A number of Build America Bond issuers are seeking voluntary closing agreements with the Internal Revenue Service to settle accidental violations of a de minimis premium rule, an IRS official told industry officials in Manhattan yesterday.

Speaking on a BAB panel at the Securities Industry and Financial Markets Association’s municipal bond summit, Clifford Gannett, the IRS’ tax-exempt bond office director, said the agency has received “some requests” from issuers seeking to enter the agreements, though he declined to say how many. He said “too few” of the cases have been finalized for him to discuss them. IRS rules require that at least three cases be closed before they can be publicly disclosed.

Gannett later said in an interview that the IRS has received “a number of requests” for voluntary closing agreements, but because issuers are coming forward “expeditiously,” the agency generally is not seeking a penalty.

Instead, the IRS is working to determine how much of the direct payment should not have been paid to the issuer because of the violation. Issuers of the taxable BABs currently receive subsidies equal to 35% of their interest costs.

Muni issuers are being given the option of either paying the IRS any excess subsidy they received due to the violation, or possibly making “adjustments to [their] debt service schedule,”  Gannett said. Adjusting the schedule would mean the issuer would apply to receive lower direct payments, sources said.

The American Recovery and Reinvestment Act that created BABs requires the bonds not be issued with more than a de minimis amount of premium, which is defined as 1/4 of 1% of the stated redemption price at maturity for the bond, multiplied by whichever comes first: the number of complete years to the maturity date or the first optional redemption date.

The provision was included to ensure issuers do not inflate the rates of their BABs to collect higher subsidy payments from Washington. But both federal officials and municipal issuers in recent months have become concerned about whether issuers are complying with the limit and what will happen if they find they are not.

The voluntary closing-agreement program allows issuers to come to the IRS with problems they have discovered with their bonds, and in exchange the agency generally will accept lesser penalties than if the problems were uncovered in an audit.

Linda Schakel, a partner at Ballard Spahr LLP, said in an interview that she expects most BAB issuers are waiting to see further guidance before approaching the IRS on any pricing issues, even though Treasury Department officials have indicated that any further guidance on BAB pricing will be strictly prospective.

“If someone went in now, they’re either extremely cautious or it was something that really was a big screw-up and not really around the fringes of the definition of issue price,” Schakel said.

Gannett acknowledged that additional guidance is in the works at Treasury, but said he could not provide a time frame for when it might be released.

While BABs have significantly altered the landscape of the municipal market, they will not reach their full potential unless Congress makes the program permanent, market participants said at the SIFMA muni bond summit. Though there have been more than $130 billion of BABs issued, representing 25% of the primary issuance market and 40% of new-money issues, the program is set to expire at the end of the year, noted Kemp Lewis, managing director at Morgan Keegan & Co. He predicted that if Congress makes them permanent, “many more” new investors that don’t normally participate in the muni market would take the time to learn about the asset class, make asset allocations, and invest in the staff and systems to research and trade the bonds.

Though the Obama administration proposed making BABs permanent in its fiscal 2011 budget proposal earlier this year, legislation passed by the House would only extend the program for two years. A separate bill introduced earlier this month in the Senate would extend the program for just one year.

Asked how the BAB market has evolved, Alan Anders, deputy director of finance in the New York City Office of Management and Budget, said a greater number of issuers are using the 10-year call feature in their BAB transactions, replacing make-whole provisions that are more common in the taxable market and also allow for the early redemption of the bonds but at a price that is guaranteed not to hurt investors.

Anders said the price the taxable market charges for the 10-year call on BABs has declined to roughly the same level it costs in the traditional tax-exempt market, and that its popularity is fueled largely by issuers’ concerns for flexibility with their debt portfolio.

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