HomeMy WebLinkAbout04-City Administrator
(
....
CITY OF SAN BERNARDINO
CITY ADMINISTRATOR'S OFFICE
INTEROFFICE MEMORANDUM
TO: Ways and Means Committee
FROM: Fred Wilson, City Administrator
SUBJECT: Next Steps Re: Pension Obligation Bonds (POB)
DATE: June 14,2005
COPIES: City Treasurer; Finance Director
As part of discussions regarding the FY 2005-06 budget, the issuance of POB's IS being
considered as one option to provide General Fund budget savings.
In May, the PFM Group (the City's financial advisor) assisted in the preparation and distribution
of a Request for Proposals seeking underwriting services for a possible POB issuance. In
response, thirteen (I 3) proposals were received from potential underwriters. On June 8, staff
from this office and the Finance Department, as well as City Treasurer David Kennedy and
Councilmember McCammack, all met with Peter Shellenberger of PFM to discuss the proposals
and the qualifications of the various firms. Another meeting was held via conference call on
June 13 to discuss PFM's analysis and recommendations. Based on their experience and
qualifications, Lehmann Brothers was determined to be the best choice to serve as the
underwriter, contingent upon the satisfactory conclusion of negotiations concerning their fees.
The attached memo from PFM summarizes the proposals and their recommendations
(Attachment A).
Lehmann Brothers (underwriter), PFM (financial advisor), and Orrick Harrington Sutcliffe (legal
counsel) would then make up the City's financing team, along with City Treasurer and City staff.
The financing team will then begin to determine how the bond issuance should be structured to
achieve the most long-term savings while minimizing risk to the City.
At this point, it is recommended that the Committee approve the proposed financing team. That
recommendation will then be forwarded to the Mayor and Council for approval by motion. At a
later date, when the various documents are prepared for the bond issuance, a resolution will be
brought forward to formally approve the financing team along with other related actions.
'\ \
\
*t.J
fa(I~1 bS'"
~Nr It-
~
.=-
~.t)c'~ ~
==~,_~~:.::ll
'-,oj ~ ....1, " (' ':1.'.'
t, .11.' 'il"J
'5 'HI'- ,. '.o:i~, ;.1., :"
., ~; ~';;7.":. :-.-1.-:
t\hr.3i,1[:'"i',).
..vv.,.... 1,1'1', r;'";".
----
=-
~-
The PF~f Group
f..~,:;; ;--\,tl',' _,!I .'.,;., ""; i;: .". 1 : Ii
~'..' :.. ','~'~'~";l;", ,~":E..~ J__,
Ii ';' ';,h.
June 13, 2005
MEMORANDUM
To: Fred Wilson, City Administrator
Lori Sassoon, Assistant City Administrator
Ci!) oj San Bernardino, G4
From: Peter Shellenberger, Senior Managing Consultant
Christine Johnson, Consultant
Publi.. Finandal Management, In<:
Re: City of San Bernardino Underwriter Proposal Summary
On June 3,2005 the City of San Bernardino (the "City") received proposals from 13 underwriting firms to
serve as Senior Manager or Co-Manager for the City's potential issuance of taxable pension obligation bonds
("POBs" or the "Bonds"). The purpose of this memorandum is to summarize the recommended strategies
and considerations from each of the proposing firms, as well as to compare the proposed underwriting fees
from the potential Senior Manager.
Summary
Many of the proposals recommended traditional fixed-rate debt for the interest rate mode for the POBs.
Current interest bonds, the most common form of fixed rate bonds, were commonly proposed together with
a "make-whole" provision that allows bonds to be called and restructured, while ensuring the investor is not
harmed if the bonds are called. The "make whole" provision provides structural flexibility with CIBs, but
does not usually result in great savings at the time of restructuring.
Some firms also recommended that the City examine the issuance of capital appreciation bonds or variable
rate debt to achieve near-term debt service relief and/or additional flexibility. Though there was discussion
surrounding the term of the Bonds, the general consensus from the proposals was that the City should use a
30-year final maturity.
The recommended size of the POB issuance varied across proposals from a $40 million transaction to a $73
million transaction. The proposed bond par amounts correspond to varying recommended funding ratios for
the City's pension liability: ranging from a 90 percent funding ration to 100 percent. Most firms
recommended a debt service structure that results in level annual savings in comparison to the original 30-
year "fresh start" amortization of the UAAL
Overview of Participating Firms
The City received nine proposals that asked for consideration as Senior Manager and/or Co-Manager, and
four proposals for Co-Manager only. The participating fums are listed below.
\. i
Lehman Brothers
Citigroup Global Markets Inc.
) P:\lorgan, Chase & Co.
UBS Financial Services Inc.
E) De La Rosa & Co. Inc.
