Emanuel Shuns Transparency After Promising Chicago a New Day: Muni Credit
Chicago Mayor Rahm Emanuel, a former investment banker who promised to end “business as usual,” is maintaining predecessor Richard M. Daley’s two-decade tradition of shunning competitive bids in his first bond sale.
Emanuel’s proposed issue of up to $500 million of general obligation bonds and $250 million of sales-tax revenue debt is scheduled to be presented to the Chicago City Council today. The mayor took office in May, and his administration is searching for ways to eliminate a projected $635.7 million budget deficit in the third-largest U.S. city.
Municipal borrowers from Buffalo, New York, to the Dallas Independent School District, are breaking a pattern of negotiation to cut borrowing costs by selling securities at public auction. So far this year, almost one-fourth of the $171.8 billion of U.S. municipal-bond sales have been sold through competitive bidding, which compares with 19 percent in the first nine months of 2010, according to data compiled by Bloomberg.
“A competitive sale removes any doubt about whether you got the lowest bid,” said Larry Throm, former chief financial officer of the Dallas district, which took bids on just more than $1 billion of bonds last year, ending 14 years of negotiated sales.
Emanuel, a 51-year-old Democrat, has embraced competition in other facets of government. Just this week, he announced plans to expand his call for competitive bidding to the city’s recycling program, saying it will “save money for taxpayers.” The terms of new bond sales, though, will still be negotiated.
The Chicago City Council’s finance committee approved Emanuel’s plans by voice vote yesterday. Alderman Richard Mell said afterward that he was unconvinced the city is getting the best deal by negotiating the terms.
“I’ll talk with Rahm about it,” Mell, a member of the committee, said in an interview. “I’d like to know what the reasoning is.”
Alderman Edward Burke, who chairs the finance committee, said he has no concerns about the sales not being bid as the city works to fill the deficit in its $3.2 billion budget.
“The tradition here in Chicago has always been to negotiate deals,” Burke said in an interview. “They’ve never been competitively bid, and we place great faith in our CFOs to get the best deal possible for the taxpayers.”
In competitive sales, or auctions, banks submit bids offering issuers the lowest interest rate to win the right to underwrite bonds. In negotiated deals, a chosen banker or group of bankers agree on fees and rates in discussions with issuers. The underwriter buys the debt at the agreed price, which may not be the lowest in the market on a given day, and markets it to investors.
Until the 1970s, almost all states and municipalities sold bonds competitively, inviting sealed bids from bankers. In recent years, more than 80 percent of U.S. municipal debt was issued through negotiated deals, according to data compiled by Bloomberg.
Academic studies and a U.S. Government Accountability Office report in 2008 have shown that municipalities pay more than necessary to borrow when they don’t seek competitive bids. Securities sold in negotiated transactions are underpriced by as much as 4.7 percent, according to a study this year by Craig Brown, who teaches finance at the National University of Singapore.
Emanuel said during his campaign that he would end the “business as usual” of Daley’s 22-year tenure.
New Boss, Same Deal
“New times demand new answers, old problems cry out for better results,” Emanuel said in his May 16 inauguration speech. “This morning, we leave behind the old ways and old divisions and begin a new day for Chicago.”
A Chicago general obligation bond maturing in 2026 yielded 4.191 percent in recent trades, about 1.4 percentage points more than top-rated benchmark municipal bonds, according to data compiled by Bloomberg. That is unchanged since trades early in the year. Moody’s Investors Service, Fitch Ratings and Standard & Poor’s all cut their ratings of the city’s debt last year.
In announcing the first bond issue of Emanuel’s administration, the city said last month that Chicago-based Loop Capital Markets would be the top underwriter on the sales-tax bonds and that BMO Harris would lead the general obligation sale.
Lois Scott, the city’s chief financial officer, defended the negotiated sales. Scott, who ran a financial advisory firm that worked on city deals before Emanuel appointed her, said the administration considered several factors.
Defending Negotiated Sales
“Chicago uses the negotiated form of bond sale, drawing upon the sales force of bond underwriters to get the best possible interest rates,” Scott said in a statement. “In addition, the city has set and achieved targets for minority and women owned underwriters who are largely shut out of the competitive bidding process by the more highly capitalized Wall Street firms.”
