Bear Stearns to Advise Tucson on Conversion To Fixed-Rate Debt After Auction Failures
Bear Stearns & Co. announced this week it will try to succeed where Goldman Sachs & Co. has failed -- convincing long-term investors that Tucson Electric Power Co.'s triple-A, 12.6% insured tax-exempts are worthwhile despite 16 consecutive failed auctions.
Tucson Electric said Tuesday it hired Bear Stearns to advise the utility how to convert the deal to a fixed interest rate and abandon Goldman Sachs's dutch auction process.
Since June 1990, the utility has suffered a string of failed monthly auctions to reset rates on its $121 million 1988 issue, sold through the Industrial Development Authority of Pima County, Ariz.
In a dutch auction, potential investors submit bids reflecting the lowest yield they would be willing to accept. The rate needed to sell the entire issue is then determined, and every bidder at or below that level receives that yield.
If the entire issue is not accounted for in the bidding process, the auction fails and no one sells their bonds. A penalty rate based on a multiple of a special market index is assigned to the deal until the next auction, when the process starts again.
Investors and market analysts say the lack of liquidity created by Tucson's failed auctions has created a vicious circle, in which short-term investors fearful of being stuck with long-term securities shy away from the auctions, contributing to their ultimate failure.
But market sources and Tucson officials have also expressed surprise that the extraordinarily high penalty rates resulting from the auction failures have been unable to lure longer-term investors willing to forego liquidity for high yields. Despite Tucson's much-publicized fiscal problems, including an ongoing effort to force the utility into involuntary bankruptcy, the credit is not considered a problem because the bonds are guaranteed by Financial Security Assurance Inc. and carry a triple-A rating.
The most recent auction, in mid-September, resulted in a rate of 12.6%, but still failed because Goldman Sachs was unable to find enough buyers. The Bond Buyer's revenue bond index, which includes credits considered riskier than Tucson, was yielding 550 basis points less at the time. The next auction is slated for Oct. 9.
"The product isn't working the way it was designed to work," said Susan Wallach, Tucson's treasurer, adding that she would have expected the most recent auctions to succeed, given the fact that yields jumped from 7.9% in July to 12.6% last month.
"That's one of the reasons we decided to do something quickly," Ms. Wallach added, referring to the decision to bring Bear Stearns into the deal. She declined to comment on Goldman Sach's marketing efforts for the deal, but noted that the firm remains remarketing agent on another letter-of-credit-backed tax-exempt for the utility.
Joseph Fichera, managing director of corporate finance at Bear Stearns, said, "It would be wrong to speculate on why the auctions failed when Goldman Sachs was the sole broker dealer."
He stressed that Bear Stearns does not expect to replace Goldman Sachs as an active marketing agent for the auctions, since he believes the ultimate solution will have to be a conversion to long-term, fixed-rate debt with rates "substantially below" 12.6%.
"The notion of trying to revive a failed auction is difficult when you have one failure," Mr. Fichera said. "It's probably near impossible when you have the stigma of 16."
He added that Tucson's experience should raise questions in investors' minds about the "flexibility and liquidity" of the dutch auction mechanism. But Mr. Fichera stressed the proposed fixed-rate bonds would be attractive to investors because the credit is FSA-backed and will be sold through a remarketing and not an auction.
The failure of the Tucson auctions has been a particularly embarrassing situation for Goldman Sachs, because the firm debuted its dutch auction product -- Periodic Auction Reset Securities, or PARS -- with the Tucson deal in 1988. At the time, Goldman said the product provides issuers with the best of both worlds: short-term rates without the high cost of accompanying liquidity facilities.
Goldman Sachs officials were not available for comment yesterday.