RBC Dain Rauscher
First Albany Capital
Morgan Stanley & Co. lne
Stone & Youn her ,LLC
Piper )affray
~Ierrill Lynch & Co.
Siebert Brandford Shank & Co.
Loa Ca ital Markets LLC
City of San Bernardino
June 13, 200S
Page 2
T raditiona!
Traditiona!
Traditional
Traditional
MBE/WBE
T raditiona!
MBE/WBE
MBE/WBE
MBE/WBE
12
6
n/a
13
2
2
$2.0 billion
S 1.27 billion
n/a
$2.1 billion
$60.99 million
$241 million
n/a
$1.813 billion
$486 million
Traditional
Traditional
MBE/WBE
MBE/WBE
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
Of the senior experience listed we should note that RBC Dain Rauscher, Morgan Stanley and Lehman
Brothers have all managed transactions for issuers in CalPERS and/or issuers participating in the California
Pooled Bond Program.
Traditional Fixed Rate Structure and Proposed Pricing
Each fum was asked to provide structuring alternatives for a traditional fixed rate issuance in addition to ideas
for an optimal structure in order to provide a relative assessment of current market conditions as well as a
base line to compare alternatives. For the traditional fixed rate structure, firms generally recommended the
use of current interest bonds ("ClBs"). Some firms suggested the use of capital appreciation bonds ("CABs")
to provide ncar-term cash flow relief since CABs do not require interest payments until maturity.
Most firms considered a 30-year term for the bonds and debt service structured as uniform annual savings
when compared to the City's UAAL amortization. The spread to Treasury for CIBs ranged from 10 basis
points ("bps") in the I-year maturity to 95 bps in the 30-year maturity. Among firms proposing for Senior
Manager, spreads for the 10-year maturity ranged from 59 to 80 bps, while spreads for the 30-year maturity
ranged from 60 to 95 bps.
The following table illustrates the estimated spreads to Treasury for current interest bonds provided by the
firms as of March 18,2005.
\',
\
City of San Bernardino
June 13, 200S
Page 3
CIBs Estimated Spread to Treasury'"
_______~!.ni!lL~!!:!!ge!L~g:~!!!,ger_.. .~.1. .__ ~.E:!4a!lage~
it) ;cjl;::~! !{I.iUoi
o . c:'; I: t ~
o - u; i o~ j ~ ad) ()
N U) C:' ~E"~ !()~.; .:.=t-J
co Gi - 'ell I' o. ...J I' 1 C:...J
..- .xIOl 101 U; -J ,( m (/J
;n. ell.... m ju i. ';;1, ad f_S 0l'1 o~ I (J).c: -ell
- -= I' '- I "" ~ u. 0'
~ .c ..:; c:(:J I UJ ! OJ 1 Q,}.t:!::' i OJ I c:(:J J t); ~ .::JI: t
en ~ m I >-1' ell.... cn I ~ 1 0.: ..0, 1 ~....o i;;
; ~ 1l!~i~:~!BiJlg!~!~j'g::E >-
^ " I. .f!! co.... , c:: c:' I ~l 0 ~ a::! Uc:, m 19 "'
~ c: 0.' (J) ! ! '" I '" '" I >- I ",. >-. OJ '5. 1 :i::
'" ~ :a ~ c:1 c: I.SI Ollf!, O/l !...JI...J: t' c3 .!ll
0. e "', "'E1LJ.., OJ<l:1 ell I eIlj=! ell'
~ E U C) j ~ ~ cn I:E ti; 5 0 'E 1 .0 " g- I W
:g . 0 co .",! 0 iii, co! a. I ~ ..., i ell! ell 0 .Q.
.>- ...l..() c:: u.t::E.1....J ,=>; ..., ,ii::.Ui.h, wl::E,. cn.L...J L.a.
-..~g~6."r~.?~ '-'331 ..!Or~l.... :~5'-1Br~2'~, 3~~ '3~r3.5Tlq~:~-~51___i5r'-59
_.~00LL3.56o/c ..4?L 23j 6Q! 4Q,,23~ 301.49; 4~}4qVOi. 4Qi 2~) 60
'-""'2~-0009'9L;'I:"-33,.'6~6~0~ ..~L 381.~~H, i.5~~~; 401 ~~. 48, ~5~.~5;._ 44L.38j 70
Ie 51' 46, 70i 50 46 481541 53' 50: 45' 47' 461 70
~--20}~~~t~.ni '-5~t--54t75['55~ 54t . 56! 58: 5'5L50rs5~ .50L 54;-'.70
.__~9.1J_-l.nZ:d. ..~.~...~: 7~~ .6~,_.6LJl.~!6~, 5?1'.!)5~~5+- 55; 63!." 73
--'-i~.~'i-t.'+~.'i~ '-~'f- ~i-fat'-~~..I :~i.' .-~~~~:~. '. :~.i~:I'~~'-. ~~l. "'~i.:.'. --~~
:=~~13.:hiji!<- 551--54'ri9! ~)3r54'.- 5~}~[ ~l~~+~~;.~.5~l s4r"~~75
..._~~J,_~:.Q~ 59 59 80 ...!3.?[~~L?~1_6~i..__62L~~r' 6.2;_.~!~..7?
