LOS ANGELES -- A public policy debate has been sparked over the decision of Lincoln, Calif., officials to refinance assessment district bonds despite the vehement objections of the district's largest property owner.
Using a pooled bond structure, Lincoln simultaneously refinanced the assessment district bonds and seven of the city'S other long-term obligations, which included certificates of participation and tax allocation bonds.
Some municipal market participants believe the Lincoln transaction may affect issuers statewide because it uses a new twist on California's Marks-Roos Local Bond Pooling Act of 1985.
The city received "in the ballpark of" $1 million in savings on the $16.7 million unrated refunding, said William Malinen, city manager for Lincoln, a city of 7,900 located 30 miles north of Sacramento.
Property owners in what is known as the Nicolaus Road assessment district will see their principal and interest assessment liens lowered slightly because of the refinancing, but developer Marvin L. (Buzz) Oates has characterized the savings as insignificant.
Oates, a Sacramento developer and majority owner of parcels in the refinanced assessment district, said he would have obtained greater savings if the city refunded the assessment bonds outside of the Marks-Roos structure.
Originally created to allow a group of localities to share in a financing pool to achieve economies of scale, Marks-Roos more recently has been used by single cities to fund pools for their own financing needs.
Lincoln council members in April empowered a city-controlled financing authority to issue revenue bonds under the Marks-Roos act to refinance the eight city borrowings.
Council members justified the refinancing after exploring what Lincoln "would be paying on those [eight] issues over the long run under their existing structure," Malinen said. They "realized we would be paying less on a refunded issue. That is the bottom line. The council realized we can go through this refinancing process and save money" on future debt service payments.
The council's most contentious decision was to issue $3.73 million of refunding bonds for the Nicolaus Road assessment district as part of the Marks-Roos refinancing.
"We told them not to do it," Oates said of the council's decision. "They did it without our permission."
Malinen said the refinancing "was not done with the blessing or consent of the property owners because it is not required under the law."
However, a source familiar with the transaction said Oates and other property owners in the Nicolaus Road assessment district were notified by letter before the financing took place.
The city gave property owners the option of prepaying their outstanding assessment liens, an opportunity that Oates failed to pursue, the source said.
The city went forward with the transaction. Malinen said property owners will see a reduction in their annual principal and interest payments, and a lowering of parcel assessments.
But Oates believes that the reductions will be minimal and that the city stands to gain more on the deal than property owners. He said he is considering legal action against the city if its officials cannot answer his questions about how they used proceeds of the re financing.
Beyond Oates' questioning of the legal validity of the transaction, some municipal market participants said they wonder whether the refinancing violates the spirit of the Marks-Roos act.
There is no consensus on "what the perfect public policy is" in earmarking Marks-Roos proceeds, said Dean J. Misczynski, transitional director of the California Research Bureau. "Should gains go to the developer, or to the public at large? Local governments are elected to do something, and they ought to decide. In this case, they decided against Buzz Oates."
Steve Juarez, executive director of the California Debt Advisory Commission, said, "I've never come across anything that says any refinancing savings have to be directed to assessment payers." The Lincoln case raises "a legitimate public policy question that local governments have to wrestle with. It should be looked at," Juarez said.
Meanwhile, Misczynski said, "There isn't any cleanup legislation" in the works to prohibit issuers from being the final judge of how to distribute savings generated from Marks-Roos refinancings. He said such legislative remedies would take place only "if, and when, the right [test] case arises."
Misczynski said he did not know if the Nicolaus Road assessment district would be a logical test case.
Using Sutro & Co. as underwriter, Oates tried unsuccessfully to refinance the Nicolaus Road assessment district last year.
When that deal fell through, the city hired First California Capital Markets Group to do a Marks-Roos refinancing that included Oates' assessment district.
Bruce Kemp, project manager for Oates, said he and Oates told Lincoln officials "in numerous letters and meetings, 'Leave us alone. We don't want to be mixed in with anybody else.' It is our property. We're paying debt on it."
Despite their pleas, Kemp said, Lincoln refinanced the district by using the pooling structure that essentially resulted in Oates owing the original amount outstanding before the deal. Oates received no significant break in assessment payments, Kemp said.
Had First California known Oates "did not want to be part of this" financing, "we would not have included" the Nicolaus Road assessment district in the refunding, said David Fitzgerald, a vice president with First California.
Oates' company "never said, 'We don't want to be part of this,'" Fitzgerald said. He said he believes that Oates was in favor of the refinancing, at least at first, because Oates expected it to net him "as much as $500,000 in savings. Instead, [Oates] ended up with far less than that amount. That's where the sour grapes came in."
Overall savings on the transaction were hurt by rising interest rates, Fitzgerald said.
"We had to reprice it a couple of times," Fitzgerald said. "Instead of hitting a home run, we got a double."
While soft market conditions hurt the Lincoln refinancing, Fitzgerald and other municipal market observers said the Marks-Roos refunding structure will be used with increasing frequency in the future.
At the same time, straight assessment refundings will decrease because such straightforward assessment refundings are becoming "more and more difficult to do," said Stephen Casaleggio of the San Francisco bond counsel firm Jones Hall Hill & White.
The justification for refunding assessment bonds remains, Casaleggio said, that "you are trying to take out old bonds that bear high interest rates." But to accomplish that goal, the issuer must create a reserve fund and pay costs of issuance. "So the savings aren't there," he said.
With a Marks-Roos structure, Casaleggio said, "You save huge amounts of money by putting the reserve fund for the assessment deal in the Marks-Roos structure." Without needing to fund a separate reserve fund, "that saves the issuer 5% or 10%."
The pooling technique allowed under the Marks-Roos act allows refinancings "that otherwise wouldn't do very well on their own," Casaleggio said.
And savings on the refinancing can be used by the city in any way its officials want, observers said.
"We don't say what they should do with their cost savings," Fitzgerald said, adding that he does not know "if it is a good idea or a bad idea" for city officials to pass along only nominal savings to property owners in the Nicolaus Road assessment district.
But speaking generally, Fitzgerald said, "Cities are trying to make money any which way they can."
The deal paid First California $417,500 in compensation, a 2.5% underwriter's spread, according to the official statement.
First California officials "are selling a lot of unrated paper, and there also is underwriting risk," said John Myers of Orrick, Herrington & Sutcliffe, the issue's bond counsel. First California "may have earned every penny of that," Myers said.