LOS ANGELES A public employee union-backed group in Los Angeles is pushing for the city to file a regulatory complaint against underwriters involved in interest rate swaps
The Fix LA Coalition wants City Attorney Mike Feuer to file the complaint with the Financial Industry Regulatory Authority.
The City Council voted unanimously in mid-August to ask BNY Mellon to return $65 million of what council members characterized as unfair profits and fees paid since 2008 on the debt. The City Council also asked City Administrative Officer Miguel Santana to renegotiate the debt and threatened to stop doing business with the banks holding the swaps.
Little progress has been made since then. The coalition wrote a letter to Feuer last month asking him to file a FINRA complaint alleging the four underwriters involved in the deal violated the fair dealing rule. The underwriters were Bank of America Securities, Jackson Securities, Loop Capital Markets and Lehman Brothers, according to Lisa Cody, a policy analyst for SEIU Local 721, which represents city employees.
Loop Capital Markets and Bank of America Securities declined to comment. The other two banks could not be reached for comment.
Matt Fabian, a managing director with Municipal Market Advisors, called the idea that the bankers may have violated FINRA's fair dealing rule "a stretch."
"The investment bankers weren't looking to pick off cities," Fabian said. "They thought this was a good idea at the time."
City officials estimate they have lost $65 million on the interest rate swaps since 2008 and will lose another $68 million at current interest rates before the deal matures in 2028. That doesn't include the $26 million the city paid in a termination fee in 2012 to refinance part of the debt.
The swaps were created in 2006 when Los Angeles sold $316.8 million in bonds to refinance debt issued in 1988 for work on the municipal wastewater system.
The motion filed by City Councilman Paul Koretz asking for the city to boycott NY Mellon and Dexia cites one 2006 swap agreement with the two institutions in which the city swapped a variable rate for a synthetic 3.34% fixed interest rate.
The assumptions behind the deal soured with the 2008 financial crisis, Koretz said in the motion.
"Instead of saving money by entering into this swap deal, the City found itself locked into a fixed rate substantially above market rate while NY Mellon and Dexia were able to take advantage of variable interest rates that were kept artificially low by the Fed," it said.
The City Council motion authored by Koretz grew out of a report released by the Fix LA Coalition on March 25 that suggested banks have engaged in predatory lending practices to cities.
In a confidential report leaked to the Los Angeles Times, Feuer discouraged the city from filing a complaint with FINRA, warning that bringing meritless litigation could harm the city's reputation and credibility in financial circles.
Koretz said city leaders need to find a way to examine this confidential report in an open session of the City Council or during a council meeting. Potential litigation is on the list of items city leaders can discuss in closed session.
Rob Wilcox, a spokesman for Feuer, said the city attorney cannot comment on a confidential report. He added that it would be up to the City Council to release a privileged communication between the city attorney and his client, the City Council.
Koretz said he knows people have characterized the city as one having a sophisticated staff that should know the risks, but he thinks the risks of what could occur if the economy cratered and interest rates dropped were not properly explained to city staff before the deals were made.
"People say we are the big boys we should have known the risk, but it is hard to find any significant example of communications discussing the risks," Koretz said.
Cody said they requested copies of any presentations made to the city by underwriters before the swaps deal was struck, and nothing they were given included analytics laying out the cost to the city if a worse-case scenario occurred. City officials provided the union with three power point presentations, but have told the coalition that no pitch books exist, she said.
But no one fully understood where things might go before the economic crash, Fabian said.
"If the industry had fully understood the risk in auction rate and swaps they would not have put so many issuers in them, because the bankers want to keep issuers whole," he said. "It was a blunder by the entire industry of not understanding what could ultimately happen."
He added that because the municipal industry is so specialized it is much more of a relationships business than other segments of the financial industry.
"When you deal with issuers, if you become someone who is not trustworthy you go out of business," Fabian said. "That is why shops that have had a lot of defaults are no longer in business."
Former North Carolina Congressman Brad Miller, a lawyer with New York-based Grais Ellsworth, who testified at the August council meeting, said in an interview there is no indication the risk of entering into a long-term interest rate swaps agreement was properly explained.
The structure of the deal means that all the advantage goes to the counter party on the swap rather than the city, he said.
"I don't want this to just float by based on the recommendation of the city attorney without some scrutiny," Koretz said. "I am trying to figure out if this can be discussed in open session. It is a confidential memo. Although, it obviously is not as confidential as it was, because someone leaked it. I am going to consider it confidential until we have that discussion."
The logical next step would be a closed session discussion, but no such meeting has been placed on the calendar yet, he said.
Koretz said he supports filing a complaint with FINRA, because he hasn't seen any significant communication from the underwriters involved in the original swaps regarding risks.
"I don't think there was any hint of the real risks in the presentations made to the city. I think it was more of a sales job than it should have been," he said.
SEIU has consulted with a number of financial industry experts, who have said if that is all that was presented to the city, the FINRA complaint would be a slam dunk, said Jono Shaffer, deputy director in SEIU's national office.
"Which is why we are concerned that the city attorney is taking such a conservative approach," Shaffer said.
The clock is ticking on the six-year period of eligibility for filing a FINRA complaint. If the period starts six years from the date the interest rate swaps plummeted, because of Federal Reserve actions to hold interest rates down, as Coalition officials have suggested, it began in November or December 2008. If that is the case, the clock runs out by the end of this year.
It is a good idea to "keep thinking about, contemplating and studying what happened in the financial crisis, because it really exposed some bad practices on the part of cities and their underwriters," Fabian said. But filing a complaint against the underwriters seems unnecessarily punitive, he said.
Keeley Webster covers public finance in the Bond Buyer's Far West region.