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By: Samuel Gruer
The National Association of Bond Lawyers (NABL) held a conference this month where a panel entitled “Tax Hot Topics” inspired a discussion on taxable advance refundings. Specifically, there was debate about whether an escrow established with the proceeds of a taxable advance refunding of tax-exempt bonds was yield restricted to the yield on the prior bonds and, if so, when it would be yield restricted. This has implications for both the structuring of the taxable advance refunding as well as the escrow itself.
As our readers are aware, tax-exempt advance refundings of tax-exempt bonds are no longer permitted under current tax law. Ironically, a taxable advance refunding introduces new complications that seem to be vexing the bond counsel community. Some members of the community are convinced that under the so-called Replacement Proceeds rule, a defeasance escrow which is pledged to a tax-exempt bond transaction is treated as proceeds of that issue and therefore yield restricted to that transaction from inception. Under this viewpoint, due to the yield restriction, SLGS would be available for that escrow if they provided an economic benefit.
During this NABL panel, many tax attorneys took a different view. Specifically, they argued that under the Universal Cap rule, the escrow must be considered proceeds of the taxable refunding bonds and NOT be yield restricted. Under this viewpoint SLGS might not be eligible because the taxable bond proceeds are not “subject to yield restrictions and arbitrage rebate requirements under the Internal Revenue Code” as described in the SLGS regulations. More importantly, this potentially introduces a new complication. If the taxable refunding bonds amortize more quickly than the escrow securities, the Universal Cap rules might cause a portion of the escrow to become transferred proceeds of the prior tax-exempt bonds in the future. In such a situation, that portion of the escrow would transfer at its then current market value. If interest rates are significantly higher at that time, the transferred portion could be deemed to take place at a yield in excess of the prior arbitrage yield restriction. In other words, an escrow that was established with a yield below the arbitrage yield of the prior bonds could, in the future, be deemed to be yielding in excess of the arbitrage yield. While this issue can be cured through yield reduction payments, such payments would have the effect of retroactively reducing the savings generated by the refunding in the future by an amount that cannot be determined in advance.
Blue Rose offers no opinion as to which of these interpretations is correct but encourages borrowers and issuers considering taxable advance refundings to discuss this topic with their bond counsel. To help determine the benefit of open market versus SLGS portfolios as well as to run sensitivity analyses regarding any potential future yield reduction payments, please contact your Blue Rose representative.
About the Author
Sam Gruer, a 30-year municipal market veteran, joined Blue Rose in June 2017 as a Managing Director and leader of the firm’s reinvestment business unit. During his career, Mr. Gruer has advised on and/or executed bond and derivative transactions totaling more than $30 billion. Serving in a fiduciary role, Mr. Gruer guides his clients through the debt/swap/reinvestment transaction process by making strategic recommendations based on sound, thoughtful and sophisticated analysis. He also offers expert advice on determining the optimal structure for reinvestment of bond proceeds by evaluating risk tolerance, identifying legal restrictions and estimating cash flow needs for his clients.Mr. Gruer can be reached at sgruer@blueroseadvisors.com
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