2016 i 4.070;' I I 851 68: . I 66; I . I i 78: 80
.....---I~....r-.'._.. -----------
....l,01L i .~.07.% i ! 901 73' i I! j ;' ! 78i 85
20'18 r 4.07% .--.t. -';'-( --7ii!.-!----.t--r--.t. r-'I--'------iit-'90
.--, ~i-"" ,ii' ~"'j'" .... r ,I. -1- ';"; -'1 . i . f'" ..,..-.
2019 I 4.07Vc :.' 83 .,..' 78, 95
--...-'---,.- .--.,. -----------
. . }020 '4,;15% 76: 75! ! 86" ! j , 85' 80: 80; 78~ 100
. - --.,,-+-., ... --.- '" ------ -r" '--' +'''r -- "I-"'j .-......-., ... ..,.... ,
'--~~~'lLHg~ --. J(....:. '+'''1'' r'" I.~ -+--i ;. .+- .~~! --
~.__. ~'" ~,_.k,__..__,_ ___________
._.JI1l~ ._j.. 4.2~'lIc - -j -I'... I .- ; .... t >- . j. . L ' 1-- 55+. ,
2024 i 4.25% I .: I ,";;' 55.
=~~~~IT:~~~ s6-'-''56[]2] . '60' 75:~1 6'0' 60' 60 55 "85
___.2'02.~,._4.~4o/< .' ___;.. t-' , l_1 J51
..... 2027 ~.j...~.34~ ~ j 1 65' I . 75
2028 i 4.34% ~ ,; 75
2'0'29-' r -4~4~!. .;.. + .; 'T: 75
'.'--2'030'-'i'-'4-.34~' 1",,"; f -;-. 75'
., ~_'''.._*..".,,~ ......f~ ... L. 1 10, .. ,I. 70t.
._']~?LL_~~~40;'1 ./... j t _..; l' 75;
-"'~~+1'~1~! -~-""';' r':'" -1 'i~:
....'_......_..,._\.....,u='w~...... ~....~I -- -4 ,-~-.~. .' -- -.J--~. - i
__203.4, J_~?4.."1-,-:.--i-... .1.......) ....?5~_ ..~5
203Sm I 4.430;' 75 ! 70 75' 75
(1) Spreads to Treasury provided by underwriter proposals.
(2) Note: 2035 maturity assumes 30-year Treasury.
Indicates high value.
Indicates low value.
'.
"1
!
i
:
;
!
i
!
!
i
~i 5 5
~ i .~ i .~
~! ~!.s
_~_L~.L ::E
'305'5:~lo
~_. "-r- '---"-r-"-'.
38 601 20
- .--.,---.,.~..._~
47 701 35
.. ..-, -"1- -
52. 701 45
"si' ..isI.59
63' 76: 55
-.- ,.--.,. -~p---
_57__ 77!.~.3
_~8L?B.(..48
...~QL_~~L?~
64' 80: 59
-"--r- -+ ".
75 85: 66
82, 90' 73
._--_.\'...~-._-.... --~
.8?~__9~ 7.8
85: 95' 78
~3 i.J. 0_O.i.J.5
55' 55i 55
._,__J...___ ._',
55' 55' 55
.55: ..55...55
55' 55: 55
-~.__!.. ----, ...~~ -
64\ 85: 55
75 75 75
70' 75,.65
,75 75~?5
_ 68;" J5d3..9
?2~ _~. Jq
75~_.?~~?~
75: 75. 75
;'--~"'r'. .,,,
75' 75' 75
_....~ -~~,_......---
74' 95' 62
..-.;.- .-;..-.-
75' 95 60
-
Ciry of San Bcrn:udi.no
.lulIe 13, 200S
Pa~c ~
In providing their financial analysis of bodl a traditional fixed rate financing and their optimal structures, all
firms provided a sense of the indicati\'e borrowing costs to the City, These true-interest costs ("TICs") are
summarized below.
Staled True.lnterest-Costs tTlCs)
_~ ...... _____-l___.,.~!!!~r"~~r!.~g!r/<iOr.!!I.!ln~g!.~~--..,.-.....-,..'--.. ...-_. ._-.J__~.".....~C.9:.M~~~_lg.!-_..~..._
, j t : ~ 1 .., .
