The Massachusetts Health and Educational Facilities Authority and Jordan Hospital purchased at par more than $7 million of their 1992 Series B revenue bonds Monday and sold the bonds to Lehman Brothers for its tender-option bond program, over the objections of bondholder Eaton Vance Management, which claimed the transaction was illegal.
The transaction was devised by New York City-based Cain Brothers & Co., the financial adviser to Jordan Hospital that issued a certificate concluding that the mandatory tender would not have a material impact on the bonds price or yield and would not impair the bonds security.
Officials from the authority and Jordan Hospital declined to comment, but sources said the buyback of the high-coupon bonds saved the hospital money, more than could have been saved had the bonds been refunded. The bonds, which had a maturity date of 2015 and a coupon of 6.875%, were callable at any time at par, with advance notice to bondholders.
Eaton Vance, however, claimed that this is another example of a coerced tender, a type of transaction that the National Federation of Municipal Analysts warned about in a recently issued position paper.
In such transactions which are being done with increased frequency in the muni market, particularly with hospital bonds bondholders are forced to tender their bonds to the issuer at par or a slight premium so that the bonds can remain outstanding and an investment banker can restructure them in the secondary market for a derivatives or tender-option bond program, the NFMA said in its paper.
Proponents of these mandatory tenders say they save issuers money and avoid the costs and delays of having to do refundings. They claim the bondholders are not harmed because there is essentially no difference between the issuers calling, or purchasing, the bonds at par.
The proponents of these deals see controversies such as these as involving poor cash-strapped hospitals trying to save money in the face of opposition from well-heeled institutional investors who are unhappy about losing their investments in high-coupon bonds.
But the NFMA contends that these transactions are unfair to bondholders because the bonds are taken away from the holders at something other than a market price and remain outstanding for the benefit of other market participants who restructure the bonds in the secondary market for profit. The NFMA insists that these transactions are illegal if the bond documents do not permit purchases-in-lieu-of-redemption and only provide for bond calls that result in the defeasance of the bonds.
One market participant said this week that while some broker-dealers will only participate in these transactions if the indenture the agreement between the issuer and trustee clearly permits it, other dealers are more aggressive and push for amendments to the indenture, raising questions about whether bondholder consent is needed.
Thomas Weyl, a vice president and manager of Boston-based Eaton Vances municipal research unit, contends that his mutual fund company should have been allowed to continue to hold the Jordan Hospital bonds unless the issuer was willing to pay it the market price for the bonds.
The bonds have been trading at an average price of above 101 since April, according to the trading disclosure history on Thomson Financials TM3 wire. Most of the trades appear to be smaller in size and to involve retail customers. But on April 8, $3.4 million of the bonds traded six times between dealers at an average price of 101.743.
Eaton Vance owned $905,000 of the Jordan Hospital bonds, not enough to make it cost effective to litigate, according to Weyl. Mutual funds often hold bonds in smaller amounts because of internal diversification requirements, he said.
Theyre picking small deals [held by] a diverse group of bondholders and a lot of retail investors that dont have the financial resources or incentive to litigate, he said.
But Weyl said he wants to warn bondholders about these transactions and the questions they may raise.
Were going to scream about this to whomever will listen, he said.
Most investors are not even aware of these transactions, Weyl said. The mandatory tender or put notices typically go through the back offices of fund companies or firms holding bonds for retail investors and are treated like calls. The bondholders do not discover their bonds were purchased until afterward, he said.
Weyl claims that, in this case, Eaton Vance talked to several law firms that informally agreed that the original indenture for the bonds did not permit a purchase in lieu of redemption without bondholder consent. A lawyer at one of the firms, who did not want to be identified, confirmed that his firm believed the indenture required unanimous bondholder approval for a change in the redemption provisions.
Based upon the Cain Brothers certificate and the bond counsel opinion sent to transaction participants, the issuer, borrower, and their advisers believed they could amend the indenture to permit the mandatory tender of the Jordan Hospital bonds because of language in the indenture stating that certain amendments could be made without bondholder consent, including those to cure any ambiguity or defect, or to add provisions which are not inconsistent with this agreement and which do not impair the security for the bonds.
But Eaton Vance claimed that the transactions participants should have focused on another provision in the indenture that stated unanimous consent from bondholders is needed to make any bond redeemable other than in accordance with its terms.
They changed the redemption terms. They created a mandatory put that didnt exist. They gave the hospital rights it did not deserve, Weyl complained.
Weyl also contends that the transaction participants did not even follow proper procedures to amend the indenture.
The indenture states: Any amendment of this agreement shall be accompanied by an opinion of nationally recognized bond counsel selected by the authority to the effect that the amendment is permitted by his agreement.
But the documents show that the indenture was amended on June 14, three weeks before Cain Brothers issued its July 6 certificate concluding that the tender would not have a material effect on the bonds prices or yield, and more than a month before Palmer & Dodge LLP issued a July 19 opinion that concluded that, based on that certificate, the amendment to the indenture was valid and binding. Palmer & Dodge was bond counsel for the 1992 revenue bonds, as well as for this transaction.
Lawyers at the Boston-based firm declined to comment.
James Cain, a managing director at Cain Brothers, confirmed that his firm was financial adviser to Jordan Hospital, but said he was not familiar with the details of the transaction.
But sources familiar with the transaction insisted that the dates on the documents do not raise questions about its legality. The authority authorized the amendments to the indenture when its members held a scheduled meeting, they said. All of the opinions and certificates were given simultaneously and the documents were all signed and in hand by the time the mandatory put notices were sent to bondholders in late July, they said.
The Cain Brothers certificate contained information from two municipal bond pricing services showing the bonds trading above 101. But the certificate noted that the indenture permitted the bonds to be called at par with 30 to 45 days notice to bondholders, and suggested the premiums were related to the call periods.
To the extent that the current bond prices or historical bond prices exceed their respective redemption prices such premiums (the call period premiums) reflect primarily the value to the bondholders arising from their ability to continue to hold the bonds during the remaining period (including the period required to exercise the notice of redemption) prior to the next possible redemption date of the bonds pursuant to the bond indenture, Cain Brothers said.
Based on this determination, the market prices of the bonds on the date hereof, adjusted to eliminate the call period premiums, are not materially greater than the respective redemption prices of the bonds, the firm said. Cain Brothers defined materially to mean 25 basis points or more in yield as calculated on a yield to maturity basis.
The firm also certified that the mandatory put would not impair the security for the bonds.
In its opinion, Palmer & Dodge made clear that it was relying on the Cain Brothers certificate.
In rendering our opinions set forth below we have relied upon, and assumed the accuracy of, the factual and financial determinations set forth in the Cain Brothers certificate . We have made no independent investigation as to the conclusions set forth in the Cain Brothers certificate or their accuracy or completeness, the law firm said.
The supplemental agreement has been duly authorized, executed, and delivered by the authority and is a valid and binding obligation of the authority enforceable upon the authority, the law firm concluded. It will not affect the tax status of the bonds, the firm said.
