IRS Auditing Build America Bonds Issued by San Antonio, Chicago District

The U.S. Internal Revenue Service is auditing $375 million in Build America Bonds issued by San Antonio and $600 million from a Chicago sewer district, five months after the agency said it would scrutinize sales of the federally subsidized debt.

San Antonio officials notified bondholders this week that the IRS will audit Build Americas the city sold in June 2009 for its municipal utility, CPS Energy. The agency, which routinely audits tax-exempt bond issues, is seeking information on who bought the taxable securities, the price they paid and how the bonds subsequently traded, according to a copy of a letter to the utility dated Oct. 14.

The IRS said in the letter that the examination was routine and that it had “no reason to believe” that the Texas city’s debt issuance failed to comply with applicable tax requirements.

“They’re being prudent and just making sure that people have proper documentation and that they’re following the guidelines,” said Paula Gold-Williams, the chief financial officer of CPS Energy, in a telephone interview today. The letter from the IRS was addressed to her.

The Metropolitan Water Reclamation District of Greater Chicago posted a one-page letter today to bond buyers, saying the IRS sent it a letter Sept. 24 notifying it that its sale of $600 million of Build America Bonds in August 2009 will be audited. The U.S. Securities and Exchange Commission is also examining the bond sale. Brad Waterman, a lawyer for the district, confirmed the letter and declined further comment.

Build Americas

Build America Bonds are the fastest-growing segment of the $2.8 trillion municipal market. The program, set to expire at year-end, was created by Congress last year as part of the American Recovery and Reinvestment Act. The U.S. Treasury pays 35 percent of the annual interest cost if states and local governments sell Build Americas instead of tax-exempt bonds for new capital projects. There have been $148 billion of the securities sold, according to data compiled by Bloomberg.

The disclosure of the audits follows a plan announced this year by IRS officials that they would begin examining the sale of the securities. The agency said in February it sent a questionnaire to issuers asking whether they monitor the trading of their Build America Bonds soon after they are issued and whether any of the securities were purchased for the accounts of underwriters, which could reap added profits if they were sold at below-market prices.

Price Gains

Steven Chamberlin, compliance manager in the IRS’s tax- exempt bond unit, said in a May 25 conference call organized by the National Association of Bond Lawyers that the agency would follow up the questionnaires with audits. Dean Patterson, an IRS spokesman, declined to comment.

The queries came after prices of some of the issues jumped in initial trading, delivering potentially quick profits to those who were let in on the offering.

San Antonio sold the $375 million of electric and gas revenue bonds the first week of June last year. The securities, which mature in 2039, were priced to yield 5.985 percent, equal to the coupon rate, according to Bloomberg data. The bonds initially traded at 100 cents on the dollar on June 2 and rose to as much as $1.04 on June 4, which meant the yield fell to 5.7 percent, according to data compiled by Bloomberg. The subsidy the federal government pays is based on the coupon.

New York-based Goldman Sachs Group Inc. was the senior manager of the seven-member banking team that underwrote the securities. Michael DuVally, a Goldman Sachs spokesman, declined to comment immediately.

The sewer district’s Build America sale cost taxpayers $8 million in unnecessary interest and resulted in a bonanza for bankers, Bloomberg News reported in December. The issue was arranged by a 12-member banking team led by Mesirow Financial Inc. and Loop Capital Markets LLC, which are both based in Chicago.

To contact the reporters on this story: Michael McDonald in Boston at mmcdonald10@bloomberg.net; William Selway in Washington at wselway@bloomberg.net.

To contact the editor responsible for this story: Mark Tannenbaum at mtannen@bloomberg.net

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