; 'I! ,( i '. 1 0 I .- ;
o . I' 1 I f U.... .
l ,j.5!'" I ~ I ( ',i \ -5 I u- I
! i" I .M! i.s ci U 1 : ~ ! -l ;
~ ol 8 U ~ g' 1lI-J
Qj to 0 "2:"':! D u 1 6S i
~ : : 5 ~ ~ ~ I .., j ~ ~ ~
~ ~ ~ ~ ~ ~ J ~ = l.., ~ ~ ~
i i ~ ~ ~ ~ j ~ ~!! ~ ~ ~
o _ ~ ~ u: li;;: ~ ~:'E ~ ~.,
~ . I ~ i i j ~ ~ ~ I j I ~ . ~ 1.2 ~ j !
~ " 1._.o__..~.~..o;;_.I__....J _+~__ ~ L_LL._.i_.rn.__....~_..w ..L__:E..._ rn ...l_.+._ it
Traditional Fixed Rat.r=.~".83%r~-:5~7~~_.~3'9~0~18~.:-5~.i1%r.~;9%;.~ioi~Li'i6%:~5;i9~~~fi2ok;_ -~9~%~......~9.%t:-)~~~
O'imaIS',"c'u,.; 492% 504% 529% 514% 5.41% 500% 502% 472% 529% 5.22% 494% 545%
-Firm s~~ts a traditional fixed r:ue structure
(I) Loop ~uAAt:sts using a. mix u( fixt:d and \'aria.blt: debt but d~s nt>t rrn\'idt: :an:alysi~
The following table summarizes d1e structuring proposals for a traditional fixed rate fmancing.
STRUCTURING ALTERNATIVES
I.,.. l' __~_~~n~~'~_~'~~fgc:.r!~~o~~r~,agcr .._, -~---'~'f~fi~agc~
j ~ !~ 0' ~ r~
~ ~ a .~ ~ ~ ~ ~ ~ ~
~ ~ ~ ~ ~ ~ 'a I ~ ~ ~ ~
~Dt'.t::Ci.20g':J~~::i
~ ~ ~ ~ 'g ~ ~ g ~ ti ~ ~ I
,8!~~IL~ ~Ii,~,~ ~i~'~l~
IUj.2'1 e-1,,g'cni:!~I' iii' c: 011::.01 lSi X.
m , ~ lOG m, ~ ~! 9 . , ! ~ .~! 0-
:~lU!:!:I...J!:l ""lu.scnfw ~ CI)....J~a..
~~~~j ~if~~~~l~;~~~j~~~~;:;~~-;r~,~:rrriidid;ihal f~d ~'tc'Sti(jftilittt!;~~~f~~~~~'~rr:{f~~,~~~'~'''~;;i~1~Jt~~
......... ~~~.j<'t~~"'~""'''''';_'''''f'~'''''',,!;;;':;~",:,.fj.-.-~'~...' ~"""," ~'-r -....~.~' ,........"'-_..~.,"'.. "~f",,~~lli1"'"''''''' i;-~""'~~"""iL>>' -'r""""'""'~~',f'.i-"",,"l"""""'"
C':'~~llnlcn:"IIo~ds(ClIIs). ' X ~. )(. ! ".1 "4 X_I ~.l x f- x I x : XL "- .1.)( f x
<:~rl~ ApP'~~~~a~'~~~~.:~J(..'\.~~~L.._... ,...._......~~.....,,~~_....r ->..-l..~- ~ .~ ~.J-.~._L..._-..:...,..~...1._,~_?-+.._~~..L .,-~-4_...~ht..'_~-,.~
Level. ~~?~~e!,:.i~~_..., ._ .L _. l-. 1 ik. X -L X j ,~. t _~ ~ 1- X . X i..
~~dSa\.!~g!i(E~.~~l:1ti!'gpcb!SCfYice) .._. .__ t. X laX .; ~ !....?C__~. x~. ~. __ ~ ~ ~ t.. ~ X
. ~:~!:rT.f1. ~~~~.~:~~~~~(l!p_f~~~~~;~t;L__._.~_.~_.~_..~_+.__..t_'_.l-'-L-.--'_._J-___~i__-i...___. .._ ~-.~_+_.- ~_.~.
~:~~~n~~S~~~~t,~~~g 'i2:i~!!~~U!!.~~~~apc~~)~~ --- + i()3.i+-'Zc')-S -;. 1()3-1 ~~203S t' iilis 'l-263'f~-203S'~'2(j35:- 2i"ns .2()35'~2()25'~'203S~'i(i34
\"
\
-
City of Snn Bernardmo
June 13,2005
Page 5
Optimal Structure
The City received many different proposals for structure and secunUes. In this section we compare and
contrast the proposals based on proposed interest rate mode (fL'(ed vs. variable rate), derivative products,
proprietary products, and amortization and structure. Many firms also included credit enhancements and
alternative structures in addition [0 their recommendation of the optimal structure proposals. A summary of
the recommended optimal structures are shown in the table below. We would of course recommend
additional due diligence prior to implementing any structure, including a detailed risk analysis.
