Aug. 14 (Bloomberg) -- The Los Angeles City Council is threatening to stop doing business with Bank of New York Mellon Corp. and Dexia SA if they refuse to renegotiate money-losing interest-rate swaps.
In a 14-0 vote yesterday, the council asked BNY Mellon, the world’s largest custody bank, and Dexia to return $65 million in what the lawmakers called unfair profits and fees paid since 2008 on debt for sewer work. The companies would also risk losing out on future business under the union-backed measure.
A six-year statute of limitations is closing for localities to try to recoup payments to Wall Street on bond deals that went awry in the financial crisis. Municipal borrowers nationwide have paid at least $4 billion to banks to end interest-rate swaps, which are derivatives contracts sold as hedges, data compiled by Bloomberg show.
“We need to hold Wall Street accountable where others have not, and let Wall Street know that we’re too big to ignore,” Councilman Paul Koretz said before the vote.
The time limit is approaching for issuers to try to claw back losses by arguing that banks misled them about the risks of the deals, former Congressman Bradley Miller, an attorney with Grais & Ellsworth LLP in New York, said last month.
Wall Street banks pitched the transactions as a way to reduce borrowing costs. Yet they unraveled after the financial crisis and the Federal Reserve’s policy of holding its benchmark borrowing rate near zero since 2008 turned many of the swaps into wrong-way bets.
If the banks don’t unwind the agreements, according to the motion sponsored by Koretz and backed by municipal employee unions, Los Angeles should terminate other business with them and exclude the companies from future contracts. The vote directs the city attorney to “evaluate potential legal remedies” against the banks.
Kevin Heine, a BNY Mellon spokesman in New York, declined to comment. Caroline Junius, a Dexia spokeswoman in Brussels, didn’t immediately respond to e-mail messages seeking comment on the measure.
Second only to New York in population among U.S. cities, Los Angeles paid $26.1 million in 2012 to terminate another interest-rate swap with BNY Mellon and Dexia, according to bond documents.
The subject of the council’s vote was part of $151.1 million in interest-rate swaps associated with a portion of $281 million in wastewater-system revenue bonds.
Los Angeles sold $316.8 million in bonds in 2006 to refinance debt issued in 1988 for work on the municipal wastewater system. The city refinanced the debt again last year, reducing the amount by half, according to bond documents.
Because of a decline in interest rates since 2006, the swaps had a negative fair value of $24.7 million as of June 2013, city budget documents show. Exiting the contracts would cost from $23.5 million to $25.7 million in termination fees, according to a June analysis by the Public Resources Advisory Group for Miguel Santana, the city administrative officer.
Santana advised the council against terminating the swaps in a May memo, saying the financing had saved the city about $21.7 million.
“Even today, the swaps are the most cost-effective action when you look back,” Santana told the council yesterday.
Santana met with representatives of BNY Mellon and Dexia in June, according to a memo he wrote that month. Dexia was amenable to renegotiating, though a significant discount was unlikely, Santana wrote. BNY Mellon wouldn’t agree to terminate the deal at no cost, he wrote.
He said he’ll keep exploring options with the banks.
The financial crisis drove up interest rates on the wastewater bonds and other city debt, something that officials couldn’t have anticipated when the securities were sold two years earlier, Santana said.
“Every financial transaction has risks,” Santana said in the memo. “When we analyze those risks, it is difficult to compare to what could happen due to changing market conditions.”
Koretz’s motion asserts that BNY Mellon and Dexia are profiting by a combined $4.8 million a year on the swaps deals. The city might lose an additional $69 million at current interest rates if the swaps remain in effect until they expire in 2028, according to Koretz.
Koretz and fellow Councilman Gil Cedillo, both Democrats who served in the state legislature, sponsored the motion at the urging of the labor-backed Fix LA Coalition. In a report this year, the coalition said Los Angeles pays about $300 million a year in interest and transaction fees while cutting services to save money.
Lawmakers’ vote yesterday drew cheers from city employees in the council chambers, many wearing stickers from Fix LA that read, “Our Streets, Not Wall Street.”
Oakland, California, considered severing ties with Goldman Sachs Group Inc. last year over a $14.8 million termination fee for a swaps agreement. The contract remains in effect and the city continues to make debt payments, Karen Boyd, a city spokeswoman, said by e-mail.
“Hopefully we’ll bring back a few million bucks,” Koretz told union leaders and workers gathered after the vote. It’d be “a huge amount for city services if we can pull this off.”
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