CITY OF OAKLAND
Agenda Report To: Attn: From: Date: Re: Office of the City Manager Craig G. Kocian Budget and Finance Agency December 10, 1996
A Resolution Selecting the Counter-party for Execution of a Master Swap Agreement Relating to the 1988 Special Refunding Revenue Bonds (Pension Financing), and Authorizing Taking of Related Actions
SUMMARY. The proposed transactions offer the City an opportunity to realize significant present value savings. While each of these proposed transactions would be closed today, the level of savings for both transactions is predicated on the City's ability to issue variable rate taxexempt bonds in 1998 and swap to a fixed rate. H conditions change such that the City is unable to issue tax-exempt bonds in 1998, the savings would be adversely affected.
As presented in the staff report and recommendations of October 15, 1996, settlement of the Columbus case has resolved many of the tax-related issues for the City.
In light of Proposition 218, the possible impact to the City will be budgetary pressures if there is loss of certain existing taxes and assessments beginning in July 1997. It is possible that these
budgetary pressures may have a negative impact on the City's general fund and its obligations, and potentially even limit the City's market access. However, there is no way to determine at this time what the ultimate effect of Proposition 218 will be on the City's credit. While staff believes that any possible market access difficulties in 1998 have been mitigated by providing a bond insurance commitment today, this transaction should be considered not only for its benefits today, but in the context of any future events and outcomes.
FINANCING ALTERNATIVES. Since the 1988 Special Refunding Revenue Bonds (Pension Financing) are not callable until August I, 1998, and since the City used its one-time advance refunding opportunity in 1988, the City has two alternatives: (1) to wait until the call date to determine the feasibility of a current refunding to realize savings (only if interest rates are favorable) or (2) mitigate interest rate risk by synthetically refunding the 1988 issue today through either the use of a Swaption or a hedge swap. Both are further defined below:
(1) A Swaption is the sale of the right, but not the obligation, to a Counter-party to enter into an interest rate swap (at a price determined today) on a certain date. Only if the option is exercised will the City sell variable rate bonds in order to exchange the stream of payments. H the option is not exercised, then the City would keep the up-front payment as well as its ability to issue bonds when interest rates were more favorable. A hedge swap (or forward interest swap) is a contract between the City and a Counterparty to execute an interest rate swap which would begin at the call date at which time the City will be required to issue variable rate bonds and swap to a fixed rate. Finance & Legislation Committee# December 10, 1996
A Resolution Selecting the Counter-party for Execution ofa Master Swap Agreement Relating to the 1988 Special Refunding Revenue Bonds (Pension Financing), and Authorizing Taking Related Actions - Page 2
Goldman Sachs has proposed a Swaption, and Piper Jaffray and Samuel A Ramirez, a hedge swap. Both the Swaption and hedge swap are very similar; both parties propose the use of a triple-A rated Counter-party and can implement either a cost of funds swap or an index-based swap. The savings associated with each alternative are shown below:
Goldman Sachs (as ofl2/04/98)
Piper Jaffray (as of12/04/94)
$20 million depending on ~
Samuel A. Ramirez (as of 10/24)
$20 MM; timing of
$12.65 vs $14.43 MM;
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RISKS. The singular greatest risk to the City is its ability to access the market in 1998. This risk should be mitigated with the acquisition of a forward bond insurance commitment. Both FSA and AMBAC have provided preliminary commitments on two structures: a pension obligation structure and an asset transfer. Other risks which are inherent to both the Swaption and the hedge swap are enumerated below:
Termination is not an option for the Counter-party during the full term of the transaction unless the City defaults on its obligations. Bond insurer governs termination under a default; optional termination is only at the discretion of the City. However, it is unlikely that the respective bond insurers would elect to terminate, since they would likely owe a payment to the Counter-party. Willingness to provide a Cost of Funds swap where the Counter-party pays the City its actual borrowing cost, or an indexed-based swap where the Counter-party pays the City the PSA index. However, since the City's paper is exempt from California income tax, it is likely that the City's variable rate bonds will have lower interest rates than the PSA index, making the PSA index potentially more cost-effective. A Cost of Funds swap would prove better if we believe that the City's commercial paper would trade significantly lower (i.e., at higher interest rates) than national averages in the future.