STRUCTURING ALTERNATIVES
I Senior Manager/Co.Manager I Co-Manager
r-r:Ti ---T -""rl' - -r r- l'--T'--r'Ir'r--
I l~!gl ,:.M'l' i iu',' ! 1;~!~1'
J ." -: 0 I ...J c: I ....
i f~ 01 I~~O :...JI. .~ III
lij ..,ul I~l.. 1ijai!8 !"'lii
1-5 ~illll ~1~1~ a. li.a 8't!' i!~
t~ ~lt' fU!(I)i~ ",!.g :x ..,'.2I~1
; ~ a: ~ ; ~ ! ~ : ~ j ~ : ~ t ~ ~; i t ~ t !
,s'a.tCl)lal+tll,c:tll;>ICG ~lmli5..I'.i
1~~e!;I':il~I~'~Ia4:~J...JI1:: ~i~
:u OJ\~ e;(/)IO .... ~'ojc'.8tQ.....
I CD : ~ l 0 i ~J' CD I ~ J ~ I g , ~ ; ~ i ~ t g : ~
,~I u ~l...J ~: ,~~ ,(/)I W4~) (/)l~;~
;Fr~,.~....\ft.<i.w..~p:~~.!~~"t~~m~2+"t''f~f<'I'~~,;;.-,,~.~,...~"....L.. ~~ ~1~:m/~~JII'y~mvZ\'- ~1~~~''t..'''Pl: .,.k:'-.i:""'!Ir"~r.-
ta~,~.,i:"!.)(t~~~l,;...I:li~~~~'t:~~~Ppl',,!!~~d.~1'!'~!lI!~~'t'~~~~i\ii~'t'if~,;;~~~,~-fu{~.;:J'::${~
.:'~:5~~!.'~~ V_',n~b~ ___... _. ._______ ..____ ._ __i.5U/~!;~/3?i_!I~)+!~!'+ 1()(~j_r!!..'.+.I!M2.15~'/5l\ ?O!5l1~_.J.l.:I!..j...!IlQ..l6Y!.~t..!~
CUrTen, InlereS! Bond, (CIB,) \ X I X X; X X: ,X X I X i X I X iX' X
C~~ital A~r;;ciati()nL\o~i~ ((:.\H~)--'-~. "--- - "T~ x' ~r---~ ~.X 'T-x"~l ~-- i .. . 1--" - ~~.~'1"x"4-~-~-'i' '-l-._.t-x~-
_S~a~.!!~i~""i;~~iN.iCS~~~~e.JL": -. "-=-_~_.=r..=r.::::I:.J= l=:=~'''''-' ,;:..-.-tx..:t=s.-~_~ ~~.=t~~~1~-=:=
_~~~~~~_~:!~~u~~:~:<::.~E>~'L.._..._ ,--- .---.. ,~.?' +, -+-- -1,---1--. +., --+ ~.. '_..~L._~~____i.__..J._~_~,__.
,~~~.~~~!..~~C:.~C:C~nt,I~~ -'::_~1,.~ ,_'_',_.. ___~.,.,__.~.m_...__.' ...L_~._~_~. L_.___~ .._._.: ~_. __. .~.~., ~ .~.~.,..?'_ :.~.~...I. ._~'" !.__~,~._~_
('..'{ully,hnkl'd NOles ;! " :..
.-..... -,.~. "-.~, - .-..- -"'~""" ~~.- .......,'~- ......._.,,--<i_ -.. .r....--...;- ~-, ....--~-.t. - -. -t: ...-_.._.,t- --( ~r._..~.t'-'~~.
,1n~~~c~f?~~:.;.&~.J:!!~~~R~_~P,I) ._.....' '._'._~~.' J..~X._l~ _u,.L.., :~a.' ~...:. . i", .~. .... :.. ~_~",.,.... ~ J--,- ,... _,_
.~.Il~~~.~~V.3P_ . _., ,"." ._. .... _.~ .!._,~,_~..~~..,~.,. _.~L __... ,.._. X r . J... ..,_-L__.t_..,."
F1o;lIing.((~~Fi~~d ~\\";P L ~ 1 X .~__._,l_,.~_ f" 'X ~; _ .,.~,,~
~~i_:,!d"o:Fl~~_ti!l~~~~p.... n,' ..1 --i--.., ._!_.~.. _.,. X f... ~
~.atl.' Lock,! Intc:re$~ Rate Collar _....- l'~' ~:~t X
S,..'aptlOn .
