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Deal in Focus

Troubled Vernon Issues With Ease

LOS ANGELES — Selling $74.3 million of electric system revenue bonds for Vernon, the scandal-ridden California city that narrowly avoided being disincorporated last year, would seem to be an uphill battle.

But De La Rosa & Co, the underwriter selected to market the bonds, found it to be remarkably easy.

On Tuesday, De La Rosa priced the debt, shutting down sales in less than an hour after the bonds — with ratings split between high triple-B and low single-A — were oversubscribed.

Benjamin Stern, a principal in the investment bank’s Los Angeles office, said the bank did not anticipate the level of interest the bonds would receive when it first began pre-marketing efforts in mid-December.

“The investors were able to wade through the noise and take a look at the underlying credit and make a decision to purchase the bonds,” Stern said. “When we started the process last year, I didn’t have high expectations that this many investors would look at the credit, but I felt they had good credit.”

The bonds are a risky investment from an individual investor’s point of view, because the city of Vernon lacks a population and residential tax base, said Michael Pietronico, chief executive of Miller Tabak Asset Management in New York.

“The city is only 5.2 square miles and it is mostly industrial,” Pietronico said. “It makes for a risky investment since industry can change quickly. Residential tends to be more stable.”

The industrial city is home to 1,200 businesses but just 112 residents.

The bonds are split into two series. Series A, $39.5 million of new-money tax-exempt bonds, will be used to pay for improvements to the city’s electric system. The taxable $34.8 million Series B bonds will refund 2009 bonds that mature later this year.

The response received enabled the underwriter to lower the yield by 10 basis points to 5.4% on the 30-year tax-exempt bonds at close, Stern said.

“I’m sure they had a lot of people lined up before the sale. The bonds are attractively priced,” said a San Francisco bond trader, who declined to be identified. “The market is strong and new issuance supply is thin for January.”

The market for the Vernon bonds is institutional investors, who are always searching for high yields, according to Pietronico.

“Institutional investors tend to be more sophisticated and can track investments like this better than individual investors can,” he said.

The preliminary offering statement contains an in-depth explanation of the controversies that have rocked the city.

Over the past two years, three of Vernon’s former senior officials have been convicted of crimes relating to city activities — the mayor for voter fraud and conspiracy, the city administrator for misappropriation of funds, and the director of light and power on a felony conflict-of-interest charge related to the hiring of his wife as a contractor.

None are currently employed by the city, and salaries of Vernon officials have been adjusted to levels comparable to other California cities.

State legislators introduced a bill in December 2010 that would have disincorporated the city after years of complaints from neighboring communities about corruption and pollution from Vernon’s power generating station.

Concerned about potential job losses in the city that employs 50,000 people, Sen. Kevin De Leon, D-Los Angeles, one of the disincorporation bill’s original co-authors, agreed to work with Vernon to defeat the bill if officials agreed to a series of reforms.

Among the changes was an agreement that the city spend an amount equivalent to what neighboring cities spend annually on parks and recreation by creating a community benefits program to create parks in the city. The amount agreed to was $60 million.

Vernon officials are considering a bond issue to pay for the parks fund, but city spokesman Fred MacFarlane said money from this week’s electric revenue bond offering will not be used for that purpose.

The disincorporation bill was defeated in September. Simultaneously, De Leon recommended a series of reforms to improve oversight and transparency that were approved by Vernon voters in two separate referendums held in November.

The measures approved by voters included a requirement that officials fill vacancies on the City Council through a special election rather than by appointment.

Other voter-approved changes to the city charter included requiring competitive bidding on contracts, retaining an independent reform monitor for four more years, and maintaining a housing commission.

While de Leon’s office is pleased with the progress being made by the city, the senator has assigned one of his deputies to meet with Vernon officials on a weekly basis to make sure the city adheres to the agreements made, said Greg Hayes, a de Leon spokesman.

The Internal Revenue Service closed an audit of the tax-exempt status of Vernon’s electric revenue bonds on Dec. 22, finding favorably for the city, which continues to be the subject of two other audits.

The California Public Employees’ Retirement System is conducting an examination of retirement benefits paid to public officials that is expected to be released in mid-February. A joint legislative audit will be released in April.

The benefits paid to Bruce Malkenhorst Sr., a former Vernon city manager convicted on charges of misappropriating funds, are considered to be among the state’s most excessive, Hayes said. He collects a $500,000 annual pension.

De Leon is working on a bill that would prevent former city officials convicted of embezzlement from receiving pensions, Hayes said.

The IRS notified Vernon that it closed its audit of $360.75 million of electric system revenue bonds issued by the city in May 2009 without changes to their tax-exempt status.

The audits were disclosed in event notices the issuers filed with the Municipal Securities Rulemaking Board’s online EMMA system.

“The close of the IRS audit with a 'no change’ determination was not unexpected,” city administrator Mark Whitworth said in a statement released in late December. “In fact, it was anticipated from the start of the Treasury Department’s examination. Vernon fully cooperated with the IRS auditors, confident that our bond financial dealings have been legal and appropriate.”

The IRS ruling was clearly helpful in selling the bonds, even though it was related to a different bond issue, Stern said.

“It cleared up some of the questions,” he added. “It definitely helped the process, although taxability was never in question on the new bonds.”

Another hurdle the bonds had to clear was the mixed ratings received from Standard & Poor’s and Moody’s Investors Service.

S&P affirmed its A-minus on the city’s electric revenue debt on Nov. 23 with a stable outlook. But Moody’s downgraded Vernon’s electricity enterprise on Dec. 6 to Baa1 from A, mainly due to declining revenues, while also giving the credit a stable outlook.

“This downgrade is due to financial operations, which just deteriorated independently of the other issues,” said Moody’s Kevork Khrimian in an interview shortly after the bond downgrade.

The defeat and aftermath of AB 46, which would have disincorporated Vernon, had minimal affect on the rating, according to Khrimian.

The Moody’s downgrade reflects weaker-than-expected operating results for 2011 and analysts’ expectation that similar results are likely to persist at least through 2014, he said.

The Vernon utility’s demand for power is stagnant and has fallen significantly short of projections, the Moody’s report noted.

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