Small Cities Are Turning to Bond Pools to Land Rates like Big Borrowers
By Elaine Johnson Staff Reporter of the Wall Street Journal
Gulf Breeze, Fla., population 6,000, is about to hit the big time
in the municipal bond market.
Sometime before the end of the year, the bedroom suburb of Pensacola
plans to sell up to $500 million of tax-exempt revenue bonds, an offering that
would be considered large for a city of any size, let alone tiny Gulf Breeze.
The issue is an example of the new twist on an old method of municipal
finance known as "pool financings". In such offerings, a sponsor, in this case
Gulf Breeze floats an issue whose proceeds are used by a number of cities. States
have long sponsored similar issues, known as bond banks, but cities have only
recently begun to sponsor their own pools.
"It's a new approach to funding local government capitol needs
by going with the old, old American way of co-ops - like the farmers' co-op,"
says Rodney L. Kendig, city manager of Pensacola, which tends to borrow up to
$85 million from the Gulf Breeze pool.
'It's Cheap Money'
The pool concept is catching on quickly because it allows similar
cities to share underwriting expenses and get the lower interest rates available
to large borrowers. "its cheap money," says Errol H. Brick, vice president for
Goldman, Sachs & Co., which is lead underwriter and remarketing agent for the
Gulf Breeze issue. Cities in California have sponsored pool financings, and the
concept is being considered in other states. The Florida League of Cities is
also working on an issue separately from Gulf Breeze.
One political roadblock, however, is tax overhaul. Loan pools
make use of some controversial financing techniques that Congress may ban or
limit beginning the first of next year. While a ban wouldn't prohibit pool financings,
it could reduce their appeal.
As sponsor of the issue, Gulf Breeze will administer the loan
pool - a task that is expected to net the town several hundred thousand dollars
in fees over the 30-year life of the issue. Gulf Breeze also gets first crack
at the money, even though the town's needs are modest. City officials have put
in for only $2.5 million, which has been earmarked for construction of a community
center, expansion of the natural gas system, and other projects. Like each city
that participates in the pool, Gulf Breeze is responsible only for the amount
it borrows, not for the entire $500 million.
The issue will be composed of variable-rate demand bonds - bonds
with 30-year maturities and put features with relatively short lives. A put allows
a holder to sell a bond back to the issuer at a predetermined price. The bonds'
structure makes them, in effect, long-term issues with the lower interest rates
generally found on very short-term notes like tax-exempt commercial paper. The
initial interest rate will be negotiated with the purchasers, who are expected
to be largely institutional investors.
'Homogenizes the Credit'
One issue with pool financings is the difficulty in rating them
because of the different ratings of the individual participants. So polls are
invariably insured or back by letters of credit. "Insurance homogenizes the credit,"
says Mr. Brick of Goldman Sachs.
Two uses of pool financings - advance refunding and arbitrage
- are under fire in Congress and may be banned or limited starting next year.
In an advance refunding, a city pays off an old issue of bonds with proceeds
from a new issue with a lower interest rate. Pensacola, for example, plans to
use some of its money from the Gulf Breeze pool to refund outstanding debt. The
advance refunding will allow the city to shave as much as three percentage points
off its borrowing costs, says Mr. Kendig, the city manager. In arbitrage, municipal
issuers can profit by investing some of the pool at a higher interest rate than
their borrowing cost.
While pool financings aren't in danger, the threat of a ban on
arbitrage and advance refunding could spark a lot of offerings before the end
of the year. "A whole lot depends on Congress," says Howard H. Weston, a senior
vice president of Arch W. Roberts & Co., Gulf Breeze's financial advisor. "If
the new tax bill is approved, why, you're going to have folks standing in line."
Orlando Agency Gets 'Eye-Popping' Benefits from 2 Long-Term Swaps
By Katherine M. Reynolds
WASHINGTON - The Greater Orlando Aviation Authority and Gulf Breeze, Fla.,
have worked out a multi-step transaction involving two long-term interest rate
swaps that authority officials say will save them millions.
