LOS ANGELES -- Investors criticized officials of Cal-Mortgage's embattled loan insurance program this week for refusing to disclose whether they will demand early redemptions for two troubled issues insured by the program.
The dispute center on Triad Healthcare Inc. of Los Angeles and Los Medanos Health Care Corp. of Pittsburg, Calif. Triad issued $167.4 million of refunding certificates of participation backed by the state program in 1993. Los Medanos, through the California Health Facilities Financing Authority. issued $11.1 million of Cal-Mortgage-insured revenue bonds in March 1990.
Both health care providers have been unable to make debt service payments, forcing trustees to tap reserve funds to make semiannual payments to bondholders.
Cal-Mortgage has said that despite the program's exposure to the troubled loans, it does not expect the condition of the 214-project, $2.03 billion portfolio to erode.
Asked if an extraordinary redemption of Triad and Los Medanos obligations was under consideration, Cal-Mortgage director Dennis T. Fenwick responded: "I can't tell you what I will or will not do not the future. No insurance company is under an obligation to unilaterally narrow its options."
But, Fenwick said, for both the Triad and Los Medanos issues, "there is no consideration being given by Cal-Mortgage, at this point, to call the bonds."
Asked if he planned additional disclosure about the troubled obligations, Fenwick said: "I don't know what you mean by disclosure. That is such a board term. We disclose everything that is in the program. It is all public record."
Fenwick, formerly a state deputy attorney general who was named Cal-Mortgage director last November, said one example of his disclosure efforts is a six-page program update he sent to Standard & Poor's Corp. this week, which he also provided to journalists. "I am not sure what additional notice is appropriate."
Standard & Poor's rates Cal-Mortgage obligations A-plus because their ultimate security is the full faith and credit of California, said Cara Bowers, a Standard & Poor's director.
Because the rating agency expects holders to receive their principal and interest payments in a timely manner, Bowers views the uncertainty over whether Cal-Mortgage will use its early redemption option as "a reinvestment problem," not a credit issue.
The mutual funds "are talking about getting their money in full at an inopportune time" if the obligations are called, which might force them to reinvest the proceeds at a less desirable interest rate, Bowers said.
But portfolio managers for mutual funds, noting the ongoing industry discussion about continuing disclosure in the secondary market, place in a broader context the question of how forthcoming Cal-Mortgage should be about its strategy concerning early redemptions.
"A lack of full secondary market disclosure can create trading inefficiencies, and potentially pose problems for mutual funds in their determination of the securities' market value," said Steven Permut, manager of municipal research and high yield portfolio manager for the Benham Group, a mutual fund company based in Mountain View, Calif.
"Until Cal-Mortgage officials covenant that they are legally responsible to provide secondary market information, we would be very hesitant to purchase any new issues that are insured through the program," Permut said.
"The officials at Cal-Mortgage have expressed surprise about our concerns," Permut said. "They seem to lack an understanding as to why an early call may have a significant impact on a mutual fund's net asset value," referring to the daily share price.
"The reason we're concerned is that actions Cal-Mortgage takes on these problem loans may impact the market value of other bonds insured through Cal-Mortgage," Permut said.
"There is a lack of direction coming out of Cal-Mortgage to give comfort to the market," Franklin Advisers Inc. vice president Tom Kenny said. "We're extremely upset with Cal-Mortgage in regard to disclosure," said Kenny, who is director of the San Mateo, Calif.-based mutual fund company's municipal bond research department. "It seems they change their mind on a daily basis."
If investors are spooked by the Cal-Mortgage program, that could cause higher interest rates for issuers that use the state insurance, said Terry Partington, deputy executive director of the California Health Facilities Financing Authority. The authority uses Cal-Mortgage insurance for about $700 million of its $4 billion of outstanding obligations.
"The next time we issue bonds insured by Cal-Mortgage, investors might say, ~I don't want to get into this,'" Partington said. "If investors won't buy, we would have to pay a higher interest rate."
The mutual funds believe it is important for the market to know in both the Triad and Los Medanos financings whether Cal-Mortgage is going to redeem the obligations prior to their stated maturity, or whether the program will continue to pay debt service according to the schedule in the official statements.
Cal-Mortgage also has the option to replace the problem loans with state debentures. But because this provision has never been used, there is no clear guideline concerning what the interest rate and payment schedule would be if that scenario unfolded, market participants said.
Mutual funds have a responsibility to price their securities on a daily basis as close to the actual market value as possible, participants said. If the issuer is not disclosing certain information, it makes accurate pricing more difficult, and can create wider price variations among evaluation services.
For example, last Friday, Kenny S&P Evaluation Services priced the Los Medanos bonds at 99.29 and Muller Data Corp., owned by the Thomson Corp., which also owns The Bond Buyer, priced them at 104.38.
The Kenny pricing reflects that firm's impression that Los Medanos "is somewhat distressed," said Jim Rieger, Kenny's manager of high yield evaluations.
Muller's premium pricing reflects an expectation that "there are no immediate plans" by Cal-Mortgage to call the bonds, said Barry Jones, a Muller evaluator.
Market sources said the gap between the two evaluations underscores that there is no way to know which price is more accurate until Cal-Mortgage says whether it will -- or will not -- call the obligations early.
This uncertainty also causes the Cal-Mortgage obligations to trade at a discount compared with the state's general obligation bonds, market sources said.
"The market assesses a greater risk factor" to Cal-Mortgage-insured obligations, said Heidi E. Holverson, a tax-exempt hospital bond research analyst for John Nuveen & Co. who is based in the firm's Irvine, Calif., office.
Cal-Mortgage obligations "don't trade at the same level as state general obligations," Holverson said. "If there were no market concern, they would trade at the same level as GOs -- and they don't. They are cheaper."
Underscoring the troubles faced by Triad and Los Medanos, both issuers in recent weeks have sought bankruptcy protection from creditors.
The 107-bed Los Medanos hospital, which has shut its doors while owners try to find a buyer, filed a Chapter 9 bankruptcy petition on April 22.
As previously reported, Triad, whose two hospitals remain open, on Feb. 1 filed a petition for reorganization under Chapter 11 of federal bankruptcy law.
Triad, Cal-Mortgage's largest obligor, represents 8.27% of the program's portfolio and its well-publicized travails have been analyzed at two recent state Assembly hearings in Sacramento.
In part to devote staff resources to untangling problems associated with its loan guarantee for Triad, Cal-Mortgage officials last September ordered a moratorium on new loan applications. The moratorium was lifted this week and applications for insurance will be accepted at a June 14 meeting in Sacramento by the seven-member advisory loan insurance committee.
A Cal-Mortgage program update released this week said that the loan committee has been reconfigured. Among its members is an investment banker -- Fred Prager, a managing director of Prager, McCarthy & Sealy in San Francisco.
The 25-year-old Cal-Mortgage program is a division of the California office of statewide health planning and development, an arm of the state's health and welfare agency.
