CHICAGO -- Cleveland and five other Ohio cities have canceled plans to issue tax-exempt bonds to pay off pension fund liabilities in the wake of Internal Revenue Service concerns that forced Columbus to scrap its deal last week.
Finance officials in the cities said this week that they had been preparing or considering bond issues totaling about $126 million in anticipation of a successful tax-exempt bond deal in Columbus. Columbus planned to sell $27 million of bonds and use the proceeds to pay off its liability to a state pension fund.
But the IRS stepped into the Columbus deal during its final pricing on Dec. 1, raising concerns about the tax status of the bonds. Hugh Dorian, Columbus' auditor, canceled the deal after a lengthy telephone call with IRS officials and has since decided to seek a private letter ruling from the federal agency.
In the meantime, the auditor's office plans to seek city council approval as early as next week to issue taxable variable-rate notes that could be converted to long-term fixed-rate or short-term variable-rate tax-exempt obligations should the IRS rule the deal can be done on a tax-exempt basis.
Officials in Cleveland, Springfield Akron, Youngstown, Dayton, and Toledo said they are awaiting the IRS ruling on the tax matter. Meanwhile, issuing taxable bonds may not be a feasible option for the cities, the officials said. Most of the cities had been working with Banc One Capital Corp., the senior underwriter on Columbus' deal, to help structure their transactions.
Steve Strnisha, Cleveland's finance director, said he had been readying a $70 million bond issue to make a lump sum payment to the Ohio Police and Fireman's Disability and Pension Fund.
Cleveland owes the fund about $108 million that it was scheduled to pay between now and 2035. A discount rate of 65 cents on the dollar that the pension board set in October would bring the city's liability down to less than $70 million.
An Ohio law that took effect this year allows cities to issue general obligation bonds to prepay the $400 million of total liability they owe the fund in return for the discount. Columbus was the first city to obtain a discount agreement with the fund.
Strnisha said Cleveland's bond issue has been canceled because of IRS concerns that Columbus' deal may have been contrary to the spirit of the Tax Reform Act of 1986. He said doing the deal on a taxable basis like Columbus may not be feasible for Cleveland, given the higher amount of the bond issue and Cleveland's lower credit ratings than Columbus.
Cleveland hoped to save $250,000 a year by issuing the bonds. The money represents the difference between debt service on the bonds and the amount the city would have had to pay the pension fund. Strnisha said he was disappointed in the IRS' action, saying the loss of the savings could mean five fewer police officers for the city.
He said the city had been planning the issue "to help ease come fiscal pressure so we don't have to knock on the door" of the federal government.
Robert Mauch, treasurers of Springfield, also took issue with the IRS, saying it was an example "of the feds holding us back."
"There just seems to be one thing after another with the IRS," Mauch said. "We're trying to operate efficiently and cut costs, and this happens."
Springfield planned a $3.5 million bond issue to take out its $3.5 million liability to the pension fund. Mauch said the annual savings for the city of 70,000 people was estimated at $15,000.
Akron was also preparing a $14 million to $15 million bond issue to save about $35,000 a year, according to Rick Merolla, the city's finance director. The city, which owes the fund about $31 million, had taken a wait-and-see approach to the issue.
"We were always fearful that what happened to Columbus would happen," Merolla said.
Merolla said that a taxable deal would probably eat most of the savings that Akron hoped to gain.
Youngstown was ready to follow Columbus' lead and roll its approximately $5.5 million discounted pension fund liability into an issue totaling $20 million, according to David Bozanich, the city's finance director. The city, which owes the fund about $8.5 million, was hoping to save at least $50,000 a year, he said.
Dayton was carefully watching what happened to Columbus as it considered a bond issue to reduce its $20 million to $21 million pension fund liability, said Timothy Riordan, the city's finance director.
"I felt from the start the tax issue had to be resolved and I wanted to wait," Riordan said.
Toledo, which has a $29 million liability with the fund, had been considering an $18 million bond issue to save the city $100,000 annually, according to James Phillips, the city's debt/capital improvements officer. Phillips said the city had concerns about the deal because its bond counsel, Squire, Sanders & Dempsey, also had concerns.
William Conner, an attorney at the law firm, which also serves as bond counsel to Dayton, Youngstown, Akron, and Springfield, said that the firm had concerns from the beggining about doing the deals on a tax-exempt basis.
"We didn't believe the IRS would approve of this technique, so we were telling people to just wait and see," Conner said.
If Columbus had successfully closed the transaction, Conner said his firm would have tried to "get comfortable" with the IRS that the deal was not arbitrage driven.
On the other hand, David Goodman, an attorney at Calfee, Halter & Griswold, Cleveland's bond counsel, said yesterday that his firm agreed with the tax opinion of Arter & Hadden, Columbus' tax counsel, that the bonds could be issued on a tax-exempt basis. Goodman said that nothing has changed his firm's analysis of the opinion, but that he knew of no government "actively pursuing" a tax-exempt deal at this time.
Dean Conley, a vice president at Banc One, said the underwriter is talking with the cities whose transactions it had been helping to structure to determine their next step. Banc One is also working on Columbus' taxable deal, he said.