Illinois is required by law to sell 25 percent of its bonds through competitive auction, according to John Sinsheimer, the director of capital markets. “Theoretically” a competitive deal may be cheaper, Sinsheimer said, while a larger deal done that way runs the risk of some bonds not selling.
“We make a decision on competitive versus negotiated on a deal-by-deal basis, wherever we feel we can get the best results,” Sinsheimer said.
After Illinois on Feb. 23 sold $3.7 billion of bonds through negotiation to fund pensions, the Chicago-based Civic Federation said the state might have saved money with competitive bids. The underwriters had orders totaling $6.1 billion, a sign that they could have had bidders compete, the federation, a nonpartisan government research organization, said in a March 3 report.
Sinsheimer defended the sale, saying the underwriters created strong demand by “hustling their investors to get the orders.”
In a competitive auction of taxable Build America Bonds in June 2010, Illinois got a lower borrowing cost than it did a month later in a negotiated sale of the same type of debt. The competitive bonds priced at yields of 28 basis points to 72 basis points lower than benchmark U.S. Treasury securities of the same maturities as the negotiated issue, according to data compiled by Bloomberg. Citigroup was both the winning bidder and underwriter. A basis point is one one-hundredth of a percent.
‘Dirty Secret’ in Dallas
In Dallas, Throm had to argue against school board members who opposed his attempt to take competitive bids for $950 million of Build America Bonds and $70 million of tax-exempt debt last November. Throm said in an interview after the sale that the district’s board pushed for a negotiated deal because “it’s a dirty little secret” that board members like to award underwriting work.
Right up until the board voted on the method of sale Oct. 28, underwriters wanting some of the deal pressured board members, he said.
“We wanted an open, competitive sale where everyone had an opportunity to bid,” said Throm, who left the district at the end of 2010. The district locked in an average cost of 4.03 percent, while comparable borrowers got 4.056 percent that day, he said.
Buffalo, New York, did its first competitive bond sale in 24 years in December and another in June. Before the December issue, Buffalo hadn’t sold debt through public auction since the 1980s because of its low credit ratings, according to a press release in June. The city drew nine bidders for its on-line sale of $22.4 million of bonds for improvement projects.
Deputy Comptroller Darby Fishkin said in an interview that interest-rate bids ranged from 3.56 percent to 4.81 percent, showing the sale provided “the lowest interest cost for the taxpayers of Buffalo.”
Following are descriptions of pending sales of municipal debt:
PALM BEACH COUNTY SOLID WASTE AUTHORITY, which provides sold waste and recycling services to 1.4 million residents and businesses in the county, plans to sell $600 million of revenue bonds as soon as tomorrow to refund debt. The bonds are rated AA+, Standard & Poor’s second-highest grade. Citigroup Inc. will lead a syndicate of banks on the transaction. (Updated Oct. 5)
The STATE OF WASHINGTON plans to borrow $1.289 billion in general obligation bonds as soon as Oct. 10. Of that, $516.7 million of the transaction is new issuance and will help fund the Floating Bridge and Eastside Project, while the remainder represents refunding to realize debt-service savings. The state is rated AA+ by Standard & Poor’s, their second-highest rating. JP Morgan will lead a syndicate of banks on the deal. (Added Oct. 5)
PHILADELPHIA HOSPITALS AND HIGHER EDUCATION FACILITIES AUTHORITY will issue $270 million in hospital revenue bonds as early as this week. The sale will help finance capital projects including construction of an ambulatory care center and parking garage. The bonds are rated AA by Standard & Poor’s, its third- highest grade. JP Morgan will lead a syndicate of banks marketing the transaction.
The STATE OF MICHIGAN is to borrow $138.7 million of general obligation bonds as early as Oct. 12. The transaction will help finance school loan programs and refund environmental program debt. The bonds are rated Aa2 by Moody’s, the agency’s third-lowest ranking. Robert W. Baird & Co., Incorporated, will lead the sale.
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