In one of its most innovative financings to date, New York City plans to sell $1.21 billion of refunding bonds tomorrow to defease some of its outstanding insured bonds, freeing up enhancements capacity for future deals and reducing debt services costs.
After months of negotiations and number crunching, the city plans to unveil the deal devised by one of its co-managers, J.P. Morgan Securities Inc., in a negotiated offering. For its efforts, J.P. Morgan was promoted to serve as bookrunner and senior manager for the offering.
The city also named to co-senior managers the five regular senior managers -- Bear, Stearns & Co., Merrill Lynch & Co., Goldman, Sachs & Co., First Boston Corp., Lehman Brothers -- and promoted Dillon Read & Co. from co-manager. The rest of the managers in its regular bond syndicate also will take part in the deal.
One of the innovative aspects of the deal -- obtaining advance pricing commitments from three of the five major insurers -- raised eyebrows at the New York Insurance Department. Municipal Bond Investors Assurance Corp., AMBAC Indemnity Corp., and Financial Security Assurance Inc. all agreed to sell bond insurance to New York City for the same price -- 75 basis points, according to the city's comptroller's office. That cost would be calculated by multiplying 0.75 by the total amount of principal and interest insured, according to an official with J.P. Morgan. The firm negotiated the commitments with the banks and the bond insurers.
The city had been paying between 100 and 160 basis points for bond insurance for previous deals.
"We don't regulate the rates that they charge," a spokesman with the insurance department said. "But we would find it unusual that they are all charging the same amount."
At stake is whether the insurers have agreed to a form of price fixing. As insurance companies, the financial guarantors "have relatively broad exemption from antitrust laws," said Mike Antilics, assistant director of the bureau of competition at the Federal Trade Commission. "The states have responsibility for regulating insurers."
Insurance executives contacted yesterday said the pricing commitments for the city's upcoming sales were arrived at independently. We had no discussions with any other insurers," said Neil G. Budnick, senior vice president of research at MBIA. "This decision was made the same way every other pricing decision was made, independently."
The refunding will defease bonds that have been either insured in the primary or secondary markets or that have letters of credit attached to them in the secondary market.
For New York City, the offering marked an opportunity to get a handle on its debt service costs without either raising the ire of fiscal monitors or loading debt service payments onto a new generation of taxpayers.
For bonds insurers and providers of letters of credit, it means an early Christmas because they can reap the premiums on the securities defeased and they are also guaranteed business on future deals.
And for investors, tomorrow will mark the last time for a while they will see an entire issue of New York City deals priced in the primary market without credit enhancement. City officials have been conducting investor meetings in New York and Boston. They say they are confident investors will buy the bonds, reaching for the extra yield that may not be there when the city next taps the market.
At that time, the city plans to use its new insurance capacity. In December, the city is tentatively planning to enhance with letters of credit or bond insurance $657 million of the $750 million of the fixed-rate and variable-rate general obligation bonds. And in February, the city expects to insure $422 million of the $750 million of fixed-rate bonds slated for sale.
The December sale will mark yet another innovation with the unveiling of Financial Guaranty Insurance Co.'s new liquidity facility product. In alliance with its parent General Electric Capital Corp., FGIC plans to back $300 million of variable-rate bonds for the first time.
Company officials declined to discuss the specifics of the liquidity facility, citing a pending decision by the Securities and Exchange Commission, but as outlined it takes the bond insurer into entirety new territory. To provide the enhancement, FGIC will need to withstand the possibility of all $300 million being "put" at once. A new corporate affiliate -- FGIC Securities Purchase Inc. -- will actually issue the liquidity facility.
Although a number of large institutional investors have expressed concern about the city's fiscal health, they said they will wait to see what the final price is on tomorrow.
City officials have said investors will buy the bonds, even though the city dropped one of its standard bond covenants from the deal, a state commitment not to do anything to jeopardize debt service payments on city bonds. The city was required to drop the covenant because the refunding issue is not being done for a present value saving, but officials said 99% of the city's outstanding bonds have the covenant.