Both approaches have proposed the use of AAA counter-parties.
....... u "
Finance & Legislation Committee# December 10, 1~96
A Resolution Selecting the Counter-party for Execution ofa Master Swap Agreement Relating to the 1988 Special Refunding Revenue Bonds (Pension Financing), and Authorizing Taking Related Actions - Page 3
The pricing of an option generally takes into consideration the volatility of the market. In this case, both the swaption and the hedge swap will be priced as if they are a hedge swap. The Swaption will be required to yield greater or commensurate savings with the hedge swap regardless of any perceived volatility, and in this sense, the City can be assured that volatility will not adversely affect the pricing of the Swaption.
Does not ask for a change in payment if a "flat tax" is proposed or passed.
Contains broader language in regard to potential consequences associated with tax law change, as well as provisions for adverse changes in trading performance based on proposed changes even if not enacted. Proposes the use of a liquidity guarantee, whereby the Counter-party would assure that liquidity will be provided for the life of the transaction. However, the price of the proposed liquidity is above the current market price and there is no reason to believe that the expense is a good investment, barring substantial deterioration in the City's credit.
Since there will be bond insurance, there is no reason to believe that liquidity will not be available, barring a deterioration of the City's credit.
OTHER ISSUES Embedded Loan and Savings Levels. Both the Swaption and hedge swaps are off-market swaps, i.e., they are not priced at par. Off-market swaps are generally used for cash adjustments when attempting to match cashflows on underlying transactions as opposed to current market levels. So the up-front cash payment is made to compensate for the difference between the off-market price of the swap and its current market rate. It is this up-front payment which raises an embedded loan question vis-a-vis the constitutional debt limitation issue, i.e., the City's authority to borrow monies without voter approval.
Therefore under either alternative the savings must be structured so that it cannot be construed as an embedded loan. Currently bond counsel has opined that approximately only $10 million in savings can be taken up-front to avoid the consideration as an embedded loan.
Interest Rate Volatility. Both the proposed transactions are very interest rate sensitive. Small fluctuations in interest rates can produce a material change in the level of savings.
Finance & Legislation COmmittee#__ December la, 1996
A Resolution Selecting the Counter-party for Execution ofa Master Swap Agreement Relating to the 1988 Special Refunding Revenue Bonds (Pension Financing), and Authorizing Taking RelatedActions - Page 4
Swap execution. Under either scenario, the City will be executing a confirmation with the
Counter-party -- either GS Financial Products or AMBAC Financial Products. With the swaption, Goldman Sachs is the principal; with the hedge swap as proposed by Piper Jaffray and/or Ramirez, the firms are acting as swap agents, who would receive a payment from the Counter-party. There is no obligation of the City to hire any of the firms as underwriters or remarketing agents for the variable rate issuance in 1988.
RECOMMENDATION. Orrick Herrington and Sutcliffe is comfortable with the structure of the Swaption, and with the savings structured over a two-year period. As such, they believe that they will be able to give the enforceability opinion necessary to secure bond insurance. Given this progress and bond counsel's preliminary analysis that the hedge swap may have to be structured with less up-front savings than the option, given that the option unto itself should produce an incrementally higher level of savings than the hedge swap, given the near-certainty that the Swaption can be implemented, and the additional layer of flexibility (albeit a very small probability) that the option may not be exercised if interest rates rise significantly, it is staff's recommendation to proceed with the Swaption with Goldman Sachs.
