"Schwarzenegger Debt Defies Academics as Negotiations Trump Bids
By Joe Mysak
April 13 (Bloomberg) -- Utah and Georgia saved money for taxpayers by selling AAA-rated bonds in the first quarter through private negotiations with banks, even though more than a dozen studies show such transactions may increase costs.
While 75 percent of Utah’s sales since 2000 involved competitive bids, the latest $394 million sale in March was negotiated with New York-based Morgan Stanley. Georgia offered $614 million in fixed-rate bonds in February, its first no-bid offering, and Virginia issued $270.8 million in AAA-rated general obligation bonds in November through a similar process.
In a market battered by underwriter departures, insurer downgrades and flagging institutional demand, each no-bid sale produced yields further below the Municipal Market Advisors AAA median yield curve than the states’ most recent competitive offerings.
The worldwide freezing of credit since August 2007 and the longest economic slowdown since the Great Depression “may have further emboldened bankers to press even harder for negotiated” offerings, said Patrick P. Born, chief financial officer for Minneapolis. “This pressure is likely to be even greater with the threat of job losses among the pinstriped set.”
Boosted by New York City’s sale of $883 million of general obligation bonds last week, the volume of no-bid sales in 2009 has reached 86 percent of $91.8 billion in issues, according to Thomson Reuters. For all of last year, they made up about 85 percent of $391.5 billion.
California, which negotiated the sale of $6.5 billion in bonds last month, paid higher yields than in the past. Yet the offering found enough demand for officials to increase it by 64 percent from a planned $4 billion. Similarly, New York officials issued $400 million more than initially scheduled last week after first selling $454 million to individual investors.
The Georgia, Utah and Virginia results differ from the conclusions of a study, “Persistent Underwriter Use and the Cost of Borrowing,” in the Winter 2008 issue of the Municipal Finance Journal. The paper by Mark D. Robbins and Bill Simonsen of the University of Connecticut was the most recent academic analysis showing that competitive bidding saves issuers money in the $2.69 trillion municipal bond market.
At the same time, a growing number of local-government issuers have seen interest payments increase significantly after engaging in negotiated bond sales that included interest-rate swaps. Jefferson County, Alabama, was singled out last week in a report by Moody’s Investors Service as having “insurmountable problems” related to variable-rate debt. The county, home to Birmingham, is facing insolvency after interest rates on $3 billion of adjustable-rate sewer debt surged last year.
Federal Reserve Chairman Ben Bernanke, in a March 31 letter to Congress, noted that variable-rate debt tied to swaps, along with the failure of the auction-rate securities market “are causing fiscal strains for a number of municipalities.”
Highly rated states pursued negotiated sales because markets were “anything but normal,” said Dave Andersen, managing director and head of municipal bond trading and syndicate for Bank of America-Merrill Lynch, the nation’s leading tax-exempt underwriter for competitive and negotiated sales. The unit is the investment-banking arm of Charlotte, North Carolina-based Bank of America Corp.
“Market forces have been behind the trend towards negotiated deals,” Andersen said in an e-mail from New York. “Retail order periods have been critical to the success of most deals, and you can’t run a retail order period during a competitive deal.”
The bank, which led a group of underwiters on the sales in Georgia and Virginia, participated in 14 competitive transactions this year totaling $2.3 billion and 108 negotiated ones amounting to $13.7 billion.
California’s record sale last month produced yields that were further above the MMA AAA curve than those from the state’s last competitive sale. Yet bankers marketed the bonds to individuals successfully, allowing state Treasurer Bill Lockyer to expand the offering, Andersen said. Underwriters can’t employ such advertising to retail investors in auctions, he said.
“California would not have been able to get the size it did, or the pricing, if it had done a competitive deal,” he said.
Republican Governor Arnold Schwarzenegger’s state paid an average of 111.6 basis points over the yield curve. The last time it sold bonds competitively, in February 2007, it was rated A1 and A+, five maturities out of 22 were insured and it paid an average 5.64 basis points over the curve. A basis point is 0.01 percentage point.
