While the idea of a federal bailout of Washington Public Power Supply System may not be very popular now, Uncle Sam will probably wind up paying for part of the fiasco anyway through tax write-offs.
WPPSS defaulted this week on $2.25 billion in bonds on its now-canceled WPPSS nuclear projects 4 and 5. To assist investors holding these bonds, brokers are offering to arrange bond swaps allowing bondholders to deduct their losses on their 1983 income tax returns. Similar swaps are also possible for nervous holders of bonds for WPPSS projects 1, 2 and 3, which have not defaulted.
The investor not only gets an immediate deduction against other income based on the losses on the WPPSS bonds, but also there is the possibility of a capital gain on new bonds obtained through the swap.
In an ordinary bond swap, the customer sells one issue and then reinvests the proceeds, without putting up any more money, in another issue that provides comparable principal, yield, quality and maturity. But because bond prices on WPPSS projects 4 and 5 have plunged so low--currently 14 to 17 cents on the dollar--there are no comparable bonds of solvent projects for investors to buy. The solution, suggests the investment firm Peters, Rickel & Co. of Union, N.J., is for holders of No. 4 bonds to swap for No. 5 bonds, and vice versa. The bonds for project 5 bear a coupon of 12 percent and mature in 2009; those for project 4 pay 11.75 percent and mature in 2010.
For each $1,000 bond, the bondholder who bought the original issue would have a long-term loss of approximately $850. If a person bought 10 bonds at par, the loss would be $8,500. The entire amount could be used to offset capital gains or, if there are no capital gains, capital losses up to $3,000 a year can be used to offset ordinary income.
For example, according to the Internal Revenue Service, if a person had a net loss of $8,500, he or she would subtract one-half of $6,000, or $3,000, against gross income. For a taxpayer in the 50 percent bracket, the tax burden would be lowered by $1,500. The remaining $2,500 loss would be carried over to the next tax year, reducing the person's taxes by $625.
Those who bought WPPSS bonds in the secondary market within the past year would be entitled to proportionately higher short-term capital losses.
By exchanging a WPPSS No. 4 or No. 5 bond, the buyer then establishes a new cost basis of 15 cents on the dollar, or $150 per $1,000 bond. If WPPSS eventually declares bankruptcy, the bondholder could then subtract the remaining 15 cents-per-dollar loss on a tax return. If, however, there is some plan worked out to repay bondholders in whole or in part, the investor would stand to make a capital gain.
In other words, according to Peters, Rickel vice president John Sabo, the investor who does a bond swap and waits it out is better off than one who simply waits it out because the latter gets no tax advantages.
For those who would like to get out of WPPSS entirely, Sabo suggests a bond swap of projects 4 or 5 bonds for depressed zero coupon municipal bonds on a dollar-for-dollar basis. He said there are about half a dozen state bonds trading at approximately the same price as WPPSS Nos. 4 and 5. Zero coupon bonds pay no interest, but neither will WPPSS 4 and 5 after January 1984. But the owners of the zero coupon bonds stand to get back the face value of $1,000 per bond when they reach maturity in 1995, whereas WPPSS has admitted it has no money to pay the principal either.
Prices for bonds financing projects 1, 2 and 3, backed by the Bonneville Power Administration, a government agency, have also declined. The 15 percent coupon on project 1, which was selling at a $115 premium last April, was worth about $84 yesterday. One credit analyst said the default was having a psychological impact on 1, 2 and 3 bonds, but he expected they would bounce back.