WASHINGTON -- Investment bankers predict strong interest in an upcoming District of Columbia general obligation bond issue, but were scratching their heads Friday over the complicated structure city officials set for the deal late last week.
"I know people are going to bid on it," one banker remarked. "But the deal is so complicated. There are just a lot of questions on it."
The competitive offering is slated to hit the market tomorrow and includes $230 million of series 1991B Variable-Rate Bonds, which will carry 12-year maturities, and $105.46 million of series 1991C Fixed-Rate Bonds, which will mature in five years.
The bonds, authorized by Congress this summer, are designed to eliminate the city's accumulated deficit of $332 million and to eliminate the need for short-term borrowings.
The variable-rate bonds are backed by letters of credit from Sanwa Bank Ltd., Sumitomo Bank Ltd., and Industrial Bank of Japan Ltd. The banks carry Aa/MIG1 and AA/A1-plus ratings from Moody's Investors Service and Standard & Poor's Corp., respectively. Fitch Investors Service has no rating on the banks and will not rate the variable portion of the issue, according to Colleen Woodell, a Fitch senior vice president.
Sanwa is backing $85 million of bonds, Sumitomo is backing $75 million, and the Industrial Bank is backing $70 million.
The letter of credit agreements with the three banks, all of Japan, will last three years. Ratings agency analysts said that after the end of the three-year period, one of four things could happen: The agreement could be extended; the city could substitute other, similarly rated, banks; the district could exercise mandatory tender or redemption options; or the bonds could be converted to fixed-rate obligations.
The district will swap the variable-rate payment on the bonds with the joint team of Pryor, McClendon, Counts & Co., and Merrill Lynch & Co. to obtain fixed-rate debt service payments. The swap agreement is for the entire 12-year life of the bonds.
The fixed-rate bonds will not be backed by any credit enhancement and consequently will carry the city's long-term GO debt ratings. The bonds will carry an A-minus from Fitch and a Baa from Moody's.
In affirming its Baa rating, Moody's on Friday credited the administration of Mayor Sharon Pratt Dixon with making "significant progress toward stabilizing the district's financial position." Standard & Poor's currently assigns the district an A-minus, but the rating is under review.
Earlier in the month, officials contemplated savings of at least $10 million through the use of the debt swaps and possibly bond insurance. Ellen M. O'Connor, the district's deputy mayor for finance, said the structure ultimately adopted could save the city close to $12 million on a present-value basis.
The new savings figure was derived by comparing various bond issuance options. For example, had the issue hit the Street on Thurday, and gone out uninsured, it likely would have carried rates of about 7.05%. Had it been insured it likely would have carried a 6.5% rate. But had it gone out with a swap arrangement, allowing the city to enjoy what is known as a "blended rate," the issue likely would have gone out at a 5.8% rate.
"We felt that the reduction in debt service payments provided consequential benefits to us in terms of money that could be spent on services, potholes, and police officers," Ms. O'Connor said Friday.
But some investment bankers questioned the savings figures. "You really have to question whether savings today are going to be savings tomorrow," one banker said. "What if rates go up? I really want to know what the downside is."
Another investment banker said that if it made economic sense to issue variable-rate debt for part of the deal, it was hard to understand why it did not make sense to issue all the bonds at a varable rate.
Ratings agency analysts said that in swap agreements, the blended rate -- generally tied to a mutually agreed-upon index, such as one kept by J.J. Kenny Co. -- usually results in a lower payment than available if a municipality issued insured bonds or variable-rate debt without credit enhancement. They said that in the case of the district issue, it appears that even after swap fees are taken into account, the city should be able to achieve considerable cost savings.
According to Ms. O'Connor, a variety of scenarios was examined.
She added that the district is not wedded to the idea of always entering into debt swaps in future bond issues. "At this time, with this deal, this option seems to be the best," she said. But she said city officials will monitor how the deal unfolds, and watch other issuers, before deciding whether to go the same route in the future.
In the process of selecting Pryor McClendon and Merrill Lynch, the city also qualified five other firms for possible use in the future should the district decide to enter debt swaps. The firms are: Citicorp, Sumitomo, WR Lazard, Laidlaw & Mead Inc., Prudential Bache Capital Funding, and Goldman, Sachs & Co. "These are all firms we would feel comfortable with," Ms. O'Connor said.
Ms. O'Connor said she hopes for broad interest in the issue, and expressed the desire of city officials for strong minority participation in any bidding syndicates.
Bids on the bonds are due by 10 a.m. tomorrow at Ms. O'Connor's office.