CDFA Spotlight: Fair Market Value For Guaranteed Investment Contracts By Stan Provus

This article reviews the IRS regulations governing the establishment of the “Fair Market Value” or rate for guaranteed investment contracts (GIGs). This article rests on material prepared by Michael Graff, Jr., a bond counsel at McGuire Woods LLP. Mr. Graff prepared this material for CDFA’s Advanced Bond Course, held annually in Washington, DC.

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This article is intended to provide accurate and authoritative information in regard to the subject matter covered. The author and CDFA are not herein engaged in rendering legal, accounting or other professional services, nor does it intend that the material included herein be relied upon to the exclusion of outside counsel.

GICs are investment agreements between an issuer and a provider to invest bond proceeds such as a construction fund or debt service reserve fund at an interest rate that is locked in for the entire term of the agreement. This removes reinvestment risk. A major advantage of GICs is flexible draws permitted with no penalty. This means, for example, that an issuer can accelerate or decelerate draws without penalty on a GIC used to invest a construction fund. GIC providers are typically AAA and AA rated financial institutions, insurance companies or special purpose financing companies.

Treasury Regulations (1.148-5(d)(6)) proscribes certain procedures for establishing the “fair market value” of GICs. These procedures are aimed at assuring issuer’s get competitive bids on the interest rate providers pay issuers. Some of the key provisions include the following:

• If an issuer or conduit borrower uses a bidding agent to conduct the bidding process, the bidding agent must not bid to provide a GIC.

• All bidders must have an equal opportunity to bid—no bidder can have a “last look” to review other bids before bidding.

• At least three reasonably competitive bids must be solicited from providers. Reasonably competitive provider means a provider with an established industry reputation for GICs.

• An issuer should conduct a bona fide solicitation (RFP) for a specified GIC and receive at least 3 bona fide bids from providers who have no material financial interest in the issue. In most cases a lead underwriter and financial adviser will have a material financial interest. However, they can still bid if they are not the bidding agent and providers who have no material financial interest in the issue submit 3 bona fide bids.

• There are several regulations on what constitutes a bona fide solicitation including, GIC bid specifications are in writing and forwarded to potential bidders in a timely manner; bidders may not consult with other bidders; the issuer must purchase the highest yielding GIC for which a qualifying bid is made (net of broker’s fees), among others.