Bond lawsuit driven by market, loss of proceeds

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Stakes are high for both sides involved in a lawsuit about the municipal bonds paid off early after Memorial Hospital was leased last year to the University of Colorado Health.

And neither side — the nine investors with about $47 million invested in the bonds nor the city of Colorado Springs — is backing down. The investors want the $18.6 million in interest that would be due them during the next six years if the bonds hadn’t been paid off early. The city doesn’t want to pay that money, keeping it instead for the newly created City Health Foundation.

But both sides are negotiating and City Attorney Chris Melcher hopes to settle the case out of court.

That might be a wise move on the city’s part, say local investment bankers familiar with the bond market. Lawsuits such as this one are rare because the grounds for early payoff are specifically spelled out. Analysts say that investors wouldn’t go to court if they didn’t feel their case was strong.

Given current market conditions and the difficulty of replacing lucrative interest payments, it’s not surprising that investors would fight to keep the payments coming.

“I’ve never seen any lawsuits over calling or refinancing a muni bond, and I’ve been doing this for more than 25 years,” said Phil Seefried, co-founder and CEO of Headwaters MB, an investment bank in Denver. “The contracts are usually straightforward and standard. It sounds like someone might be getting cute with the triggering clause.”

That’s what the investors think as well. The city leased Memorial to UCH in October, following a special election in August. The legal documents, however, say the hospital is leased to Poudre Valley Health System, a partner in the UCH entity, for at least 18 months. Leasing it to a nonprofit — instead of the state entity — allowed the city to pay off the $101.9 million 1995 bonds early, since nonprofit groups can’t hold tax-free bonds like the 1995 series. Under the terms of the contract, the bonds wouldn’t have been paid off until 2019.

But the city didn’t sell Memorial, and therefore still retains the collateral used for the bonds, said Allan Roth, owner of Wealth Logic in Colorado Springs.

“It’s a lease, not a sale,” Roth said. “So it’s a sticky situation. It’s not black-and-white, like these things usually are. It’s definitely gray.”

The current market plays a role in going to court. The bonds pay an interest rate of 6 percent, something that is impossible to replace with municipal bonds issued in 2013, with bond interest around 2 percent.

“There’s no way to replace the investment,” Seefried said. “So the investors are angry. You see it all over the market now. Everyone who can refinance is doing so, because it saves money. But to the investors, they’re losing money and it puts them on shaky ground. But angry doesn’t equal lawsuit. It could be that the city’s being too clever by half.”

But Melcher doesn’t think so.

“We’re in discussion with the plaintiffs,” he said. “And we’ve explained the strength of our position. We’re hopeful that this will be resolved soon.”

Today’s low interest rates are probably the trigger for the suit, Roth said. If interest rates were higher now than in 1995, the investors would be happy to get out of a bond agreement that paid them less money than they would receive otherwise.

“This is a good deal,” Roth said. “You can’t get these kinds of interest rates these days; the Fed’s keeping rates so low. It was proving to be a good investment — and now they lost it.”

Roth says he can see both sides of the issue. The investors are unhappy because they had a lucrative product that was yielding higher interest than current bonds. The city, on the other hand, has no control over the asset any longer, and won’t for the life of the bond. It made sense to pay them off.

“Of course, they’re unhappy,” Roth said. “Interest rates dropped and they had a premium investment. Instead of having that money to rely on, they got paid off at par. No wonder they’re mad.”

Melcher says the city is confident it handled the bond payoff correctly. The city hired Washington, D.C. heavy hitters Wilmer Cutler Pickering Hale and Dorr to handle the lawsuit, and the group is currently negotiating to settle out of court, Melcher said.

“But if it does go to trial, we’re confident,” Melcher said.

Even if the city has to pay the entire $18.6 million, it won’t endanger money for the newly created City Health Foundation. That’s because about $25 million to handle legal issues resulting from Memorial’s lease is being held in a separate escrow account. The city also is holding about $259 million in a different account pending the outcome of a lawsuit with the Public Employees’ Retirement Association. None of the legal fees or settlements will come out of the city’s general fund.

“There’s more than enough money to handle this and other issues that might crop up,” Melcher said. “And we’re certain that — if it goes to court — we’ll prevail.”

And if they prevail in both cases, the new foundation could be what Melcher calls a “generational asset” — with nearly $300 million on its first operational day.

If the city loses the PERA suit, it could have to pay about $161 million, based on the value of PERA’s investment on the day the lease closed. That still leaves plenty of money left over for the foundation to start operations, he said.