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Read Pat Boylston's e-mail for a more complete explanation, but, the bottom line is that borrowing solely to post collateral is a risky deal for the bond-holders, because it is unclear how the IRS would treat this transaction. On the other hand, PGB suggests that a tax-exempt pre-pay for power is do-able if, and it's a big "if," you can get bond counsel to sign off on a legal opinion blessing the transaction.---sch
-----Original Message----- From: Boylston, Pat [mailto:PGBOYLSTON@stoel.com] Sent: Monday, October 29, 2001 12:27 PM To: Hall, Steve C. (Legal) Subject: RE: Tax-exempt financing Something is in the air. This is my third pre-pay question today. Very complicated subject because it falls into a gray area where the IRS has not been very comfortable creating bright lines because of a perception of the potential for abuse. Reason for IRS fear, probably justified, is that one very central and primary theme of regulation in this area is to prevent a municipal entity borrowing at "subsidized" tax-exempt rates and investing the money (in whatever form of investment you can think of) in something producing a higher return. Yes, the classic "arbitrage" play. Concern has been that by pre-paying municipality was, in effect, making an investment in the physical energy asset and there would be some form of return, real or expected, which needed to be tested to see if it violated the regulations rule governing permissable investment return on tax-exempt funds. Despite that, IRS did issue a ruling based on facts out of Alabama in the early-mid 1990s which sanctioned an electrict energy and capacity pre-pay deal. Facts were pretty tight. They included, either expressly or by pretty clear implication, that the energy and capacity were solely for the use of the pre-paying entity. Also, the deal was set up for business reasons independent of the fact that the pre-pay money could be borrowed at tax-exempt rates. (There are also other factors cited which one would need to work through if a real deal is being proposed.) In the late 1990s the area became very problematic because of a series of very large natural gas pre-pay deals which came to market. This are still being debated and are technically still under IRS review. Most of these had a significant element of purchase for resale. Some also included the purchase of gas in the ground assets as opposed to the obligation of an independent third party to deliver as existed in the Alabama private letter ruling. Following the IRS's announcement that it was going to review the entire pre-pay area the blockbuster public pre-pay deals came to a halt. That is not to say they are not still doable. However,the risk profile is very different than it was five years ago and the ability to get an approving outside legal opinion may be a significant closing issue. All that being said, the most "middle of the road" deal would be a pre-pay of a contract to provide electric energy and capacity. If I remember correctly, the Alabama ruling also involved some element of extending an existing relationship rather than being a totally "new" contract with a new buyer. There is some precedent for munis to bond for large ascertained financial oblgations, such as the WPPSS participants who issued bonds to fund the payment of their shares of the liability while awaiting their insurancers settlement of their claims. I do not think borrowing to cover margin payment obligations is specifically covered in the IRS regulations. However, there are several policy/ general principles reasons that I do not think it would fly. Same thing for borrowing to pay SOLELY for loc costs. Although paying for the LOC portion of a bricks and mortar transaction is not a problem. A number of other issues are also raised which would have to be worked through. For example, if the purpose is borrowing to pay for an LOC, how much do you borrow. One year's 150 bps fee? Several years fees? Do you cash collateralize the LOC, which is just an investment to secure the LOC and which then has to go through the IRS investment return regulations (although in fact you can do this if linked to a bricks and mortar type situation although you are forced by the way the regulations work to be negative on your investment spread borrowing to investment return.) In general, tough but not impossible to put together a pre-pay energy deal. Not a happening thing with the financial margin/ LOC transactions. -----Original Message----- From: Hall, Steve C. (Legal) [mailto:Steve.C.Hall@ENRON.com] Sent: Monday, October 29, 2001 10:27 AM To: Boylston, Pat Subject: Tax-exempt financing Pat, We have a few quick questions relating to tax-exempt financing. 1. Can munis use tax-exempt financing to pre-pay for power? 2. Can munis use tax-exempt financing to meet financial obligations relating to power purchases, e.g., use the cash to post margin or pay for a letter of credit? Thanks, Steve < -----Original Message----- < From: Shields, Jeff < Sent: Monday, October 29, 2001 9:44 AM < To: Hall, Steve C. (Legal) < Cc: Calger, Christopher F. < Subject: muni margin calls < < Steve, < < I believe muni's can not use tax exempt financing to pre-pay for < power. However, do you know if there is a mechanism to prepay using < tax exempt debt on a margin call? < < Jeff ********************************************************************** This e-mail is the property of Enron Corp. and/or its relevant affiliate and may contain confidential and privileged material for the sole use of the intended recipient (s). Any review, use, distribution or disclosure by others is strictly prohibited. If you are not the intended recipient (or authorized to receive for the recipient), please contact the sender or reply to Enron Corp. at enron.messaging.administration@enron.com and delete all copies of the message. 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