September 23, 2009
Utility Snubbed by Banks Shows States Pay Too Much
By Michael Quint
September 23 (Bloomberg) — — East Bay Municipal Utility District in Oakland, California, which hasn’t missed a bond payment in 86 years, is being told by banks that its credit isn’t as good as companies that Moody’s Investors Service says are 90 times more likely to default.
While the public utility serves more than 1 million residents and has the highest AAA debt rating, lenders for a $200 million credit line want to charge East Bay as much as triple what banks are seeking from California Water Service Group on a similar facility. The investor-owned company’s first- mortgage bonds are ranked AA-, three levels lower.
The search for funds by East Bay is an example of how state and local governments, which almost never default because they can raise taxes and fees, routinely allow taxpayers to pay more than they have to when borrowing. The utility’s operating revenue rose about 6 percent to $360 million in the year ended June 30 after a 3.75 percent water-rate increase and drought surcharge, according to its annual report.
Banks want local governments to believe they are different from companies in financial markets “because it allows them to charge above normal fees and make above normal profits,” said Christopher Taylor, the former executive director of the Municipal Securities Rulemaking Board in Arlington, Virginia. With letters of credit, “that product differentiation is artificial,” Taylor, who headed the municipal bond industry’s self-regulator from 1978 to 2007, said in an e-mail.
Build America Bonds
Jefferson County, Alabama, with 660,000 residents, has struggled to avoid the biggest U.S. municipal bankruptcy after debt-service costs on more than $3 billion of sewer bonds surged when bond insurers lost their top credit ratings during the worst credit crisis since the Great Depression.
Local governments have sold $33.1 billion of taxable Build America Bonds under President Barack Obama’s economic-stimulus program, paying interest rates as much as 0.84 percentage point more than market yields for debt issued by companies with similar credit ratings, according to data compiled by Bloomberg.
Borrowers in the $2.72 trillion municipal-securities market “absolutely” pay more for credit, said Laurence Fink, chief executive officer of BlackRock Inc., which will manage about $3 trillion in assets after completing the purchase of Barclays Plc’s investment unit. “We could find a lot of examples of that,” Fink said in an interview Sept. 17.
Millions in Fees
At issue for the Oakland agency, as well as the top-rated Metropolitan Water District of Southern California, which is also seeking a credit line, are the millions of dollars in fees taxpayers will have to pay to obtain backing from banks to sell variable-rate bonds.
Such debt comprises $400 billion to $500 billion, or 15 percent to 18 percent of the municipal bond market, according to testimony to a congressional committee by David Wilcox, the deputy director of research and statistics at the Federal Reserve.
A record $108.7 billion of variable-rate demand debt was sold last year by 796 local governments and not-for-profit organizations, according to Bloomberg data. This year, 253 issuers sold $23.1 billion of the bonds through Sept. 18.
The securities are long-term obligations whose yield is typically reset daily, weekly or monthly. A letter of credit and a bank’s agreement to become the buyer of last resort are one of the strategies municipalities can use to make the debt eligible for money market funds.
‘Love Your Credit’
Charlotte, North Carolina-based Bank of America Corp. and JPMorgan Chase & Co. of New York are among lenders proposing fees of 0.85 to 1.25 percentage points for a credit line, according to East Bay finance director Gary Breaux. San Jose- based California Water Service was quoted a price of up to 0.4 percentage point annually by Bank of America, said Bob Soldwich, a senior financial analyst at the utility.
“‘We love your credit,’ the bankers say, then they ask for a 100 basis-point fee,” Breaux said in an interview, referring to a yearly payment equal to $2 million for the credit line. “I don’t feel so loved.”
A basis point equals 0.01 percentage point.
What sets East Bay and Los Angeles-based Metropolitan apart from many issuers that depend on taxes to pay bondholders is that the water utilities resemble corporations. They generate revenue by charging ratepayers for services and post quarterly financial reports, just like shareholder-owned companies.
The districts are “different than other borrowers in the municipal market, where reports of declining tax revenues could make lenders and investors nervous,” said Metropolitan’s chief financial officer, Brian Thomas. “Our bills get paid promptly every month.”
Higher costs for municipalities couldn’t come a worse time. Officials are cutting expenses in the recession that started in 2007. State tax revenue fell 11.7 percent in the first quarter of this year, the sharpest drop in at least five decades, according to the Nelson A. Rockefeller Institute of Government in Albany, New York.
