Massive debt makes state the largest distressed borrower.

WHEN it comes to desperation borrowing in recent years, no one tops the state of California.

Nearly $11 billion in power revenue bonds to bail the state out of the energy crisis. Another $4 billion in bonds to be repaid with tobacco settlement funds to help close a budget deficit last year. Then there's $12.5 billion in short-term notes to ease a cash crunch.

And now, the prospect of another $11 billion in "deficit reduction bonds" that legislators passed to close this year's record $38 billion budget deficit, although litigation could delay the deal or even it to be scrapped.

With all these bonds going to market, competition among New York investment banking firms and other companies for a piece of the action has become more intense than ever. A whopping 73 firms have made the cut to become members of the state underwriting pool, ranging from the big firms like J.P. Morgan Securities Inc. and Merrill Lynch & Co. to smaller boutique houses like Alamo Capital or O'Connor Southwest Securities.

"Virtually every single major underwriting firm in the nation goes after California's municipal bonds," said Mark Tenenhaus, executive director of municipal research at Morgan Stanley & Co.

Last year alone, Tenenhaus added, California's state and local governments issued $49 billion in debt, about 20 percent of the entire muni bond market in the United States.

As recently as 10 or 15 years ago, the state of California didn't use bond underwriters all that often. The bond deals were straightforward and revenue streams to pay them back were predictable, so the state could take the deals directly to Wall Street.

"It used to be that Bank of America and Goldman Sachs would fight it out with the state to buy the bonds," said Reid Smith, senior portfolio manager of the municipal bond group for Vanguard Group Inc. "Now, the bond deals are so complex you need an underwriter to help package the deal."

Smith said that bringing on underwriters could add several million dollars in fees and commissions to each deal. But with the complex nature of today's bond deals, "that money is more than made up when the bonds go to Wall Street. The bond packages that result are more focused and structured and tend to sell more quickly."

The investment bankers

Although 73 firms vie to underwrite bond deals, most of the largest "desperation bonds" of recent years have gone to a handful of major firms with significant financial and technical resources. And the key players at these firms have largely remained the same over the last several years, forming a tight circle of relationships.

At the top of the list is J.P. Morgan Chase & Co. and its senior California banker, Nathan Brostrom. J.P. Morgan was lead underwriter for the $11 billion in power revenue bonds last year, probably the most complex bond deal the state has ever undertaken. A total of 47 investment banks helped broker the bond sales, taking home $78 million in commissions and fees, according to Rochelle Williams, Far West bureau chief for the Bond Buyer.

Among other firms netting big bond deals in recent years are Lehman Brothers Holdings Inc. and Goldman Sachs & Co., which teamed up last year to underwrite $12.5 billion in short-term "revenue anticipation notes."

Lehman's senior banker to the state is Peter Taylor, managing director in the firm's L.A. office. Goldman Sachs has three key players in California: former state Treasurer Kathleen Brown, Tim Romer, who used to head Merrill Lynch's West Coast public finance division, and Andrew Nakahata in the firm's San Francisco office.

Morgan Stanley and Merrill Lynch have won a sizable portion of the state's general obligation bond business in recent years. Morgan Stanley's top bankers to the state are Celeste Davis, the firm's executive director in California, and Andrew Garvey, who heads up the companywide public finance division out of New York. Merrill Lynch's key person is Ed Burdett, managing director of the firm's Western region.

While all these firms have been longtime players in California's bond market, there has been one surprising entrant of late: Bank of America. The banking giant had handled several major bond issues in the early 1990s before leaving the market. Now, it has re-entered as lead underwriter in a $1.5 billion general obligation bond deal set to he offered this week. Bank of America's senior underwriter in the state's municipal bond market is Curt Hagfeldt.

Bringing these multibillion-dollar bond deals to market involves more than investment bankers. There are financial advisors to handle the preliminaries, bond counsel for all the legal complexities, and--perhaps most crucial of all these days--the three bond rating agencies.

Although they don't actually put together the bond deals for the state, Standard & Poor's, Fitch Ratings and Moody's Investor Service have played crucial roles. Earlier this year, all three rating agencies downgraded the state's bond rating, making it more expensive for the state to sell bonds.

If the state doesn't want to spend billions of dollars extra in interest payments, it will have to convince the three rating agencies to upgrade the state's bond rating. The key people are Dave Hitchcock at Standard & Poor's, Ray Murphy at Moody's and Claire Cohen at Fitch.

East Meets West

Key players in California municipal bond market.

J.P. Morgan Securities Inc.  Nathan Brostrom, vice president, public
                             finance division

Lohman Bros.                 Peter Taylor, managing director

Goldman Sachs & Co.          Kathleen Brown, president, Western office
                             (Los Angeles); Tim Romer, vice president,
                             Western office; Andrew Nakahata (San
                             Francisco)

Citigroup Global Markets     Anthony Hughes, Western region managing
                             Director; Cody Press, managing director

Merrill Lynch & Co.          Ed Burdett, managing director, Western
                             region

Bank of America              Curt Hagfeldt, municipal finance
                             underwriting executive

Montague DeRose &
Associates                   Douglas Montague and Darlene DeRose,
                             principals

Orrick Herrington &
Sulcliffe LLP                Roger Davis, chair, public finance
                             department

Source: Business Journal research; Bond Buyer