LOS ANGELES -- Owners of 25 commercial high-rise buildings in Los Angeles will use proceeds from a city-sponsored $96.4 million private placement to install sprinklers and other fire safety systems.
Los Angeles' first-ever private placement closed last Thursday. Institutional purchasers will receive an 8.48% fixed rate of interest on the notes, which mature in September 2015.
The federally taxable notes are exempt from California personal income taxes and carry double-A ratings from both Fitch Investors Service and Duff & Phelps Credit Rating Co.
One reason Los Angeles chose a private placement rather than a standard municipal bond issuance was to avoid registration with the Securities and Exchange Commission, city officials said.
The SEC might have gotten involved if the deal had been a typical public finance transaction because the proceeds are earmarked to benefit private parties, normally the purview of the SEC.
The city wanted to avoid SEC registration because it is "an expensive, time-delaying process," a source said.
But the transaction "benefits the public as a whole," so the city wanted to put the Los Angeles name behind the financing, the source said.
"The public will be coming into these buildings. If they weren't retrofitted, the public could be in danger in case of fire," the source said.
According to an offering memorandum, investors purchased "limited obligation medium-term improvement notes, Series A."
Series B notes are not yet scheduled for market. However, council members have authorized the issuance of a total of $200 million of notes for high-rise fire safety, said Gerry Miller, a finance specialist for the city administrative office.
The owners of the 25 buildings will be responsible for the debt service payments, to be made in the form of semiannual assessment levies. Los Angeles is acting as a conduit in the financing: The city's only pledge to investors is that it will foreclose on delinquent properties.
Los Angeles officials "have no involvement in the installation or the maintenance of the improvements," a source said. "That is the private property owner's job."
The city council's willingness to fund fire safety improvements stems from a spectacular late-evening fire in May 1988 that damaged several floors of the 62-story First Interstate Tower in downtown Los Angeles. The blue, which killed one man and injured 40 others, was the subject of a 1991 television movie, "Trapped on the 371h Floor."
In the aftermath of the fire, council members adopted an ordinance that mandated upgrading of fire safety systems in about 350 older high-rise buildings scattered throughout the city.
The ordinance covered buildings 75 feet tall or taller, the equivalent of seven stories, that were built before strict fire regulations were instituted in mid-1974. Skyscrapers built since that time are equipped with emergency power systems, stairwell ventilation, enclosed elevator lobbies, and fire sprinklers.
About 50 of 350 buildings subject to the ordinance requiring fire safety retrofitting have fully complied, Los Angeles fire inspector Neal Reitzell said. Another 250 buildings are in partial compliance. The remaining 50 buildings "have not done anythings" Reitzell said.
The 25 buildings participating in the private placement were selected after a stringent screening process, Miller said.
Initially, about 80 building owners expressed interest in the program. Forty-five buildings owned by that group were submitted to rating agencies for review.
Of the 45 buildings, 25 were chosen as finalists. The cast-off buildings were dropped for a variety of reasons. Commonly, they suffered "cash-flow and vacancy problems," Miller said.
The goal of the rating agency selection process was to guarantee that the notes would obtain high-quality ratings "to keep interest rates low" for the final group of building participants, Miller said.
Fitch Investors Service focused on the "credit of the underlying real estate" -- not on the creditworthiness of Los Angeles, said Dean Britton, a senior vice president for the Fitch commercial mortgage group. The assessment levies are senior in obligation to any private mortgage liens on the properties, and are co-equal to property taxes.
A noncontiguous assessment district was created for only the 25 buildings that participated in the private placement. The district is spread out citywide, not in one location.
In addition to paying assessments to cover the notes, building owners will pay levies for a reserve fund equal to 10% of the issuance amount. The reserve will grow by retaining interest earned over the first six years of the life of the notes.
Last week's private placement is the culmination of a six-year effort to find financing sources for fire safety systems in Los Angeles.
The original financing plan, developed in 1988, called for the city to sell bonds enhanced with a letter of credit from a commercial bank. The backing would have made the bonds exempt from SEC registration.
But, the letter of credit bank pulled out in 1991 because of the soft real estate market.
The city's financing team then explored how to issue long-term obligations without SEC registration requirements, and hit upon the private placement concept.
"Registration issues were raised because it was not clear whether the SEC would treat the underlying assessments that support payments of the notes as a separate security," a source said.
The long-term obligations themselves would have been exempt from SEC registration, the source said. But the SEC refused to provide assurances that it would not categorize the assessment levies paid by the building owners as securities subject to registration.
In the final transaction, the city sold the long-term notes, as well as the underlying assessments, to an underwriting syndicate led by senior manager Morgan Stanley & Co. The underwriters, including co-managers Kemper Securities Inc. and Grigsby Brandford & Co., resold the obligations to qualified institutional buyers.
Structuring the transaction in this manner exempted the city from registration requirements under Rule 144A of the Securities Act of 1933.
The notes were issued under an indenture between Los Angeles and First Interstate Bank of California, which is trustee.
Ironically, First Interstate's trust department is on the 11th floor of the high-rise building that was damaged in the 1988 blaze.
"The trust department encountered a lot of water damage. We were right below the fire," said Mike Klugman, a senior vice president and manager of corporate trust and stock transfer services.
Damage was so severe that the department had to use temporary facilities for 18 months.
First Interstate's role as trustee for the private placement "is coincidence," Klugman said.
But, Klugman said, it is ironic that First Interstate "is administering this [private placement] from the building that had the fire" -- a catastrophic event that "gave rise to fire safety improvements in Los Angeles."