The very mention of Philadelphia's credit has for months sent investors scurrying for a place to hide, but yesterday marked what some are calling a turning point as a few investors decided the city's bonds are worth at least a nibble.
Market sources reported a $215 million revenue bond prison deal priced yesterday went extremely well for the city, including a $42 million unrated and unenhanced portion that was priced to yield 8.85%.
"Nobody would suggest we're back yet, but this is a significant first step," said city Treasurer Benjamin Blakney.
Philadelphia had been effectively blacklisted from the credit markets since last summer, when a quickly deteriorating cash crunch brought its rating into the low end of even the speculative-grade categories.
In its return yesterday, the city first offered the unenhanced bonds at 8 5/8%, but was forced to sweeten the yield during the course of the day. Mr. Blakney said Kidder, Peabody & Co., the underwriter for the deal, made the right decision in trying to price the deal as aggressively as possible early on, to keep the ultimate cost to the city below 9% -- which was its main goal.
The 8.85% yield is only 30 basis points above the $560 million general obligation sale in June by New York City, another financially stressed Northeastern issuer. Given that Philadelphia has a CCC rating from Standard & Poor's Corp. and a B rating from Moody's Investors Service -- and New York City still retains an A-minus from Standard & Poor's -- the Philadelphia sale appears to offer far less reward for the risk undertaken, tax-exempt buyers said.
Charles Rzepinski, managing director of Kidder Peabody's municipal bond department, said two insured portions and the unenhanced series were sold mainly to managed bond funds. He said there was "normal" retail itnerest in the insured series, and high-yield funds were the main bidders on the uninsured block. By teh end of the day, all of the bonds were sold.
Despite what appeared to be a strong showing by the city yesterday, the Philadelphia name still carries a sour connotation for many tax-exempt bond buyers. Offered the 8.85% yield, portfolio managers of various mutual funds, including some high-yield overseers, demurred.
"They're not out of the woods," said Joseph P. Deane, managing director of tax-exempts at Shearson Lehman Hutton. "They are a long way from solving their problems. My guest is that [Kidder Peabody] was hoping that with the shortage of yield paper around, it might fly," he said, "but it's still not an area that we want to get involved with."
Peter Allegrini, portfolio manager of the Fidelity Spartan Pennsylvania High Yield Fund, suggested that the aggressive pricing was made possible by pressure on national high-yield fund managers to convert new cash from investors into yield. The problem has been a shortage of high-coupon securities, he said.
"High-yield buyers don't care about quality spreads right now," Mr. Allegrini said. "From a historical perspective, they're tight right now. Cash is there to be spent.
"Typically, triple-B credits are about a 7.70%, you can pick up 100 basis points with this deal," he said. "And there's a tremendous appetite for yield." Mr. Allegrini did not purchase any of the bonds.
The insured sections of the deal were broken into a $133 million Securities B insured by Financial Guaranty Insurance Co. and a $40 million Series A insured by Municipal Bond Investors Assurance Corp.
Mr. Allegrini said the insured pieces of the deal were also priced very aggressively. He pointed out that on Tuesday, an insured Schuykill, Pa., lease deal was priced to yield 7 1/8 in 2013. The Philadephia sale netted buyers only eight basis points more on the FGIC-insured 2018 term maturity sold yesterday.
But some bankers said they expected Philadelphia would have to offer even higher yields than 8.85% to attract enough interest. They agreed with city officials that the relatively low yield on the uninsured portion seemed to signal a shift in sentiment about the city's junk bond credit, especially among institutional investors.
"I think the institutions that are right on top of the city's credit have a lot more confidence than they did six or eight months ago," said Alan Schankel, a senior vice president and manager of the municipal bond department at Philadelphia's Janny Montgomery Scott.
Mr. Schankel said the establishment in June of a fiscal oversight board to supervise the budget process and issue deficit bonds on the city's behalf is making at least some buyers feel secure enough to give Philadelphia a chance.
Several market sources said memories of New York City's successful Municipal Assistance Corp. bonds in the mid-1970s might have also played a role in convincing investors to sign up for the Philadelphia deal. The MAC bonds also offered relatively high yields compared to the rest of the market, and turned out to be a sound investment.
Market sources also noted that the $42 million uninsured portion is a small amount, and a bigger stack of bonds probably would not have fared as well. "They're are always a few yield buyers" to take down a small offering, one public finance expert said.
Other factors in Philadelphia's favor yesterday were recent revenue sales by two utilities, which reintroduced Philadelphia's name to the market.
Philadelphia Gas Works, for example, sold $75 million of revenue bonds last month, and the Water Department's $290 million deal in May also went well.
Mr. Blakney said the road show that accompanied the water deal was instrumental in preparing investors for yesterday's deal.
"Anything that had the city of Philadelphia's tag on it was going to carry some burden, and I think the institutional road show allowed us to proceed with clarifying" the city's fiscal and political situation for the market, Mr. Blakney said.
Mr. Blakney said the key was convincing investors that political infighting had come to an end, and various city and state factions were now cooperating.
David Johnson, portfolio manager of the Van Kampen Merritt Tax Free High Yield fund, agreed that the 8.85% pricing was based on the ability of Kidder and the city to instill in buyers "political faith" that Philadelphia will pull itself up by its bootstraps.
Although he did not buy the uninsured term bonds, he said they may be attractive to high yield managers because they are likely to be more liquid than the private placements and other below investment-grade positions that populate the majority of such portfolios.
The original bonds refunded by yesterday's issue were sold in 1986 to fund an early version of a prison and criminal justice center construction plan. Philadelphia is under court order to ease overcrowding in its prison system. But large cost overruns forced the city to abandon the original proposal, leaving downtown Philadelphia with a huge hole in the ground next to city hall and no means of financial construction.
Mayor W. Wilson Goode announced the new bond plan earlier this year, offering it as a means of preserving the insurance from the original bonds while also testing market waters for an unenhanced portion.
City officials hope yesterday's deal bodes well for the new oversight authority's first bond issue, which authority officials say will be about $350 million and come near the end of the year.
"This is the kind of pre-marketing activity for tht transaction that will stand it in good stead with the market," Mr. Blakney said.
