LOS ANGELES -- The phone started ringing after Leslie Porter selected only minority- and women-owned firms to underwrite a $700 million transit bond issue. And the calls came from some of the biggest names on the Street.
"A banker would say, ~Listen, you're taking a big risk here, and if those firms can't perform, we're prepared to backstop you. We can take this deal down,'" said Mr. Porter, finance director for the Los Angeles County Transportation Commission.
The preconceptions are familiar: These firms don't have the capital or the contracts for a heavy-duty deal; bonds may flood the secondary market. And the county's transit sales tax bond refunding was one of the biggest deals a team like this had ever been given.
In fact, it was the second-biggest, according to Securities Data Co. Or it was after Mr. Porter made his $70 million deal into $107.6 million.
"I've been taking these kinds of risks for a long time," he said.
He is not alone. Minority- and women-owned firms are becoming more important to the market as public officials across the country, responding in part to state and local targets, give them a larger place in municipal deals.
The question the officials face is whether the firms are up to the load. In Mr. Porter's case, the gamble paid off. The eight-member team, led by black-owned Grigsby, Brandford & Co., sold the issue June 10 with serials priced to yield 5.10% in 1997 through 6.10% in 2004. The refunding, insured by Financial Guaranty Insurance Co., is expected to save the commission $10 million over the life of the bonds.
Only an everage amount of the all-serial issue showed up prematurely in the secondary market, several market participants said, although some traders added that the deal was easier to sell than most. They pointed to its manageable size, a rising market, and features like an advance guarantee of bonds to co-managers and a back-stop offer from the senior manager.
However, observers say that even with those features, the transit financing demonstrated that some minority- and women-owned firms have the muscle to handle certain deals on their own. And some say a national trend may be gathering force.
From California to Washington, D.C.
Robert Lamb, a professor at New York University's Graduate School of Business and an author on municipal bonds, said Chicago and "other cities" are thinking of using teams of all minority- or women-owned firms. "This is a very strong trend across the entire nation," he said.
Mr. Lamb said he is "convinced that minority and women-owned firms are going to excel in the 1990s." He predicted that city councils and agency boards in urban areas will increase pressure on finance officials to encourage the use of minority firms.
Established Wall Street firms can expect the newcomers to "eat into more of their business and capture a greater portion of market share in the 1990s," Mr. Lamb said.
Such firms have increased their share of the municipal market in the past decade, partly because of affirmative action programs by many major cities and public agencies. Some cities and states mandate that majority firms include the firms in management groups.
Urban centers like New York City, Los Angeles, Chicago, and Washington, D.C., have some of the most aggressive policies.
California, meanwhile, recommends that minority-owned firms participate in 15% of state bond business and women-owned firms work on 5% of issues.
The state is "right on target" to reach its 1992 goals and hopes to surpass those for planned negotiated bond sales later this year, said Hal Geiogue, assistant state treasurer. The state once had trouble meeting its participation targets, both because it sells most of its issues competitively and qualified firms were scarce.
"What you have seen in the past few years is many firms developing and getting started because there is hope they will get business," Mr. Geiogue said.
In February, the state sold a small bond issue with a team of all women-and minority-owned firms. Artemis Capital Group was senior manager, and E.J. De La Rosa & Co. was co-manager on the $7 million public works bond issue, Mr. Geiogue said.
More firms of this kind are also serving as senior managers on financings.
In 1990, Pryor, McClendon, Counts & Co. senior managed a $319 million Atlanta bond issue, the largest deal ever led by a minority-owned firm, according to Securities Data. Artemis Capital Group, a women-owned firm based in New York, recently was named lead banker on a $80 million San Jose Airport financing.
Volume figures track the increase in such firms' participation. In 1983, minority- and women-owned firms as co-managers captured about one-tenth of 1% of all municipal bond business, or $69 million, according to Securities Data.
In 1991, minority- or women-owned firms served as lead or co-manager on 702 deals totaling $68.4 billion. At least one minority or women-owned firm served as lead or co-manager on 39.9% of all long-term new issues sold in 1991, according to Securities Data Co.
When asked whether the fact that he is black affected his selection of an all women- and minority-owned team for the Los Angeles County Transportation Commission deal, Mr. Porter said, "I would hope not," adding that he has "a lot of sensitivity to the need to advance women- and minority-owned enterprises."
This goal is "certainly a personal interest," he said, "but it fits in with the directives of the commission."
A major reason commission officials decided to use an all minority-and women-owned team on the Series B June refunding was the nature of the Series A portion.
That $98.7 million advance refunding involved a "proprietary derivative product" underwritten by senior manager Smith Barney, Harris Upham & Co., Mr. Porter said. This created a hurdle to bringing in other firms, so an all women-and minority-owned lineup was needed on the Series B portion to meet the commission's 25% minority participation goal for the entire financing, he said.
Mr. Porter was comfortable with the plan because of the firms' "proven track record," but said he also asked questions about the team's capital adequacy.
Each firm submitted a form disclosing its net capital to the commission, so "we had data on what a firm's capital adequacy was and we allocated bonds on that basis," Mr. Porter said. "We knew from a factual basis that the firms could handle the load."
