looking into the matter, but declined to call it a "glitch" at this point.