..., ~-'~.'.'-'>'" --,. ..~.._.-,.. .... ". ~...... "."---"-1' .......1- .._~
(~~n~_ert~b.1:.,Al~~ ~ap 1\R.."'.0I_ft~!c~r.~3i_l~ d:llc}_~_ _..._. -',.~__L, _ ~ _
Co_"'.c.~tt~ll' C.'\~!O ~;1Y C.I~._afl_~r cc~~.~i~ .~i~tcl. .. 1!
~.I.~,:~I L'~~_tM~~~.yi~....__..,.._._.............__ .. _,,_ .;._ M .,J...- _;_ __.... ~ I
_-'~~~L~a"~!:g!O (g~~~!0~.!~~~! ~cr:.i~~) ~ ._,..__~_..~. _~ ,.1, )~ .,~ ~~_~~_.L !-.-l.. _~ _~
~~:npre~.~)S (i,':;...~~!O_!~R9.9 d~~t...!.~~:~ ~'1~~~~~..)~....,_" t .., -..i..- ~',' ~"l,.", ,,' ''''..',._ i
Term (FlIlal Malurity) ~ 20H ~ 20)5 . 2llH j 2035 2035
... -... -".
_.. ~--,._.- ~
,
+- .
L ... _ L.
...!....-...
..
X X X'
_ ~- ~_"~.: ~~_.L)~'Mj=..~,_L ~~.~.-t-.~:'=.-~~:~
I. I i ~ 1
"'~r'203'5 ! 2U35,l.-il')35 noistioisi-20i4;-ilJ4"
Interest Rate Mode
Many firms leaned towards locking in fL'Ced interest rates, which remain near historic lows, and recommended
a portion of the optimal POB structure include traditional fixed rate CIBs with some discussion of the use of
CABs. CABs carry an overall higher yield than corresponding CIBs and are generally used only when
necessary to meet revenue constraints. Most fums that suggested uniform savings to the amortized VAAL
contribution as their optimal strategy also suggested the use of CABs. Variable rate bonds were examined by
most firms as a component of the overall structure. Subject to the proprietary products discussed below,
which have some variable component, RBC Dain Rauscher, Citigroup, Merrill Lynch, Stone &
Youngberg, VBS, Loop Capital Markets, First Albany, EJ De La Rosa and Siebert Brandford Shank
& Co. all recommended a portion of the City's debt to be in variable rate.
Most firms examined the use of variable rate bonds as a method for increasing restructuring flexibility and
reducing the total borrowing cost. While variable rate bonds do entail rate fluctuation and uncertainty, they
"
\
-
City of San Bernardino
J unc 13, 2005
Page 6
also result in lower borrowing rates than fixed mte bonds, on average. Perhaps more important than their
relative cost is the increased flexibility that variable rate bonds can provide the City. Most firms
acknowledged the advantages and disadvantages of variable rate bonds. Nearly every firm recommended
Auction Rate Securities ('ARS") as the preferred variable rate instrument, versus variable rate demand
obligations ('VRDOs"). ARS are usually insured, but do not require a letter of credit, which must be
renewed every three to five years. A notable exception to this trend was RBC Dain Rauscher who
suggested the use of LlBOR-indexed bonds.
As requested, all firms briefly discussed the impact of the most recent occur~ences on the ARS market. As a
recap, in 2004 the SEC began to investigate possible pricing inequalities in ARS auctions for the municipal
market. In addition, a major accounting firm revised its stance on investor's accounting treatment of auction
rate securities leading to fears that there could possibly be a major sell-off. Most firms agreed that the taxable
ARS marketplace was still a very viable option for municipal variable rate debt. Citigroup recommended
that the City consider using a 28-day periodicity should it choose to incorporate ARS into its financing
strategy.
Derivative Produces
Some firms recommended hedging a portion of the City's variable rate debt with an interest rate swap as an
alternative fmancing strategy, with RBC Dain Rauscher suggesting a Floating to Fixed interest rate swap as
a pan of its optimal strategy. Derivative products were seen by most fums as a potential to hedge against
higher interest rates in the future, given the potential appreciation of a fixed payer swap in a rising rate
environment. At the same time, there was some general disagreement as to the actual economic benefit in
the current market between fixed and synthetic fIXed rate bonds. Morgan Stanley argued against the use of
synthetic fixed rate bonds in the current market citing higher swap rates (based upon 3-month LlBOR) in
relation to yields on insured taxable fixed rate bonds across the entire yield curve.
