WASHINGTON -- The municipal bond industry has a new buzz word: TEMIC.
Is it a new brand of designer sneakers? An allen from the movie "The Coneheads"?
Neither of the above.
A TEMIC is a proposed investment vehicle for municipal bonds that industry officials say could dramatically increase the secondary market for derivatives, improve the liquidity of the overall tax-exempt bond market, and lead to lower borrowing costs for states and localities.
TEMICs, or tax-exempt municipal investment conduits, are proposed pass-through tax structures under which tax-exempt bonds could be restructured into new securities that would still provide tax-exempt interest to investors.
TEMICs would be modeled after REMICs, or real estate mortgage investment conduits, which are used to pool and securitize mortgage loans.
"It's basically the tax-exempt bond equivalent of a REMIC," said a lawyer who did not want to be identified.
In a TEMIC, tax-exempt bonds that have already been issued could be pooled and put into a trust, derivatives or other products could be created from the pooled bonds, and the various cash flows from the new products could be passed through to investors who would purchase certificates in the trust.
The certificates would be backed by the bonds. The trust would be a tax-exempt entity, and all of the tax-exempt cash flows from the bonds would flow through the trust to investors.
The structure would also work for single bond issues.
For example, if a New York State year, fixed-rate bond issue to finance new money construction, the bond issue could be put into a trust and restructured into variable-rate and inverse floater bonds. The floating-rate bonds could provide short-term variable interest rates to a corporation that needs them.
The inverse floater bonds, which would float inversely to rates in the short-term market, would, provide mutual funds with the opportunity to earn above-market yields.
The TEMIC concept was first proposed earlier this year by Arthur M. Miller and Aaron Gurwitz, two vice presidents at Goldman, Sachs & Co. in New York. It has since been embraced by the Public Securities Association, which is now trying to win the support of Treasury officials and members of Congress.
"It is a good idea," said Micah S. Green, executive vice president of the PSA. "It could increase liquidity and lower the cost of borrowing in the municipal market. It would not create new tax-exempt income. It would just be a question of packaging it correctly in a pass-through entity."
Tax laws would have to be changed to permit the creation of such structures and to allow tax-exempt interest to be passed through them to investors.
The TEMIC proposal surfaced too late to be considered in pending tax legislation, Green said. But Goldman officials and lawyers from Cleary, Gottlieb, Steen & Hamilton in New York, are developing a legislative proposal that they hope will be considered by Congress later this year or next year as part of the next tax bill.
TEMICS were proposed in part to help increase the market for municipal derivatives and other complex tax-exempt products, according to Miller and other industry officials.
Investors have been willing to pay more for derivatives and other products that can be tailored to fit their needs. But too often issuers are either reluctant or unable to employ these complex new structures because they are committed to issuing only "plain vanilla" bonds, or they are subject to state law or other restrictions.
Some investement banking firms have created derivatives in the secondary market by "securitizing" tax-exempt bonds through partnerships or grantor trusts. However, these arrangements have proven to be cumbersome and have raised tax law concerns because generally there is no tax law or regulatory road map for restructuring municipal bonds in the secondary market.
"No one's been able to do secondary market derivatives very easily," said Miller. "~The tax questions surrounding them are complex."
"If we can make a derivative created in the secondary market as clean as in the primary market, in terms of tax analysis and everything else, we think it will make the municipal market mom efficient and that this will therefore lower interest costs for municipalities," he said.
Miller and others reason that if a new investment vehicle can be established under the tax laws so tax-exempt bonds can be restructured into products that are more attractive and less costly to investors, the demand for tax-exempt bonds will increase.
"When you increase the efficiency of structuring and decrease the transaction costs, the net effect is that mortgage loans or tax-exempt bonds bring a higher price in the secondary market," said George C. Howell 3d, a lawyer with Hunton & Williams in Richmond, Va., and head of the American Bar Association's committee on financial transactions.
"If you can get a higher price in the secondary market, you can afford to charge a lower interest rate in the primary market," said Howell.
Industry officials hope TEMICs will do for the tax-exempt bond market what REMICs have done for the taxable mortgage market.
REMICs, which were first authorized by the 1986 Tax Reform Act,. dramatically increased liquidity in the mortgage market and reduced interest costs for borrowers, industry officials say.
An industry position paper on TEMICs estimates that REMICS have saved owners of single-family homes with conventional mortgages between five and 10 basis points in interest costs since 1986.
"That translates into savings of between $50 and $100 million in interest expenses on just those loans acquired by mortgage pools since 1992," the position paper says.
But TEMICs may be a tougher sell than REMICs, most industry officials concede, because they will pass through tax-exempt interest.
The Treasury and Congress will want to be sure that any tax-exempt interest that is passed through a TEMIC is really tax-exempt, and that TEMICs do not create more tax-exempt interest than the underlying bonds.
"The toughest concept is passing through the tax-exempt interest," said Green.
But Miller said the concept should not cause tax law concerns.
"What we're trying to do is to allow municipals to be sliced and diced in a way that gives investors what they want but does not in any way create more tax-exempt interest than was there to start," Miller issuers money."