Representatives from each firm in the eight-member team provided The Bond Buyer with the following figures of net capital adequacy as of June 30, 1992: Grigsby Brandford & Co., $4.6 million; Artemis Capital Group, $4.5 million; Smith, Mitchell Investment Group, women-owned, $553,342; E. J. De La Rosa & Co., Hispanic-owned, $253,342; M.R. Beal & Co., black-owned, $3.4 million; I.C. Rideau Lyons & Co., black-owned, $297,558; Bancroft, Garcia & Lavell Inc., Hispanic-owned, $293,957; and W.R. Lazard, Laidlaw & Mead Inc., black-owned, $1.57 million.
The early retention and allotment process for co-managers worked well with the transit financing, participants and observers say. Retentions of bonds, or the amount of securities each co-manager would be given to sell, were provided 48 hours before the sale to assist with premarketing efforts.
Bond allotments ranged from $3 to $20 million, and co-managers could select maturities to match orders. Grigsby sent a memo capping retention at 25% of each maturity.
The commission ordered managers not to sell bonds to the Street until the syndicate restrictions were lifted.
"Given that many of the managers for the Series B bonds are not heavily capitalized firms," Grigsby noted in its June 4 memo, it would provide a backstop by making an unconditional offer to buy any manager's retention bonds at the takedown price during the order period.
"Any manager found to be 'dumping' bonds during the underwriting period ... at discounted prices .. will be exposed to the commission," Grigsby warned in the memo.
Steve Kincade, managing director of trading and underwriting at Grigsby, said financing team members "beat the bushes" to find investors because they felt they had something to prove.
Participants said the retention process gave them a chance to establish relationships with large institutional investors as well as smaller investors who might not be contacted by the larger firms.
One salesman had 42 orders for an estimated $4.5 million of bonds, and another co-manager brought in two orders from investors who had never bought Los Angeles County or Los Angeles transit municipal bonds, he said.
"They knew if the deal was not successful, there'd be a lot of people whispering in Les' ear, 'You made a mistake,'" he said. Co-managers were expected to "work rather than cheer on the benign senior manager."
The Port Authority of New York and New Jersey uses a similar retention process annually on a negotiated financing. The senior manager is given 45% of the bond issue, and the other 55% is structured as early retentions to a team of minority firms.
"We make sure they get bonds to sell. We've had three fairly successful deals," said John E. Haupert, treasurer at the authority. "Frankly, our board has been urging us to do more business with minority firms. It is in our interest to help those firms."
Measuring success and evaluating rewards
One way market watchers track the success of municipal bond deals is to monitor how many securities end up in the hands of permanent investors and how many bonds get dumped in the secondary market once the bonds are freed to trade. Several traders said approximately $1 million in each serial group ended up in the secondary market in Series B of the Los Angeles transit deal.
"It was an average amount," said one San Francisco trader at a midsized investment banking firm. "My feeling was that they handled the deal well. It was priced well."
Another trader called the retention process "enlightening," and said the financing participants handled a tough marketing situation well, considering the maturities were all serials.
But a Los Angeles-based trader said he "saw a lot more than $1 million" in each maturity trading in the secondary market. The trader questioned whether the firms should be "patting themselves on the back," noting that a rising market on the day of pricing coupled with the special offer from Grigsby to buy bonds at takedown price really helped the deal.
Some market observers also said the fact the bonds were sales tax revenue bonds, rather than a more complex story bond such as a certificate of participation, aided the sale. One trader questioned whether some of the smaller women- and minority-owned firms had the sales force to handle more complicated "story bonds."
Indeed, firms that are more established sometimes complain that undercapitalized minority- and women-owned firms often get into deals they do not have the skills or the capital to handle.
But the newcomers often complain that as co-managers, they must pester both senior managers and issuers to make sure they are allotted bonds.
"What we found is that for the last few years co-managers have not been well treated," said Grover L. McKean, a partner of Lazard Freres & Co. in Los Angeles, financial adviser on the transportation commission issue. "As long as one day they get to be senior manager, they don't raise a ruckus."
But the firms that are always co-managers instead of senior managers say they may get a lot of the work but not of the payoff. They may participate in deals and put capital at risk, but then fail to reap large profits because they are alloted an insufficient number of bonds.
"They have much less access to the pie, and when they do have access they work like the dickens," said Mr. McKean. "They really produce."
Participants in the transit deal and the marketplace said women- and minority-owned firms need more opportunities to sell bonds in larger financing to show they can be substantial players.
"If you're not allowed to practice, how do they expect you to perform when you get on the field? The commission gave us the chance to participate in the game," said Lamar Lyons, principal of I.C. Rideau Lyons, a Culver City, Calif.-based firm.
"I think there will be gradual sensitivity to the fact that although emerging business firms aren't heavily capitalized, we do bring something to the transaction," he said.
Barbara Mickens, deputy finance director for the New York State Metropolitan Transportation Authority, said the authority has never used an exclusively minority-or women-owned syndicate. But she called the Los Angeles issue a "great step forward" for these firms.
"They seldom get the chance to show their stuff," she said. "To hear that the deal went well, and to hear it from more than just the bookrunner, is very encouraging. It means the Street is moving forward."
She said the financing "goes a long way to showing that the rumors regarding minority- and women-owned firms are unfounded and the problem is really barrier issues. For the transportation commission to have the wherewithal in the face of rumors to the contrary to say, 'Hey, these firms can do it' -- we salute them."