IRS Moves to Curtail Dean Witter's Mortgage-Backed Security Issues

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NEW YORK -- The Internal Revenue Service has dealt a blow to Dean Witter Reynolds Inc. by moving to block further issues of a pioneer mortgage-backed security.

The filing of the proposed regulations late Friday sent Dean Witter officials scrambling -- they had just announced they were ready to sell another $500 million worth of the securities.

Officials at Dean Witter, a subsidiary of Sears, Roebuck and Co., met Monday with revenue officers to appeal for "grandfather rights" to go ahead with that second issue, said William Vasu, Dean Witter managing director.

Mr. Vasu said his company hopes to get a decision by the end of the week on the second issue, which would follow another $500 million issue sold in February.

"The IRS was very responsive and sympathetic," he added. "They realize that we're sitting on a ton of inventory."

Dean Witter bought mortgage securities to back the public offering, prepared in the name of Dean Witter's affiliate, Sears Mortgage Securities Corp. Dean Witter will hold those mortgage securities, guaranteed by the Government National Mortgage Association, or Ginnie Mae, while awaiting the revenue service's decision.

First Boston Corp., the nation's leading underwriter of mortgage securities, gave the Dean Witter structure a vote of confidence last week by agreeing to comanage the issue. But no contracts were signed, and Dean Witter retains the risk in holding the mortgages, Mr. Vasu said.

"They clearly hit us at the worst possible time," he said of the proposed regulations. "We couldn't have been any closer to marketing this issue -- we were just waiting for the right market conditions."

Treasury officials hinted they might move against the deal's structure after the investment banker sold the first public offering. Dean Witter also has sold about $125 million of the securities in private placements, Mr. Vasu said. 'Intended to Squash Second Deal'

A Washington attorney familiar with the proposal said he doubts Dean Witter can save the second half. "It's clear from the IRS's timing that they intended to squash this second deal," he said.

The IRS specifically wants to outlaw the multiclass structure of the Dean Witter deal, which essentially channels payments from the underlying mortgages into a series of bond-like instruments.

The proposed legislation upholds the legal opinion from Dean Witter's New York-based law firm, Sullivan & Cromwell, that the structure is not forbidden under current tax law. That protects the original Dean Witter issue in January from retroactive changes.

Unlike collateralized mortgage obligations, a popular innovation that also splits one-class mortgage securities into multiclass instruments, Dean Witter's structure sells shares of the underlying mortgage securities outright. The obligations are sold as debt, with the securities as collateral for a general obligation of the issuer.

By splitting the cash flow into a series of securities with different maturities, both structures give the resulting instruments more predictable terms than have the underlying collateral. …