One firm, Merrill Lynch & Co. suggested the use of a Fixed to Floating interest rate swap as a method of
creating synthetic variable rate debt. This was suggested should the City want to include variable rate exposure
in its issuance with the possibiliry of achieving an overall lower cost of funds.
Proprietary Produces
JP Morgan Chase suggested the use of their Equity Pension Obligation StrUcture (EPOST). The City
would use this structure in lieu of the issuance of POBs. The Ciry would enter into a total return swap with
JP Morgan in which it would select certain investments, and receive any appreciation. The City would pay JP
Morgan a fixed spread to LlBOR plus any depreciation in the investments. The City would deposit a note
into the Pension System in the same amount as the swap. As the swap amortizes every year, JP Morgan
would deliver a portion of the securities to the Ciry.
Structure and Final Maturiey
Proposed strUctures for the POBs fell into two main categories: level debt service for the POBs, ascending
debt service with a fL"ed spread to the UAAL (uniform). Although mJst firms recommended that the City
amortize the POBs over a 30 year period, Siebert Brandford Shank & Co. considered a final maturity of
2025 for the optimal strUcture. We should note that the City would be justified in choosing any of the
recommended structures and would need to determine the fmal structure based on policy as well as financial
considerations.
\\
\
City of San Bernardino
June 13, 2005
Page 7
Proposed Fees
Firms submitting proposals for Senior l'vlanager were required to submit a fee proposal for both a traditional
fLxed rate issuance and a variable rate issuance. These firms provided very aggressive bids (including expenses
and counsel) ranging from $3.37 to $6.37 per bond for a traditional fLxed rate issuance with a par amount of
$~O million The average fee was SS.071 per bond. While management fees are normally common for
pension obligation issuances, only four firms proposed a management fee for tlus issuance. Although
Lehman Brothers presented one of the stronger proposals, they also proposed the highest fees in the group at
a combined cost of $6.37 per bond. The fee proposals for a traditional fixed rate issuance are p:ovided
below:
Fixed Rate Estimated Costs
Fixed Rate
Average Takedown
Management Fees
Underwritino Fees
Expenses
Und rwrite~s
Total
l-.---.-......,......T _--,-_..Se'1i9~ M~!'.~g~rfC~.:Mi,!..ger_'__'__r-'_r-__
I li~lli I~i uj , 1 uju! I
~.,~i8:ili~i ~jl i
~ ! .~ ~ u t Gi ~ u ~ 1 :
~ I ~ II 51 ,rJJ "" ~i5. ~ .8 I .
.I:.~.o,21(ij m :J ~ -ccv gtt
e 6 U'2 fi /}, ~ s 8
~ 0. I ~- ~ j .~ ~; (J) I ~ ..
., o::;)~~'U:'''' a _,c lCJ,'
E'~lol I.... ~I~;.cv't!
. '''''~'''',Cllu - ~.cl"
;'ij:€ja..!aJi-,tccl ~j 01,9 >1
t-----'....t--u..../-.-=>..-+. ..:'.--1..... w ...1.....1%:.....\-_..... +... ~."..l.. ...."'........;--<-1'
, j ; I f l , j , I
5.0001 3.790' 3632! 2000; 4000j 3.98.0.:,' 4250l 3.500] 35001 3.739:
0.630: 0.500 -).., 0250: 0850 0.558'
l' . _I,: !
-i --1 -;
0.360: 0.260 0.323:
, 0 25' 0.761;
5.175 5.071
Not all firms submitted bids for variable rate securities due in part to their experience and proposed structure.
Although ~ven firms submitted bids for VRDOs, only one firm, Stone & Youngberg suggested VRDOs
within their optimal structure and three other firms merely mentioned VRDOs as a possible option for
variable rate securities. Conversely, two firms, Citigroup and E.]. De La Rosa suggested ARS as part of
their optimal strategy and seven other firms suggested ARS should the City want to incorporate variable rate
securities. An exception to this trend was RBC Dain Rauscher who provided fee bids for both VRDOs
and ARS but discouraged the use of either in favor of LIBOR-indexed notes for a fee of $5.00 per bond.
Hence, we have only included fee proposals for ARS within this memo. Estimated costs for ARS ranged
from $1.84 to $5.12 per bond.
\ \
X~
City of Sail Bernardino
.I une 13. 2005
Page 8
Auction Rate Estimated Costs
,
,
_.-~- ..-,
_ ..___.""")"''''' ..,_~_ n_
O
.E
o
u
.,
"
..
'"
L:
U
..
"
(J
.~
"
<fl
o
.E
o
u
.,
'"
..
o
tl:
'"
...J
"
o
Q;
U
..
::J
'"
tl:
"
'iij
o
u
0)
tl:.....,
]i
'is.
'"
U
,..