Market participants said the deal may come on tomorrow with a maximum yield of 7.0%.
City officials are glowing about tomorrow's deal. It represents months of hard work and negotiation with bond insurers and banks. And to sift through roughly $2.5 billion of credit enhanced bonds to find the bonds that would provide the best savings, the city combined the efforts of J.P. Morgan's professionals, Brown & Wood as bond counsel, the city's financial adviser Public Resources Advisory Group, and the staffs of the comptroller's office and the Office of Management and Budget.
Eric Altman, managing director of J.P. Morgan's public finance department, said, "We had been spending time with the city trying to help get credit enhancement, and, really, one day the idea just popped into my head -- defease the insured bonds," but, of course, get assurance from the bond insurers and the banks. The city's problem was mostly a capacity problem and not a credit problem, he noted.
Darcy Bradbury, deputy comptroller for the city, said promoting J.P. Morgan to manage the offering caused some grousing among the regular senior managers. But she said the firm did all the negotiating with the bond insurers and the banks and deserved to be handed the books for the deal. The firm provided "classic investment banking services," she said.
She cited the firm's efforts in getting the bond insurers to agree to participate in the defeasance. For example, although the city is planning to refund only $1.21 billion of bonds, bond insurers and banks have signed letters of commitment to insure or enhance up $1.63 billion over the next 12 months.
MBIA, AMBAC, and FSA are expected to insure a total of $1.06 billion of fixed-rate bonds with intermediate maturities.
The bond insurers said the city's refunding is likely to pave the way for future capacity-relieving deals from other high-volume municipal issuers. "We foresee this happening for other issuers for which there is limited insurance capacity," a FGIC spokesman said.
Other insurance officials said the price-fixing issue is made moot by the extremely tight capacity restraints on the industry. The major firms can only insure what is freed up by the issuer -- in this case the city -- so are only really using their own capacity in the future deals, one executive said.
Fuji Bank, Sumitomo Bank, Industrial Bank of Japan, and Morgan Guaranty Trust Company of New York plan to provide letters of credit for roughly $190 million of variable-rate bond with shorter maturities. City officials said the banks and FGIC will be working for about 55 basis points per year.
Along the way, the city persuaded MBIA to insure bonds beyond 2008, a date the insurer had never gone beyond because it is the year the Financial Control Board, a state fiscal monitor of city finances, expires. City officials felt the insurer's decision was a vote of confidence in the city.
Through FGIC and FGIC Securities Purchase, the city plans to use letter of credits on long-term variable-rate bonds for the first time. The city received authorization from the state this summer to sell these bonds. The city sold its first variable-rate bond offering in March through a syndicate headed Lehman Brothers, under a three-month authorization granted by the state in December 1990. The bonds have short maturities and were priced to yield 1.75%.
Commenting on the deal, City Comptroller Elizabeth Holtzman said, "The city has faced constraints on its credit-enhancement capacity for year, and this transaction finally solves that problem and allows the city to reduce its debt service costs.
"The city can now take advantage of its ability to issue variable-rate bonds under newly passed legislation that we worked hard to get passed," she added.
The city is expected to gross over $140 million in present value savings. After expenses, the city will see about $118 million in present value savings and reap about $87 million for its fiscal 1992 budget, which began July 1. To achieve this, the city will include a refunding of about $100 million of uninsured bonds and move principal payments out slightly.
Although the city has been criticized in the past for using refundings, this offering has received a nod off approval from fiscal monitors.
On Friday, Standard & Poor's Corp. reaffirmed its A-minus rating on city GOs on Friday, with a negative outlook. The agency noted that the deal's "effect on out-year debt service is minimal."
Allen J. Proctor, executive director of the State Financial Control Board, said, "Our sense is that this is a reasonable way to use refundings. I think this one comes very close to being a plain-vanilla refunding."
The purpose of a lot of the other [refunding] deals was to reschedule amortization, he noted.
