Municipal market dealers and investors have different opinions on whether to tender bonds issued by the Government Development Bank of Puerto Rico as part of an unusual offering from Cargill Financial Services Corp.
Cargill has offered to purchase the outstanding bonds of a $450 million government development bank offering at a minimum price of $114.25 per $100 face value of the bonds, plus accrued interest. The tender offer is unusual because it is rare in the municipal market for a party other than the issuer or its designated agent to offer to purchase bonds. The proposal expires at 5:00 p.m., eastern standard time, on July 29.
While some brokers are advising clients to accept the tender offer, other portfolio managers say they would not give up the 10% yield available on the bonds without a fight.
"We've been telling [investors] to tender the bonds," said Chris Hall, a partner with Howe, Solomon & Hall Inc., a municipal broker in Florida.
"Unless somebody knows something about this bond going to maturity that I don't, I would take the tender," Mr. Hall said. "But it's tough to find anything around that yields more."
Lebenthal & Co., which also expects the bonds to be called at the first call date in February 1994, is also advising its retail clients to tender bonds for purchase.
"It works at $114.25. It really makes sense if you intend to reinvest," said Jim Lebenthal, chairman of the firm.
"It makes sense to reinvest at current rates if you believe interest rates in February 1994 won't be appreciably higher," Mr. Lebenthal continued. "Cargill's got you, so lay back and enjoy it."
But clients who are not interested in reinvesting their windfall should probably hold on to the bonds and continue collecting interest until at least 1994, Mr. Lebenthal advised.
John D. Hartman, senior manager and director of sales at Lebenthal, said, "Our assessment of the Government Development Bank of Puerto Rico bonds is that those bonds that are not tendered are very likely to be called" in 1994.
Mr. Hartman calculated that an investor who owns $100,000 of the government development bank bonds and tendered bonds at $114.25 would receive $114.250 from the tender offer on a par cost basis. The calculations apply to investors who purchased their bonds at a price of $104 or lower.
A New York City resident in the 39.1% tax bracket filing a joint income tax return would pay approximately $5,572 in taxes and gain $8,678 if he decided not to reinvest, Mr. Hartman said.
However, a similar investor who chose to revinest only $110,000 of the funds received from the tender at a 6% rate would receive $6,600 annually on the investment, or a total of $9,900 over an 18-month period. Then on the expected first call date in February 1994, the investor would have a total of $18,578.25, Mr. Hartman calculated.
An investor who decided to hold on to the bonds until February 1994 when they could be called at a price of $104 would receive only $104,000. After taxes, the investor would gain $17,436, Mr. Hartman said.
Meanwhile, Ed Potts, manager of Qualivest Capital Management Inc.'s $241 million Tax-Free Trust of Oregon bond fund, expressed mixed feelings about tendering his bonds.
Mr. Potts, who owns about $1.75 million of the government development bank bonds, is concerned about selling all the bonds now because of uncertainty about whether Cargill plans to call them in 1994. As a result, he said he plans to tender only about $750,000 of bonds.
"When you don't know what's going on, you have to hedge yourself. If they go to maturity, some people say the bonds could be worth $140," Mr. Potts added. "But if the bonds are called in 1994, they're worth $104 - and that's a gamble if you don't submit your bonds to Cargill." Mr. Potts purchased the bonds in 1989 at $114 per bond.
Other portfolio managers, despite the possibilities of tendering their bonds, see more benefits in holding on to them.
"There's no way, unless you pay an absolutely ludicrous price," said Joe Deane, senior vice president and managing director at Shearson Lehman Advisors.
The fund manager said he would not be interested in selling the bonds "unless your tender offer starts at $214. That's an income stream that's just irreplaceable for us," Mr. Deane said, pointing out that some long-term tax-exempt bonds are currently offering yields below 6%.
"If you can keep a 10% coupon for another couple of years, God bless you," Mr. Deane said. The portfolio manager added that he could only think of two reasons why an investor would tender the government development bank bonds: "if you're looking at a credit problem," or "you've absolutely lost your mind overnight."
The firm's $1.72 billion Shearson Managed Municipals fund owns $3.16 million of the bonds, "and they will be there for the duration," Mr. Deane added. The bonds were purchased in the primary market at the initial offering back in 1983.
"It is an attractive offer," said Sheila Amoroso, portfolio manager for Franklin Resources' $124 million Puerto Rico Tax-Free Income Fund.
The Fund holds about $2 million of the government development bank bonds, and Ms. Amoroso said she plans to keep them.
She said she believes the fund she manages may be the only Puerto Rico municipal bond fund. "And as far as diversification, there aren't a lot of bonds to choose from," she added.
Furthermore, she said, "you can't replace the yield."
While the portfolio manager plans to hold the government development bank bonds, she does not expect to reap the benefits of a 10% coupon beyond the first call date in 1994.
"I expect the bonds to be called because they have a 10% coupon, and paying that kind of interest is almost ridiculous."
The Government Development Bank of Puerto bonds have a final maturity of 2013. The bonds were sold in 1983 priced as 10%s at par. They are backed by a letter of credit and securities known as Treasury Investment Growth Receipts, or TIGRs, which are 12% bonds which have had their interest coupons stripped.
Semiannual interest payments on the bonds through Feb. 15, 1994, are secured by an irrevocable letter of credit issued by seven banks led by Bank of America. The remaining interest and principal payments are secured by the TIGRs, which carry the unconditional guarantee of the federal government.
The strong backing on the bonds earned the issue a Aaa rating from Moody's Investors Service.
At the time of the sale, on Dec. 1, 1983, the issue was considered to be the largest single term bond offering, according to an official at Merrill Lynch & Co. Merrill Lynch and Bank of America were co-managers.
In June, Cargill, the largest privately held company in the United States, purchased the right to buy the TIGRs from Merrill Lynch. Merrill had purchased the right from First Boston Corp. in late 1989.
Earlier that year, First Boston entered into an agreement with the government development bank giving the firm an option to purchase the receipts. In addition, as optionee, First Boston had the right to cause the bonds to be called, in whole or part, prior to maturity. But the government development bank could not redeem its 10% bonds without the consent of First Boston.
At the time of the First Boston purchase, Cargill also bought a small portion of the TIGRs option.
Cargill's move to purchase the remaining TIGRs options and its effort to purchase the outstanding bonds gives the firm the ability to decide if and when to redeem the government development bank bonds.
Cargill will purchase the bonds by means of a modified dutch auction. Once all of the bids have been received, Cargill will set a maximum price it will pay for the bonds.