Municipalities turned to variable-rate debt in 2008, after credit markets seized up and caused the $330 billion auction- rate bond market to collapse.
Auction-rate yields are set at bidding handled by securities firms and used to offer short-term interest rates on long-term securities. Last year, local governments were forced to pay as much as 20 percent when banks stopped offering to buy the bonds back after doing so for almost two decades. When municipal officials turned to variable-rate bonds instead, banks began increasing fees for letters of credit and similar contracts called standby purchase agreements that backed the securities.
‘A Little New’
The California public utilities are trying to lower financing costs by sharing information about letter-of-credit prices. Both are clients of Saber Partners LLC of New York, whose chief executive officer, Joseph Fichera, provides independent analysis for Bloomberg News. “I know our request is a little new to the banks,” said Breaux of East Bay, which serves 1.3 million consumers. A fee of less than 0.5 percentage point would be reasonable, he said. That would cut about $1 million a year from the utility’s fees.
In addition to a lower price, water district officials want a corporate-style credit line from a group instead of a single bank, as is the practice in the municipal market. They want the flexibility to choose whether to borrow from the credit line, use their own cash or obtain funds from another source. That’s different from most agreements in the municipal market, where cash is withdrawn automatically from a lender when variable rate bonds don’t sell immediately.
Brian Marchiony, a spokesman for JPMorgan Chase, said bankers didn’t want to comment on cost comparisons of municipal and corporate credit lines. Louise Hennessy at Bank of America Corp. in Charlotte, North Carolina, declined to comment.
Yields on highest-quality variable-rate demand bonds averaged 0.25 percent during the week ended Sept. 10, according to Bloomberg data. When combined with the typical 1 percent cost of a letter of credit and a fee to remarketing agents, an issuer might spend an amount equal to 1.3 percent of the debt. The Dormitory Authority of the State of New York paid 1.25 percentage points to Toronto-based Royal Bank of Canada in July for a standby purchase agreement to replace an expiring contract that cost 0.18 point six years ago, according to Division of Budget documents.
“When we raised questions about price, banks told us this is a scarce resource and they have more requests than they can honor,” said Michael Givens, treasurer of Jacksonville, Florida, the state’s most-populous city with 850,000 residents. Taxpayers were charged about one percentage point for new agreements with Wachovia Bank, a unit of San Francisco-based Wells Fargo & Co., the most ever, on $117.6 million of debt in April, he said.
Lenders say the charges are required because they risk owning variable-rate bonds they can’t sell. The promise to purchase securities was rarely invoked until the credit seizure last year, when banks were deluged with demands to buy the debt, Patrick Boyer, a vice-president in New York at the Barclays Capital, said in a telephone interview.
In May, about $50 billion of variable-rate bonds were held by banks serving as buyers of last resort, according to Wilcox, the Fed official.
“The fundamental risk profile of this business has changed,” Boyer said at a June speech at a conference sponsored by the Securities Industry and Financial Markets Association. Lenders now see “risks are higher than reflected in bank prices prior to last year.”
While Boyer said in an interview that companies get lower prices than local governments because lenders see more opportunity for additional business than they do with municipalities, Fichera of Saber Partners said he found “no verifiable evidence” that this is the case “in any example put forward by banks” to his clients.
“Saber contacted the companies mentioned by bankers directly to verify the information,” Fichera said. “My clients do have substantial business and other opportunities available, just as companies do.”
When East Bay selects firms to handle $200 million of bonds it sells annually, manage cash or oversee construction funds held in escrow, Breaux said he would be willing to favor banks that “provide us with credit at a reasonable price.”
Utah, which is rated AAA, paid 0.11 percentage point more on $491.8 million of 10-year Build America Bonds on Sept. 16 than the yield on comparable debt of Wal-Mart Stores Inc., according to Trace, the pricing system of the Financial Industry Regulatory Authority. The world’s largest retailer is ranked Aa2 by Moody’s and AA by Standard & Poor’s and Fitch Ratings.
In Oakland, East Bay is asking to be treated no differently than investor-owned companies.
“We want investors to look to us as the source of repayment, not a bank’s promise,” Breaux said. “We want a line of credit based on our credit, just like corporations use.”