"
'"
.c
;;:
- -"'" '..._."...._.~- ...-"
I
(J
.E
o
u
.,
,..
"
c
'"
ii5
"
'"
e-
O
. ::a:
l-......~..."-._'
i
..
'"
I! .
. ~ I
<( ,
'-i-'-'" ..-+.
, I
o
.E
..
Qj
~
'"
::a:
'iii
.c
o
l5
Co
::J
o
I g
t ._ G..
Ongoing Auction Rate Fees
Broker/Dealer Fee (bps)
(Interest rate frequency)
Auction A n F
--I
28-day!
c
'"
Cl
(;
::a:
! ~ I
t..... . r~
i i
~
i.i:_.
ARS
Manaoement Fees
Placement Fee
Ex n
Total
-.1
0.375,
2.8211
0.876!
3.804
i
1
i
25.0 bps;
,
\
25.0 bps!
28-day!
1. b ,
u;
1. b s
(1) RBe lisled (\\'0 \':uues for takedown. The higher one is listed here.
No fee proposals were made for interest rate swaps. Those flCms that proposed their possible use indicated
that swap pricing could be negotiated at a later date.
Additional Considerations
TIle proposals varied in the strength of their discussion of additional considerations for the City but
collectively they covered dle majority of the issues that the City should consider.
There was much discussion as to methods of increasing the City's flexibility to restructure or call the debt at
some point in the future should such a decision be timely in the marketplace. The majority of the firms
suggested incorporating some variable rate debt into the issuance to offset the relative inflexibility of taxable
fixed rate debt. The ratios of fLxed rate to variable rate debt proposed ranged from 75/25 to 50/50. Some
flCms discouraged the City from pursuing variable rate debt arguing that the small size of the transaction and
the newness of the City's credit in the taxable POB market warrant conservative financing strategies. In
addition to the issuance of variable rate debt, some firms suggested methods of creating call flexibility for the
fixed rate debt Firms suggested 10'year par calls as well as "make-whole" calls as methods of creating
flexibility for traditional fixed rate debt. E.}. De La Rosa and Lehman Brothers both argued for an
increase of the UAAL to be funded by a potential POB issuance. Although the currendy proposed funding
amount does bring the City to a prudent 90% funding ratio, Lehman Brothers cited the changes in CalPERS
actuarial calculation methodology to argue that a higher funding amount would most likely not lead to a
situation of "over funding".
Most flCms did not recommend obtaining a corporate rating for the proposed POB issuance with the
exception of one flCm. A corporate rating is often viewed as marketing strategy for international investors.
However, obtaining a corporate rating is cosciy and may not provide benefit for the City given the smaller size
of its proposed transaction Corporate ratings are most often useful for transactions with a par value greater
than approximately $500 million. Most firms agreed that the City should instead opt to assess the economic
value of obtaining bond insurance at the time of pricing.
In terms of a targeted marketing strategy for the POB issuance, most firms were able to cite their ability to
market to international investors and major American institutional investors. Taxable POBs do not usually
\.
\ '
City of San Bernardino
June 13,2005
'Page 9
playa substantial role in the local retail market hence, the City should focus its attention on underwriters who
will be able to garner attention for the City's issue through its marketing methods.
Final Analysis
\V'hile the final recommendation and selection should come from the City, we can provide some opinion on
how to narrow the field based upon our reading of the proposals. In terms of the combination of POB
financing experience, structuring recommendations and discussion of other issues pertinent to the City's
proposed financing we feel that the top three firms are Morgan Stanley, Lehman Brothers, and UBS. The
City may also want to consider E.]. De La Rosa as an alternative. However, this firm is a regional California
firm and based upon their representation of marketing capabilities, may not be the strongest candidate for a
sole manager position for this financing.
Next Steps
We believe that the proposing underwriter's have provided enough decision-making information that oral
interviews should not be necessary. We therefore propose that the City narrow their choices based on these
three major factors 1) the thoroughness of the discussion of the issues pertinent to the City's POBs, 2) the
ability to connect these issues into a coherent plan and strategy and 3) cost proposals. The City may also wish
to consider firms whose proprietary products or strategies have sparked interest.
Based upon a successful choice of underwriter this week, the City should take note of the following major
milestones for this transaction.
.
June 16th - City Council meeting to formally select underwriter
Week of June 20th - Finance team kick-off meeting
Week of June 27th - Plan of Finance delivered to working group
Week of August 1st - Meetings with Rating Agencies
August 15th - City Council approval of financing
August 31st - Pricing
September 13th - Close
.
.
.
.
.
.
We hope that you have found this summary of the Underwriter Proposals received by the City useful. We
look forward to working with you on choosing an underwriter and beginning this transaction. Should you
have any questions or comments, please call me at (415) 982-5544.
\'"