Legal delay saves city money by shifting deal to low-rate environment

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Delays caused by the threat of three lawsuits ended up benefiting Vallejo, California, by pushing a bond deal into last week's muni market rally.

The city and its advisors say the $37.8 million water revenue refunding deal priced 40 to 50 basis points lower than if the bonds had sold late last year as originally planned.

Rates in the $3.8 trillion municipal bond market were the lowest they had been in 38 years as investors' concerns about Covid-19 drove up demand in a flight to safety.

"We were comfortable with the transaction based on the very strong legal structure provided by the revenue bond pledge,” said Suzanne Finnegan, Build America Mutual’s chief credit officer.

The city, which has been working to overcome the reputational stain of its 2008 bankruptcy, priced Feb. 25 a $16.9 million tax-exempt Series 2020A and $19.9 million 2020B federally taxable Series 2020B through bookrunner Raymond James to refund its outstanding Series 2006 and advance refund its outstanding Series 2013 bonds.

The deal garnered $64.1 million in orders on the $37.8 million offered, Rekha Nayar, the city’s finance director, said in an emailed response.

The city realized $5.59 million in net present value savings, 13.9% of refunded par, well above the estimated $3.3 million net present value savings anticipated when the City Council approved refunding the bonds, Nayar said.

The Series 2020 bonds carry an underlying rating of A-plus from S&P Global Ratings. The Series 2020 bonds maturing from 2023 through 2030 will be insured by Build America Mutual, with a AA S&P rating. The 2020-2022 maturities will not be insured, Nayar said, as it was not economic to do so.

PFM is financial advisor with Orrick Herrington & Sutcliffe as bond counsel.

“We were comfortable with the transaction based on the very strong legal structure provided by the revenue bond pledge,” said Suzanne Finnegan, BAM’s chief credit officer.

The city had originally planned to price the bonds in October, and then was tentatively scheduled to come in late December on a day on which it may have been the lone deal on the calendar.

The pricing was delayed “due to the receipt by the city of several claims alleging that in 2018 and 2019, the city’s water rates violated Proposition 218,” Nayar said. “At least 10 other California cities have received similar claims with a similar statement of facts.”

California voters approved Proposition 218 in 1996, a constitutional amendment limiting the ability of local governments to increases taxes, fees and charges without voter consent. Some lawsuits have claimed that the law prevents cities from levying utility fees and charges that exceed what is needed to provide water and electricity and that it prohibits imposing a fee or charge on ratepayers to pay for basic city services.

The city explained in bond documents that it plans to defend vigorously against the claims and expects to prevail.

“The delay ultimately worked in the city’s favor, as the Municipal Market Data index was approximately 40 to 50 basis points lower across the maturity range of the 2020 bonds on the date the bonds priced on Feb. 25 as compared with the original planned pricing date, and the U.S. Treasuries were similarly lower,” Nayar said.

The 20-year maturity on the Triple-A MMD scale for general obligation bonds went from 1.85% on December 16 to 1.38% on Feb. 25, a nearly 50 basis point drop, said Daniel Berger, a Refinitiv senior market strategist.

The pricing resulted in aggressive spreads to MMD and Treasuries based on a very strong market and investor demand, Nayar said.

“It is possible they saved themselves a boatload of money,” Berger said.

The city's Chapter 9 bankruptcy more than a decade ago was not a meaningful factor in the transaction, Reyka said.

In California, enterprise funds and operations of cities, such as utility systems, have demonstrated themselves to be particularly strong, whatever the economic environment, said Mark Capell, a BAM vice president.

During its bankruptcy, though Vallejo made adjustments to its other debt, it continued to make payments on all its utility debt on time, Finnegan said. BAM views special revenues favorably, she said.

“If you look at Vallejo, San Bernardino and Stockton, all three were California cities that went through bankruptcy but never missed a payment on water and sewer enterprises,” Capell said.

BAM also looks at the underlying economy on any sewer and water deal and Vallejo’s has improved dramatically over the last six or seven years, according to the insurers.

“Comparing Vallejo in 2008, when the city declared bankruptcy to Vallejo in 2020 is a fairly different story,” Capell said.

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