2018 has started badly for Midwest Fertilizer Company and its proposed nitrogen complex in Mount Vernon, IN.

Last week, Midwest (MFC) disclosed that the IRS has made an “adverse determination” to confirm its earlier, provisional ruling that MFC’s $1.259 billion tax-free bonds are not tax-free after all.

There is a procedure for appeals and, if MFC can convince the IRS that these bonds do indeed qualify as tax-exempt, then the project might still move forward. This outcome now seems unlikely, however. Without bond financing, it is hard for me to see how this project is viable.

This issue began in January 2017, when the IRS launched its examination into “one of the tax-exempt market’s largest-ever junk-bond sales.” In July 2017, the IRS issued a notice of proposed issue, saying it was likely to decide MFC’s bonds did not qualify as tax-exempt. At that time, MFC stated that “the Company is responding to the IRS … the Company and counsel continue to be confident that there should be no change to the tax-exempt status of the Bonds.” This claim was repeated, almost word-for-word, in the disclosure confirming the IRS’s decision.

In the first week of January 2018:

The Company hereby gives notice that the IRS has issued a Notice of Proposed Adverse Determination with respect to each of the Bonds and the Refunded Bonds to the County and the Authority, respectively. Such Notices state that the IRS has made a proposed determination that the Bonds and the Refunded Bonds are not qualified tax-exempt Midwestern Disaster Area Bonds and therefore the interest paid to the holders thereof is not excludable from gross income under Section 103 of the Internal Revenue Code of 1986, as amended.
Midwest Fertilizer Company, EMMA notice [PDF], 01/05/2018

Of course, the company claims that it will fight this determination. Whether that legal work represents a worthwhile investment to the project sponsors, Fatima Group in Pakistan, time will tell.

Charles Henck, a partner at Ballard Spahr, is representing the company and Posey County, Ind., which took over as issuer after the Indiana Finance Authority dropped out and then refunded or remarketed the bonds six times between July 2013 and November 2015.

“The project continues to have very strong support of county, state and federal officials,” he said. “We believe we complied with the rules and that the IRS analysis is incorrect.”
Bond Buyer, IRS auditors determine Midwest Fertilizer Company bonds are taxable, 01/05/2018

Only two weeks before the company disclosed this very negative news, local press had been quoting a regional economic development executive sounding rosy about MFC’s progress in 2018. With hindsight, this might have been a bit over-optimistic:

“They are telling us by the end of the first quarter, or early second, they will be ready to break ground,” said Greg Wathen, director of the Economic Development Corp. of Southwest Indiana …

“They are still working through the process. Nothing negative has happened.”
Courier & Press: Seven local business stories to watch in 2018, 12/25/2017

In 2017, the IRS had also launched an examination of the tax-exempt bonds issued to OCI’s Iowa Fertilizer Company for its plant in Wever, IA. That examination concluded that the Iowa bonds did indeed qualify as tax-exempt.

So why didn’t Midwest’s bonds qualify at tax-exempt?

Bonds for both projects were rushed to market in December 2012 so they would be tax-exempt Midwestern Disaster Area Bonds before the authority for those disaster bonds expired …

The $1.2 billion bonds for the Iowa Fertilizer Co. were spent within two years, the project was built, and it launched production in April 2017.

Almost all of the bonds for Midwest Fertilizer Co. in Indiana remain unspent and the project hasn’t gotten off the ground.

Under IRS arbitrage rules, bond proceeds can be invested at yields above the bond yields for a so-called three-year temporary period without becoming taxable arbitrage bonds if the issuer reasonably expects to comply with three tests, one of which to spend 85% of the proceeds within three years. There is also a five-year temporary period available.

If the issuer doesn’t expect to meet the three-year temporary period requirements, the bonds are hedge bonds and taxable unless the issuer reasonably expects to spend certain percentages of the proceeds over a five year period.

While the companies for each project may have reasonably expected to meet these requirements, Iowa Fertilizer actually met them and Midwest Fertilizer did not.
The Bond Buyer: Why did IRS auditors keep bonds for one fertilizer plant tax-exempt, but not another? 01/08/2018

More information about the Midwest Fertilizer project is in my Research Note for Mount Vernon, IN.