‘We All Lose’
The March 24 deal offered a top yield of 6.10 percent on $1.2 billion of securities maturing in 2038, 82 basis points more than the Municipal Market Advisors’ index at that maturity.
Las Vegas paid the same yield on the same day in an auction of $31 million of 30-year bonds rated AA by Standard & Poor’s and Aa2 by Moody’s Investors Service, Andersen said.
The trend away from bidding may cost borrowers in the long run, said Ken Rust, director of the Bureau of Financial Management for Portland, Oregon.
“If you believe, as I do, that competitive sales produce the best sale results, then issuers pricing bonds in a negotiated sale need competitive sale results to serve as market leading comparables,” Rust said in an e-mail.
Unless issuers bargain harder with banks, “negotiated sale results move further away from market results that could have been realized in a competitive sale,” Rust said. “Ultimately we all lose.”
Competitive debt offerings force banks to submit the lowest interest-cost bid to win business. In a negotiated sale, issuers decide in advance which banks will market the bonds. Underwriters say the no-bid method lets them get better prices by tailoring the debt to specific types of investors.
Georgia had planned to sell its recent debt by auction last year, “but the market wouldn’t cooperate,” said Lee McElhannon, director of bond finance at the state Financing and Investment Commission. Mutual funds and hedge funds stopped buying municipal bonds after the onset of the credit crunch, leaving only individual investors, he said.
“We’re back to a much more limited investment base in the municipal market, and we needed a mechanism to reach out to that base,” he said.
The state’s first negotiated sale of new general obligation bonds Feb. 2 drew yields on its 5-year instruments that were 51.8 basis points less than the Municipal Market Advisors’ AAA median yield curve. At auctions last year, Georgia’s 5-year bonds yielded an average of 11.6 basis points below the median.
Beating the Curve
“We could not have been more pleased,” McElhannon said.
For 20-year bonds, the state paid almost 41 basis points less than the median in February, down from an average of 7.4 basis points below it last year.
Concord, Massachusetts-based Municipal Market Advisors, an independent research firm, produces its median curve by surveying dozens of bond dealers and professional money managers daily on where they think AAA yields should be.
Utah paid an average of 17.5 basis points under the MMA AAA yield curve on its $394 million negotiated sale on March 2. Its last competitive issue, $75 million in June 2007, yielded 3.7 basis points above the curve. Virginia paid an average of 29.7 basis points beneath the curve for its negotiated sale of Nov. 10, after paying 22.8 basis points below it for a June 4 auction of $98 million.
“The benefits of transparency and the reassurance of fair pricing are lost when governments use negotiated sales,” said Robbins, one of the authors of the recent study. “In the long run, you have to hope that competitive sales return.”
Bid sales saved issuers 17 to 48 basis points “on average and all else equal,” the researchers said in the study.
“Highly volatile markets are times when issuers worry about getting too few bids to have a successful competitive sale,” Robbins said in an interview. “If there ever is a day when negotiated sales are warranted, days without bidders are the ones.”
After credit markets froze in September, dozens of issuers postponed or canceled bond sales, according to data compiled by Bloomberg. By December, municipalities were paying a record 2.2 times the federal government’s costs. Top-rated issuers now pay 1.18 times, still above the average 0.86 percent.
In Idaho, “we actually sold bonds at auction in November and breathed a sigh of relief” afterward, said Liza Carberry, executive director of the Idaho Bond Bank Authority and state investment manager.
May Trend Back
Idaho paid an average of 16.3 basis points below the AAA median in its Nov. 6 sale of $27.8 million in revenue bonds rated Aa2 by Moody’s Investors Service. At its Jan. 26 negotiated sale of $48.8 million, it paid an average of almost 4 basis points over it.
Georgia may sell new general obligation bonds this quarter, McElhannon said. The state hasn’t decided which method to use. There are signs that demand is perking up. Institutions led by mutual funds purchased about $3.2 billion of California’s issue, roughly half the total.
“It depends upon the market,” McElhannon said. “If we continue to see improvement, and if an issuer has a history of selling competitively, I think you can see more issuers trend back to competitive sale.”