Dolores E. Blanchard Director, Budget and Finance Agency
Prepared by: Janice S. Mazyck Treasury Manager Approved for forwarding to the City Co cil:
Finance & Legislation c<JJnrnitl£e#C December 10,1996
Date: To: From: Subject: December 9, 1996 Oakland City Council Goldman Sachs & Co. 1988 Pension Refunding
Goldman Sachs has proposed that the City refund its outstanding 1988 Pension Revenue Bonds. Estimated savings as of December 3,1996 are approximately $20 million. In the last few weeks a number of concerns have been raised and we thought it might be helpful to briefly discuss these points. • Why is Goldman Sachs' Swaption program being recommended by staff? Over the past four years Goldman Sachs has worked with various City officials to develop the best program for the City. The first program we discussed and reviewed with the City was the "hedge swap" but since the swaption provides more savings to the City, this option became the recommended plan. Isn't the Swaption more risky to the City? The" swaption" plan is a managed plan whereas the hedge swap is a fixed plan. If interest rates increase dramatically, Goldman Sachs will not require the City to enter into the swap on August 15, 1996. In this situation the City will keep the up front payment of $10.5 million and continue to pay debt service on the outstanding bonds. It would also be free to sell another "swaption." The disadvantage is that the City may not receive the same savings as it would if it executed a hedge swap. Why can't the City receive all the savings up front? Under Califomia law, municipalities cannot borrow money as part of an interest rate agreement. Therefore, the City's bond counsel must be satisfied that any payment paid by Goldman Sachs to the City is not a disguised or an "embedded" loan. After a lengthy analysis, bond counsel has agreed to a maximum up front payment of $10.5 million. The balance of the savings ($10 million) will be received on the call date in 1998. Do other plans provide more savings than the Goldman Sachs plan? The savings from the refunding plan will depend upon interest rates at the time the swap is executed. As is the case with the pricing of the City's bond issues, the City's financial advisor will review the terms of the Goldman Sachs proposal---eheck with outside sources-and recommend that the City either accept or reject the proposal. Their analysis to date indicates that there is no basis for other counterparties to claim either greater or the same level of savings. In addition, the other plans provide for a ''finders fee" to be paid-an amount which would be deducted from the City's savings. Does Goldman Sachs' plan use lower rated entities? Under the Goldman Sachs plan, FSA will be the swap and bond insurer and GS FINANCIAL PRODUCTS U.S.L.P. will be the counterparty. FSA was selected after a review of proposals submitted by various insurers. AMBAC's proposal resulted in a premium approximately $1 million higher than FSA. FSA is rated Triple A by the rating agencies. GS FINANCIAL is also rated triple A by the rating agencies. Has Goldman Sachs been working on this refunding plan very long? Goldman Sachs first discussed this transaction with City staff at the end of 1992 and made a formal proposal in January 1993. Since that time, we have had numerous discussions with bond attorneys, bond insurers and other parties to the transaction. We solicited, on the City's behalf, an IRS ruling and developed the bond structure that allowed the City to get swap and bond ir:'lsurance. Others may complain that they haven't had access to all the problems but that is because they have just started working on the transaction.
Why doesn't Goldman Sachs have a minority participant? The execution of the interest rate agreement is a "principal" transaction with Goldman Sachs and unlike the other proposals does not involve a "finders fee" (which could be subject to minority participation). The refunding plan will be completed in 1998 with the sale of the refunding bonds. At that time, the City will select a team of underwriters which will include a minority firm. Is there tax law risk in this transaction? Goldman Sachs' agreement does not change in the event of federal tax law amendments. Other proposals provide for ''termination'' in the event tax law changes the way municipal bonds trade. . . Other proposals have "guaranteed liquidity," why doesn't Goldman Sachs' plan have this feature? Guaranteed liquidity is available for any City program (including the Goldman Sachs Plan), however, it may be more expensive than soliciting liquidity ever few years. Any problem acquiring liquidity has been mitigated by securing insurance from FSA. Does Goldman Sachs' plan have onerous "termination" provisions? The swap will be terminated if the City defaults on its swap obligations. If a termination payment is due from the City, FSA will decide how that payment is made. This is a standard provision and is the same in other proposals. Has Goldman Sachs done anything for Oakland? During the last three years Goldman Sachs has contributed over $80,000 to the City and various nonprofit agencies in Oakland.
