April 26, 2022
Finance Department
DATE: April 26, 2022
TO: Mayor Butt and Members of the City Council
FROM:
Anil Comelo, Interim Deputy City Manager
Subject:
Approve Contracts to Provide Underwriter, Swap Advisor, Bond Counsel, and Disclosure Counsel Services for the
Pension Obligation Bonds.
FINANCIAL IMPACT: None
PREVIOUS COUNCIL
ACTION:
April 6, 2021; October 5, 2021; December 7, 2021
STATEMENT OF THE
ISSUE:
The City currently has approximately $130 million in
Pension Obligation Bonds (POBs) that need to be
refinanced. Therefore, the City needs a Bond team in
place for the potential sale of municipal bonds. To that end, City staff conducted a Request for Qualifications
(RFQ) and have identified firms to assist with the
possible sale of municipal bonds.
RECOMMENDED ACTION:
APPROVE contracts with Loop Capital Markets and
Hilltop Securities to provide Co-underwriter Services in an amount of 0.30 percent of the principal amount
(approximately$480,000), and Legal Service Agreements
in an amount not to exceed $75,000 each with Jones Hall for Bond Counsel and $55,000 with Best Best & Krieger
for Disclosure Counsel services - Finance Department
(Anil Comelo/Delmy Cuellar 510-620-6600).
AGENDA
REPORT
April 26, 2022
DISCUSSION:
The City currently has outstanding two series of pension obligation bonds ("POB's"), an approximately $18 million series maturing in 2023 (the "B-1 Bonds") and a $130 million series maturing in 2034 (the "B-2 Bonds"). The City needs to refinance the $130 million series. The City is also party to two interest rate swaps (the “Swaps”) associated with the 2005 Bonds. However, the swap for the B-2 Bonds (the “B-2 Swap”) is subject to mandatory early termination on August 1, 2023, before which time the City will need to either (a) arrange financing to pay the market value of the B-2 Swap upon such early termination (currently ~$30 million) or (b) amend the B-2 Swap to remove or delay the mandatory early termination. City staff is clear that the goal is to refinance the POBs with minimal cost and risk (recognizing that there is an inverse relationship between cost and risk). City staff will be seeking to provide the City Council with any private placement offers from banks. Additionally, the City Council will likely also be provided with the option to direct staff to seek conventional financing as a publicly offered municipal bond.
We are in a dynamic rate environment where interest rates are highly likely to increase significantly. In fact, the Fed has already indicated that the interest rate could be increased by as much as 1 percentage point in the next eight (8) weeks. Therefore, the sooner we can form a City bond team, the sooner we will be able to refinance the $160 million debt. (Including the termination fee of $30 million). We do note, however, that it is believed that the swap itself may negate any benefit from low interest rates because the termination payment amount is linked to the interest rate (such that as the interest rate increases, the swap payment decreases by a corresponding amount) and thus there may be zero savings on the B-2 Bonds regardless of when it is refinanced. City staff members and consultants are reviewing this further.
To ensure that the City is prepared to market the bonds, City staff conducted a Request for Qualifications (RFQ) processes which was sent out on March 28, 2022. A total of 5 firms provided responses to the Underwriter RFQ, 5 firms responded to the Bond Counsel RFQ, and the same 5 firms responded to the Disclosure RFQ. The Proposals were reviewed by the City’s bond team consisting of the City Attorney’s office, the City Manager’s Office, Finance Department, NHA Advisors, the City’s municipal advisor and the City’s consultant Mr. Gardner. After reviewing the submittals, City staff is recommending following firms in accordance with the RFQ:
Bond Counsel: Jones Hall, A Professional Law Corporation Jones Hall is a firm comprised of 16 attorneys, all of whom practice exclusively on municipal finance as bond counsel, disclosure counsel, underwriter’s counsel and special tax counsel. The firm operates from a single office in San Francisco. Jones Hall is organized as a professional law corporation and has been practicing continuously for more than 40 years.
Disclosure Counsel: Best, Best & Krieger
BB&K’s Public Finance practice group has acted as bond counsel and disclosure counsel for many pension obligations over 20 years.
April 26, 2022
Both firms provide the requested services and each contract has been provided extra room for fees over the quoted proposal rate to accommodate expenses, validation action and complexities ($10,000 for Jones Hall, $5,000 for BBK).
