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The Honolulu Advertiser
Posted on: Thursday, September 1, 2005

Bond deals fair to taxpayers?

By William Selway
Bloomberg News Service

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As Honolulu planned to sell $153 million worth of bonds last month, there was no question about who would set interest rates on the debt: Citigroup Inc. and UBS AG, the investment banks it had hired to sell bonds without using competitive bidding for the work.

Hawai'i, the ninth-smallest U.S. state by population, and its cities and authorities have sold more than $10 billion in bonds for roads, schools and other projects since 1997, not once seeking bids at a public auction, according to data compiled by Bloomberg News Service. That's a stretch unrivaled by any other state. The practice may have cost taxpayers $6 million at Hawai'i's latest state sale alone, the data show.

"They have to take the word of their underwriters that they are getting the best deal," says Gary Kitahata, an independent financial adviser who lives on the Big Island. "There are benefits by going to a competitive sale."

Hawai'i is the most extreme state in the $2 trillion municipal bond market where, for 81 percent of bonds sold, public officials pick Wall Street banks without public bidding to arrange offerings and negotiate fees and terms on the debt. In 1974, public finance work was awarded with no bidding 27 percent of the time, according to Bloomberg and Thomson Financial data.

As the auctions that were once the dominant way of selling bonds dwindle, finance experts such as World Bank senior economist Alec Gershberg say, borrowers may be left paying higher rates, depriving them of resources for parks and roads.

Hawai'i gets good pricing on its public finance even without competitive bidding, says Roger Davis, a San Francisco-based attorney with the firm Orrick, Herrington & Sutcliffe, which served as counsel on Honolulu's last sale.

"There's enough interest in working in Hawai'i I don't know if it's the weather or what it might be that the underwriters have fallen all over themselves to give them extremely favorable treatment," Davis says.

Economist Gershberg has doubts. "It's hard to believe they are getting the best price," says Gershberg, co-author of a study that found hospital bonds sold through auctions yielded half a percentage point below those sold without public bidding. "They may be getting what they want, but they are paying too much."

In competitive bond sales, banks bid to underwrite deals. Public officials then choose the bank offering the lowest cost to the taxpayer. In so-called negotiated sales, issuers choose a banker and the two agree on fees, interest rates and a date on which the bonds will be bought by the bank and resold to investors.

Comparisons in the municipal bond market are difficult because there are more than 1.4 million securities sold by thousands of borrowers in the U.S., with varying credit ratings, tax rates and populations that may affect how much they pay. There are municipalities that are comparable.

In four out of six instances this year when Hawai'i state and local governments sold bonds at about the same time a similar issuer in another state took bids on debt, the publicly bid bonds were priced at lower rates, Bloomberg data show.

New York-based Citigroup spokesman Joe Christinat says the largest U.S. bank secured good rates for Hawai'i and Honolulu in bond sales it managed this year. "We're a market leader in both negotiated and competitive sales," he says. "We're pleased to consistently deliver quality execution and competitive pricing to all our clients."

UBS spokesman Peter Casey says the Zurich, Switzerland-based bank declined to comment.

"I truly believe you get better rates by going competitive," says Natalie Brill, who oversees debt management for Los Angeles. The second-largest U.S. city after New York uses negotiated sales only for large bond issues or variable-rate debt, bonds with interest rates that change as benchmarks go up or down.

The Chicago-based Government Finance Officers Association, a trade group of government workers, bankers and lawyers involved in municipal finance, recommends that states and cities sell bonds competitively if seven conditions are met, all of which Hawai'i issuers do meet.

Hawai'i, with a population of 1.26 million, in May sold $966 million of bonds in a negotiated sale arranged by New York-based Citigroup one day after Pennsylvania took bids on $200 million of debt.

The Hawai'i bonds were priced with yields that were an average of 3 basis points, or 0.03 percentage point, more than top-rated debt, as measured by Concord, Mass.-based Municipal Market Advisors, a company that develops benchmark yields used for pricing municipal debt.

By contrast, Pennsylvania's bonds were priced to yield an average 1 basis point less than top-rated debt.

Both issues mature over 20 years, and for those insured against default, carry the highest AAA ratings. The underlying ratings for Hawai'i and Pennsylvania are similar, at Aa2 by Moody's Investor's Service, and AA- and AA, by Standard & Poor's.

Hawai'i will pay $3 million more in interest on its bonds than top-rated debt over the life of the issue, while Pennsylvania will pay $675,000 less, based on the yields the two states got and taking dollar amounts and maturities into account. Had Hawai'i received the same prices as Pennsylvania, Hawai'i would have saved $6.24 million.

Without any auctions in Hawai'i, it is impossible to say for sure whether investment banks are helping municipalities get the lowest cost for their taxpayers, financial adviser Kitahata says. He is the only independent financial adviser in Hawai'i, according to the Bond Buyer's directory, and he commutes to California for work.

He says Hawai'i public officials are listening only to bankers, and not to academics whose studies show that competitively bid bonds are less expensive than negotiated financing.

"People should really be considering the other side," says Kitahata, who says banks have no incentive to advise public officials to sell bonds competitively because they reap higher fees from negotiated sales. "The fact that competitive sales are not being done is because the issuers have bought the arguments these guys are pitching."