For more information, please contact John Melvin at 415-393-7647 or Gail Covington at 415-393-7712.
City of Oakland Charitable Contributions/Charity Dinners 1993-1996 YTD Organization Request ID Staff and Project Description Grant Date Amount
Spanish Speaking Citizens Foundation Oakland, CA Walter Kaitz Foundation Oakland, California United Seniors of Oakland and Alameda County Oakland, California Boy Scouts of America, Bay Area Council Oakland, California Oakland Sharing the Vision Oakland, California Oakland Community Fund Oakland, California Boy Scouts of America, Bay Area Council Oakland, California Walter Kaitz Foundation Oakland, California Marcus A. Foster Educational Institute Oakland, California Mayor's HiJnger Relief Program Oakland, California Black Women Organized for Educational Development Oakland, California 960706 96058
Table at 30th Anniversary Dinner Dance. Grant-Table and full page ad 9/25/96 at 13th annual dinner. POKiernan .request Grant
$2,500 $10,000 $5,000
960432 960135 951505 950524 950979 950260 940921 940650 Grant-Table and ad at 9/19/95 12th annual dinner. AMnuchin request; Host-PDKiernan. Grant-Table at 3/23/95 annual awards dinner. Grant-Support of Oakland's Holiday food drive. GWood will personaily contribute $500. Grant-Sponsorship of 10/13-15/94 in support of BWOPAIBlack Women Organized for Political Action conference Grant-$2,500 contribution to 2/10/96 Citywide Youth Policy kick-off event. Grant-Support of annual Mayor's toy drive
05/09/96 02/29/96 12/21/95 09/10/95 07/20/95 03/21/95 11/16/94 09/08/94
$2,000 $2,500 $5,000 $2,000 $10,000 $1,500 $1,000 $2,000
.City of Oakland Charitable Contributions/Charity Dinners 1993-1996 YTD Organization Boy Scouts of America, Bay Area Council Oakland, California Walter Kaitz Foundation Oakland, California Marcus A. Foster Educational Institute Oakland, California Boy Scouts of America, Bay Area Council Oakland, California Walter Kaitz Foundation Oakland, California Mayor's Hunger Relief Program Oakland, California Close Up Foundation Close Up Foundation College Preparatory School Partners Program 6100 Broadway Oakland, CA 94618 Measure I Oakland, CA Strong Mayor Initiative Oakland, CA Same as above. Cooperative program between The College Preparatory School and the Oakland Public Schools. .Request ID Staff and Project Description Grant Grant-Table and ad at 9/21/94 dinner Grant-Table at 3/24/94 event Grant Date
940744 940429 940017 940038 930666 930287
09/23/94 07/21/94 03/18/94 03/25/94
$1,500 $10,000 $1,500 $1,000 $6,000 $1,000 $2,000 per annum $1,200 $1,000
Grant-Table and ad at 9/23/93 dinner Grant-Contribution in support of 12/92 Oakland's Holiday Food Drive
08/05/93 12/07/92 1991-96 1996 1996
Bond measure for various city improvements
12/06/96 (02:36 PM)
City of Oakland Charitable Contributions/Charity Dinners 1993-1996 YTD Organization Request ID Staff and Project Description Grant Date Amount
The Oakland Museum 1000 Oak Street Oakland; CA 94607 Oakland Family History Library The Oakland Museum 1000 Oak Street Oakland, CA 94607 Mills College 5000 MacArthur Blvd Oakland, CA 94613
1995-1996 Corporate Business Council
1994-1995 Corporate Business Council 1994-1995 Corporate Business Council
Minority Scholarship Program
12/06/96 (02:36 PM)