Co -Underwriter: Loop Capital Markets and Hilltop Securities City staff and the City's municipal advisor, NHA Advisors, recommend that two bond underwriters, Loop Capital and Hilltop Securities, be retained as the City's bond underwriters for the purposes of refinancing the POBs. Loop Capital is the largest minority owned municipal bond underwriting firm in the nation and has been in business since 1997. Hilltop Securities is national municipal bond underwriting firm and a leader in the private placement of pension obligation bonds in California. Both firms are highly experienced in underwriting pension obligation bonds in general.
Loop Capital's proposal provided very helpful analysis on how to structure the refinancing to maximize the City's ability to retain its full pension tax override for the long term under the 2003 Huntington Beach State appellate court decision. This court decision restricts all California public entities with pension tax overrides to only levying the tax at a level consistent with CalPERS benefits in place prior to July 1, 1978. While the City's overall CalPERS payments for pre-July 1, 1978 benefits now exceed the "Huntington Beach limit" significantly, that may not be the case in the future. Since the City's pension tax override now generates about $25 million per year, this idea has the potential to save the City several million dollars.
In addition, Loop Capital's proposal offered the insight that for technical reasons the owners of the 2005 POB's may want to accept an offer by the City to be taken out of their bonds now through a refinancing, as opposed to holding them until they are callable on August 1, 2023. If so, such a "tender offer" could save the City several million dollars on the refinancing.
Hilltop Securities provided a letter in email form from a major bank indicating an interest in doing the entire 2005 POB refinancing as a private placement. Because the size of the refinancing, including the swap termination payment, may be as large as $160 million this indication of interest is a real "game changer". Prior to this, the largest pension obligation bond private placements have not exceeded $30 million.
A private placement has the advantage of shortening the financing schedule by several weeks and reducing the costs of issuance. Consequently, this offer through Hilltop Securities has great potential value to the City. In addition, the Hilltop Securities proposal also provided insights on how to protect the City's pension tax override revenues for the long term.
The City will enter into a smaller contract of under $10,000 with Hilltop Securities to obtain consulting services related to Swaps. In particular, the City will include appropriately qualified/certified Hilltop Securities staff as part of the City team in meetings with RBC regarding Swaps and the termination fee.
April 26, 2022
Municipal bond underwriting firms are compensated for selling a bond issue through receiving a portion of the proceeds of the bond sale as a contingent fee. This is commission is called the "underwriter's discount". It includes compensation for both the bond salespeople and for actual investment bankers who will work on analyzing and structuring the bond issue prior to sale. The practice of having two different bond underwriting firms work on the same transaction can result in a modest increase in the overall cost of the bond underwriting with respect to just the amount paid for the investment bankers, but not for the sales personnel. This cost impact for the proposed underwriting team for the 2005 POB's is shown below:
Hilltop
Securities
Loop
Capital
Hilltop and Loop
Capital as "Co-
Managers"
Proposed
underwriter's
Discount 0.232% 0.250% 0.30%
Total
underwriter's
discount
assuming a $160
million bond issue
371,200
400,000
480,000
Total proposed
increase in
underwriter's
discount:
108,800
As a % of a $160
million bond issue 0.068%
As shown above, the City will pay approximately $100,000 more for the benefit of having two bond underwriting firms on this transaction. Here are the extra benefits the City receives from this extra cost:
- Having the option of both a private placement and a public offering - Having "two sets of eyes" from experienced investment bankers on this complex transaction
- Having good insights on how to preserve the City's pension tax override revenues for the long term from two different firms
- Loop Capital, a minority owned firm taking a leading role on a major bond underwriting for the City
- Hilltop Securities has a swap trading operation that can provide timely market information for the City's finance team on the RBC swap
The City's finance team believes that these extra benefits justify the increased cost. As noted in the table above, given the size of this transaction, these extra costs amount to less than 7/100 of 1 percent of the amount of the bonds proposed to be issued.
April 26, 2022
Swap Advisor: Hilltop Securities will also act as a swap advisor for the City in an amount not to exceed $10,000.
DOCUMENTS ATTACHED:
Attachment 1 - Bond Counsel Contract – Jones Hall
Attachment 2 - Disclosure Counsel Contract- Best Best & Krieger Attachment 3 - Contract from Underwriter, including swap advisor Loop Capital Markets Attachment 4 - Contract from Underwriter, including swap advisor Hilltop Securities