A special redemption this month on $95 million of Battery Park City Authority bonds has raised the ire of some investors who say they bought the bonds unaware that a call threat existed.
The bonds, issued by the authority in 1980 with an 8 5/8 0/0 coupon, were not callable under normal circumstances until 2006. With bonds recently changing hands at prices as high as 130, several investors were clearly not expecting the call at 103 1/2 issued by the authority on Dec. 1.
But in calling the bonds, the authority was exercising a right plainly delineated in the official statement, which says that beginning June 1, 1990, the bonds may be redeemed "from the proceeds of any voluntary prepayment of the mortgage loans."
The proceeds of the 1993 issue were used to fund a new mortgage for the owners, Hudson Towers Housing Co. and Marina Towers Associates, allowing them to pay off the 1980 mortgage.
Market sources say that is it not unique for a tax-exempt entity like the Battery Park authority to sell bonds to provide a mortgage for private firms. It is, however, a relatively new wrinkle in the housing bond market that housing analysts say is being used with increasing frequency. Still, the fact that the authority issued the bonds to provide a new mortgage to the owners of the property, in essence acting as a mortgage bank, had some bondholders questioning the validity of the transaction.
"If the authority induced the prepayment and used that clause to refinance the issue, then it may have the appearance of being unfair because it may seem to be contrary to the spirit of that provision," said one source familiar with the transaction. "But we don't know if [the owners] haven't been requesting to prepay for years. If so, the authority is just accommodating them, so if that is the situation, maybe that's not entirely improper, either."
Matthew Monahan, public affairs director for the authority said "the owners announced their intention to prepay. We didn't offer it."
Barry K. Gottfried, vice president at Goldman, Sachs & Co., the lead underwriter on the deal, disputed the argument of some bondholders that the voluntary prepayment was used to circumvent the 2006 optional call.
"I think it's a case of a lot of bondholders not having had the opportunity to read the official statement," Gottfried said. "The only reason they could be up in arms is if they hadn't read the OS. On any deal, particularly a housing deal, the market is aware the bonds can be called as a special redemption."
Several investors, however, were clearly incensed, and said quotes on the bonds from pricing wires gave no indication of the call threat.
One veteran housing analyst, speaking anonymously, called the authority's use of the voluntary prepayment provision "controversial," but said the bigger issue involves the quoting of the bond prices.
Prior to the call, Muller Data quoted the 1980 bonds at 130 and Kenny S&P had them at 125, market sources said.
The analyst said that pricing did not take into account the "very real" possibility of the voluntary prepayment.
"Whoever said they were pricing at 130 was wrong to begin with," the official said. "I can't see how you could have ignored the possibility of this voluntary prepayment occurring. To ignore extraordinary call provisions on housing bonds is foolish."
The housing analyst said the call options are "freely documented in the OS" and the bonds should have been quoted at around 103 "because anyone can see that's a prime refinancing candidate."
He said the "unusually distant" optional call in 2006 should have been a "red flag" to investors.
A source at Muller Data, who asked not to be identified, said, "No bondholders have contacted us regarding any particular problem. When these bonds came out, we did our usual procedure on all refunding bonds."
He said that as the 1993 bonds were priced, "the exact bonds being called out were not determined. As soon as they were, we adjusted the price," although he declined to give specifics.
A spokeswoman for Kenny S&P said the firm based its pricing on active trading.
"We had seen trades at the level where we evaluated the bonds. We reflect the market as it is trading," the spokeswoman said. "When the announcement came out about the call, we dropped the bonds to around the call price."
In addition to the reported price quotes, bondholders also questioned why the original offering statement would define the term maturity as having a first optional call 26 years out from 1980, if that was not the intention.
"Why they would have an optional call date so long in the future was beyond me," another market source said. "Maybe it was for marketing reasons. I don't know what the original intent [was].
"This special call provision is really a disguised optional call. No one can tell me if this has happened before, but you can bet that someone tries it again."
Monahan said that some of the "agitation" from the early call stems from the fact that "Bloomberg had apparently inadequately summarized redemption provisions the authority had in the 1980 OS. We're comfortable we fully and appropriately disclosed everything we need to."
Scott Clopton, a senior research assistant at Bloomberg Financial Markets, said the company does not distinguish on its wire service among special call provisions like the ones on the Battery Park deal.
"We list them as mandatory extraordinary provisions and people know to contact us about that," Clopton said. "That is our standard procedure."
Although the Battery Park issue was insured by the Federa Housing Administration, the "special call" was not an extraordinary one like those on other recent FHA-insured mortgage deals, which are usually triggered by a default. In the past, institutional investors complained that such defaults were used on FHA-insured mortgages by developers so they could utilize the extraordinary call provisions to lock in lower rates.
Tax-exempt housing bonds backed by FHA-mortgage insurance, particularly those issued in the early 1980s, have in recent years become suspect portions of institutional and mutual fund portfolios, according to investment managers. The bonds would normally trade at a premium because of their big coupons, but when a mortgage default is threatened and the possibility of a call looms, traders knock the bonds down nearly to par.
When a developer cannot, or, as some investors argue, will not continue to make payments on a FHA-insured mortgage, it triggers an automatic extraordinary call, usually at par, which drives down the value of those bonds trading at substantial premiums.
Aaron L. Task is a reporter for The Guarantor, The Bond Buyer's credit enhancement newsletter.