"The numbers presented were eye-popping in terms of the economic benefit to
the authority," said the authority chief financial officer Linda Lindsey in a
telephone interview last week. "It's an extremely complicated deal but it has
resulted in fabulous rates."
In conjunction with the first portion of a $1.2 billion capitol improvement
program, the airport authority wanted to borrow $250 million. Consequently, it
issued $170 million of bonds subject to the alternative minimum tax in November
at a true interest cost of 5.45%, and took out a $90 million, floating-rate loan
from Gulf Breeze's loan program last week.
For the city to fund that loan, it issued $90 million of revenue bonds Tuesday,
at a fixed coupon of 4.50%, a yield of 4.95%, and an all-in true interest cost
of 5.04%, according to Charles LeCroy, a vice president at Raymond, James & Associates.
The authority decided that a swap was a better alternative to straight variable-rate
demand bonds, LeCroy said, adding that the authority saved approximately $16.9
million. Aside from the economic advantage of the swap-loan structure, variable-rate
debt exposes issuers to the costs of a liquidity of facility and remarketing,
as well as the risk that those costs might increase over the decades when the
debt is outstanding.
"You always have the renewal risk, credit risk and remarking fees," he said.
"You have all sorts of market risks that you can't control. Synthetic floating-rate
debt is simply more efficient and often more cost effective."
During the first five years of the transaction's life, under the first swap,
Gulf Breeze will pay J.P. Morgan & Co. the floating rate on the loan, and Morgan
will pay the 4.50% coupon on Gulf Breeze's bonds. Meanwhile, the airport authority
will pay the city a floating rate on the loan based on a composite index that
will be slightly more than The Bond Market Association municipal swap index.
The authority also pays nine basis points for a program fee.
Then, in year six, the second swap takes effect. Under this agreement, the
aviation authority will pay Goldman, Sachs & Co. 4.45% and receive the TMBA index.
Also the Gulf Breeze swap will change, with the city paying Morgan TBMA minus
26 basis point, and receiving 4.50%.
Year six will also see the floating rate on the loan change to TBMA minus 26
basis points. When taking into account the nine basis point fee the authority
pays Gulf Breeze to administer the program, the variable rate will effectively
rise to TBMA minus 17.
Thus, the authority will be paying TBMA minus 17 to Gulf Breeze, paying 4.45%
to Goldman, and receiving TBMA from Goldman. The net effect will be a 4.28% fixed
cost on $90 million of funds for 25 years.
"We've locked in 25 years of financing at a rate of 4.28%," Lindsey said. "That
talks real money to the airlines and the authority."
From Gulf Breeze's point of view, the city receives 4.50% from J.P. Morgan,
which pays the rate on the underlying fixed-rate bonds. But Gulf Breeze also
pays TBMA minus 17 from GOAA, netting the city the nine basis point program fee.
Three of those basis points the city can't keep, but must spend on trustee,
verification, and other costs associated with the loan administration.
"We were quite pleased with the transaction. When our customers are pleased,
we're pleased, "said Ed Gray III, former mayor of Gulf Breeze, and a current
special consultant to administer the program. Gray noted that the program fee
is paid separately from the interest on the loan, and is not included in the
arbitrage calculations for Gulf Breeze's bonds.
Lindsey stressed it took a collaborative effort to make the transaction work,
from the authority's general council Gordon Arkin at Foley & Lardner to the airline
partners to the authority's board and its chairman.
"A lot of people worked very hard," she said. "That chemistry and that professionalism
and that leadership are really what make us able to do these types of deals."
The authority didn't want the transaction to fully take hold until after five
years because it wants to pay floating rates for as long as possible to avoid
negative arbitrage, LeCroy indicated. But "we didn't want to miss the market
opportunity for today's fixed rates," he added. | 
