LOS ANGELES -- Los Angeles County finance officials are pitching a record-size negotiated sale of $1.97 billion of taxable pension obligation bonds to corporate investors in the United States and Europe.
The complex offering features fixed-rate debt and insurance-backed variable-rate debt hedged by various derivative structures.
John Edmisten, a senior finance analyst for Los Angeles County's chief administrative office, said the deal is expected to be priced today. But he added that the finance team is still "tinkering with everything, [so] it is impossible for me to tell you exactly what is going to happen."
The nearly $2 billion issue will be the second largest long-term municipal financing ever and the largest taxable long-term financing, according to Securities Data Co.
The New Jersey Turnpike Authority set the record for the largest long-term municipal deal in 1985, when it sold $2 billion of tax-exempt revenue bonds. The record for taxable long-term debt issuance belongs to California, which issued $602 million of taxable general obligation bonds in 1991.
Befitting its size, the Los Angeles County pension obligation bond issue has "the most moving parts of any issue I've worked on, that's for sure," Edmisten said. "We're just very anxious to get it done."
"This is the most complicated transaction I've ever done, and I've been in the business 21 years," said James H. Gibbs, a Lehman Brothers senior vice president. Lehman Brothers is senior managing underwriter of the deal, which has 14 co-managers.
The average sales commission to be paid to the underwriters has been set at $3.50 per $1,000 of bonds, totaling nearly $7 million if all bonds are sold. Gibbs described the takedown as a "corporate-type" commission that is "extremely low" compared with typical municipal underwriting commissions.
In an unusual move, the county will list the fixed-rate bonds on the Luxembourg Stock Exchange to give European investors "that comfort level'' to know that a major exchange outside the United States has "looked at" offering documents, Edmisten said.
However, Edmisten and Gibbs said the bonds would not trade on that exchange.
"The exchange reviews the official statement and satisfies itself that these are proper securities," Gibbs said. "It gives a stamp of credibility."
The need to list the bonds on the overseas exchange was "related to" the large size of the issue, Gibbs said. "The added demand that we can generate in Europe will simply help the marketing and pricing," he said, though it is possible that the issue could be sold entirely in the United States.
"There is enough size here to warrant doing the extra steps to make it accessible to European investors," Gibbs said. "From,the standpoint of credit and structure of the issue, we know that there are elements that would be attractive to them."
The pension obligation bonds are legally structured as refunding bonds, and therefore do not represent new county debt.
Typically, the purpose of issuing refunding bonds is to refinance an earlier issue to reduce debt service payments. But "refunding savings do not enter into" the Los Angeles County transaction, Gibbs said.
In this case, bond proceeds will be paid to the county retirement association, allowing the county to discharge its responsibility to fund 97.5% of its unfunded pension obligation liabilities owed to its retirement system.
An unfunded pension liability refers to the present value of what the retirement system is projected to pay in benefits earned by employees, less the assets projected to be available to pay those benefits.
The amount of the liability is based on a number of assumptions, including the average life expectancy of the system's employees, payments made into the system, and earnings on assets.
The county and the retirement association have agreed to divide surplus earnings from the bond issue during the next five years, with 75% earmarked to the county and 25% to the association.
For the 1995 fiscal year, which began July 1, bond sale proceeds will generate $265 million, of which a net $150 million will be used to help balance the county's general fund budget.
"We're funding 100% of the unfunded liability as of the June 30, 1992, valuation," Edmisten said.
"We now know, and the retirement system has agreed, that there is additional unfunded liability equaling 2 1/2%. So, when we give them the $1.9 billion, the retirement system will be 97.5% funded."
The assumed rate of return on the county's pension fund is 8%, and Edmisten said he expects the pension bonds, because of the variable-rate component, to be sold at a lower true interest cost than the effective rate charged by the pension system.
"We have to sell these bonds at a TIC of less than 8%, so the bonds won't be sold unless that is accomplished, and we expect to accomplish that," Edmisten said.
The transaction provides "roughly $2 billion transferred into the pen- sion fund, in exchange for adjustments in the county's relationship" with the Los Angeles County Employees Retirement Association, Gibbs said.
The financing consists of Series 1994A current-interest bonds, Series 1994B floating-rate bonds, Series 1994C capital-appreciation bonds, and Series 1994D select auction variable-rate securities, also called SAVRS.
The variable-rate portion, expect- ed to cover about $600 million of the issue, will be triple-A-rated because of insurance provided by Municipal Bond Investors Assurance Corp. Additional credit enhancement "beyond the $600 million" is available to the county, and might be used for the capital appreciation bonds"and other securities in the structure," Gibbs said.
"It makes a lot of sense to offer a triple-A insured instrument in the variable-rate market," Gibbs said. "It's in the county's interest to bring in credit enhancement since the county has just had a downgrade and maybe some rocky period is still ahead for them."
Los Angeles County's GO bonds were downgraded on Sept. 30. Standard & Poor's Corp. dropped its GO bond rating to A-plus from AA-minus and Moody's Investors Service lowered its GO rating to A1 from Aa. The rating actions were in response to the county's declining revenues and reduced financial flexibility because of the prolonged recession and other factors.
The credit agencies announced their GO bond downgrade at the same time they assigned A ratings to the pension obligation bonds. Despite the downgrade, Edmisten Said he believes "this bond sale will go well," primarily because of expected "corporate interest."
To the corporate market, Los Angeles County is "a new name and an A-rated credit that corporate bond buyers can put in their portfolio," Edmisten said.
Lehman's Gibbs predicted that "a large proportion of these bonds will be sold to traditional corporate bond investors who never buy municipal."
Premarketing efforts required the financing team "to educate that corporate marketplace to what is a municipality, what is a county, and why [Los Angeles County] is a good credit relative to IBM or Philip Morris or Sweden or Israel," Gibbs said.
On Wall Street, Gibbs said, there was the challenge of bringing "the culture and practices of the corporate bond underwriting and sales areas to work well with" their municipal bond counterparts.
"Those are two different cultures," Gibbs said. "They have different jargon [and] different marketing strategies."