Bond Deals: City Gets A Bit, Dealers Get A Lot
The bond-market deal makers who raised the cash to build Spokane’s garbage incinerator are hot with new ideas.
They’re putting together packages to refinance the 1989 solid-waste bonds and give Spokane lower interest payments.
The dealing started in 1993 when interest rates were low and refinancings were common. It continued last week with another refinancing package. A third proposal is in the works.
While ratepayers achieve some modest savings, the people arranging the transactions are rolling up multimillion-dollar fees.
Ratepayers have spent as much as $7 million to date on fees, or about 7 percent of the local investment in the garbage system.
The transactions raise questions about who really benefits from all of this. Is it Spokane’s garbage ratepayers or the financial gurus promoting the bonds?
One transaction involved the use of unorthodox bonds known as derivatives, the same type of bonds that Orange County dived into before going bankrupt and losing billions.
Critics say the city is guilty of cozying up to their bond-market buddies, and paying little attention to ratepayers’ interests.
“At the outset, it makes you wonder if they negotiate the best price,” said Dick Adams, a taxpayer advocate and the most vocal critic of the refinancing proposals.
He said the city repeatedly deals with the same attorney, bond consultant and underwriting company, raising questions about the independence of the relationships.
They include bond attorney Roy Koegen of Spokane, financial adviser Alan Dashen of Seattle Northwest Securities and Bob Campbell of Lehman Brothers, the underwriting firm.
City officials say Koegen, Dashen and Campbell are among the most talented in the business, and ratepayers benefit from their work. In turn, the trio says their relationship with the city is strictly professional.
“I think you have to look at the bottom line,” said city Finance Director Pete Fortin. “Have we saved the ratepayers money?”
Figures supplied by Lehman Brothers indicate the city has.
Payments on garbage bonds are due for 15 more years, and over that time, Spokane is saving $3.4 million in interest charges.
A refinancing proposal in the planning stages could save as much as $3.9 million more.
A big chunk of the savings won’t come until the years 2009 and 2010 when the bonds are retired.
The lawyers, underwriters, consultants, insurers and rating agencies already have their money, Adams pointed out.
Those involved with the transactions say the fees are not unlike those charged to refinance a home mortgage. When interest rates dropped in the early 1990s, a lot of homeowners set up new loans to lower their monthly payments.
The case is the same for the city, which manages the countywide garbage system.
Still, fees charged homeowners are generally less than the cost of the savings after a few years.
In the case of the solid waste system, ratepayers are paying nearly $3 million in fees in order to save the $3.4 million in interest. The savings amounts to about $10 per person in the county over 15 years.
“I guess it’s always a point of debate,” said Patti Tigue, an analyst in Chicago for the Government Finance Officers Association. “It’s hard to know if you are getting a good deal.”
Spokane originally sold $105 million in bonds for the solid waste project in 1989. Those bonds carried interest rates of 7.9 percent a year.
In 1993, the city refinanced $36 million of those bonds to take advantage of lower rates, which were about 5.2 percent at the time. The savings on that deal will be $3 million by the time the bonds are paid off.
But the savings come at a price.
Private firms took $1.2 million off the top, including $300,000 for underwriting, $540,000 for bond insurance and $168,000 for the bond lawyer.
“You can’t sell bonds without paying a salesman a commission and paying lawyer fees,” said Bob Campbell of Lehman Brothers, the underwriting firm on all of the solid-waste bonds.
“I am very proud of what we have done with the city of Spokane. We have saved the ratepayers a lot of money,” he said.
One way Lehman Brothers did that was by offering a complex bond package tied to swings in interest rates, a bond known as a derivative.
Since the Orange County bankruptcy, derivatives have fallen out of favor, and federal regulators are discouraging them, bond experts said.
About half of Spokane’s refinancing in 1993 involved the derivatives.
The deal was a complicated, threeway transaction. Here’s how it worked:
An investor, one of the Putnam group’s mutual funds, bought the Spokane bonds, which were designed to make the group money if interest rates stayed low or went down.
Lehman Brothers then found another set of investors to buy a second set of bonds known as a hedge. Those investors would make money if interest rates went up.
The investment house protected Spokane from gambling on the interest rate moves by guaranteeing the city a fixed interest rate in what is known as a rate swap.
Interest rates did go up, and the value of Putnam’s bonds went down 19 percent. Putnam tried to unload the bonds by selling them, but no one would buy, so it asked Lehman Brothers cancel the bonds.
The Spokane City Council went along with replacing Putnam’s bonds, but only because the city got at least $400,000 in interest savings.
The city paid Lehman Brothers a $1.3 million fee to compensate the investors who bought the hedged bonds and saw the value of their investment increase with the jump in interest rates.
Initially, Lehman Brothers sought a larger termination fee, but Fortin said the city negotiated the fee down.
“We don’t get that money,” underwriter Campbell said. “We passed it through to get the hedge off.”
Last Tuesday, the deal was closed and conventional bonds were sold as replacements.
Such is the Byzantine world of municipal financing.
But it goes further.
Lehman Brothers now is offering to buy an option on $74 million in bonds used for the actual construction of the West Plains incinerator. Those bonds cannot be refinanced until 1999 under federal tax law because a private company is running the incinerator.
Under the option proposal, Lehman Brothers would pay the city $3.4 million now to preserve its right to refinance the remaining $74 million of 1989 bonds during a five-year option period starting in 1999.
As a result, Spokane could lock in lower interest rates in the future and receive the $3.4 million as an advance payment should the option be used. Lehman Brother would get a fee of $390,000.
If rates go up and the option is not exercised, the city gets to keep the advance payment.
Finance Director Fortin said he is going to ask the City Council to approve the deal because ratepayers stand to gain.
“It’s actually a simpler transaction than the one we just refunded,” Fortin said.
Bond attorney Koegen is expected to receive $70,000 for Tuesday’s deal. His fee was higher than normal, Fortin said, because extra legal work was needed to iron out technicalities.
The financial adviser gets $20,000.
The underwriter received $136,000 for marketing the bonds. That was 0.87 percent of the total $15.5 million sale, slightly higher than the average in the industry for similar negotiated deals.
Campbell said the complexity of last week’s deal contributed to the higher cost.
Other fees included bond insurance, $75,000; rating agency fees, $16,000, and printing, $21,000.
Critics like Adams get sticker shock when they see those numbers.
“It’s a pretty comfortable living for Mr. Koegen and company,” he said.