WASHINGTON - The District of Columbia plans to rid itself of costly variable-rate demand obligations insured by downgraded bond insurers when it brings about $125 million of VRDOs to market on Sept. 3.
The deal will replace insurance from MBIA Insurance Corp. on the general obligation refunding bonds with a direct-pay letter of credit from Dexia Credit Local, district finance officials said last week.
This transaction brings to a close the city's efforts to get out of auction-rate securities and VRDOs insured by struggling bond insurers. The district will have converted, refunded, or remarketed nearly $1 billion of such debt since the ARS market collapsed in February and floating rates spiked to unprecedented highs after bond insurers were stripped of their triple-A ratings.
The $125 million of MBIA-insured VRDOs the city is remarketing next week had rates peak at the maximum of 10% and have stayed that high, said Raj Srinath, associate treasurer.
This is up from an average of 2% when MBIA was still triple-A, district Treasurer Lasana Mack said in an interview Friday. Mack said the rates dipped as low as 1%. The treasurer said that while the district did consider going to fixed-rate with this transaction and others throughout the year, it is the low rates that variable-rate debt historically can garner that keep the district from going fixed.
"We made a policy decision some time ago to have a certain amount of variable-rate exposure, which typically gets us lower rates and therefore lower debt service costs ... We decided to cure the problem but still keep variable-rate debt," Mack said.
Mack said that when the auction-rate market was doing well, the district's interest rates were often as low as 1%, but the rates peaked at 15% when the market collapsed.
As a result, in late May, the city converted $524.7 million of auction-rate securities that were insured by various downgraded insurers to VRDOs backed by LOCs.
The district also converted around the same time about $24.3 million of Financial Guaranty Insurance Co.-insured ballpark revenue bonds to VRDOs backed by an LOC from Bank of America NA.
Earlier that month, the city refunded $252.5 million of VRDOs that had been insured by FGIC. The district secured LOCs for the refunding bonds from JPMorgan and Dexia and dropped the insurance.
The district's transaction next week comes as the options for obtaining LOCs have been drying up because of high demand from issuers with illiquid VRDOs and ARS. And even the remaining triple-A rated financial guarantors are on shaky ground.
Moody's Investors Service in mid-July put the ratings of Financial Security Assurance Inc. on review for a possible downgrade. FSA's parent company, Dexia, also has a negative outlook from Standard & Poor's and Fitch Ratings in July. The bank has long-term ratings of AA-plus from Fitch and AA from Standard & Poor's, but its outlook was cut to negative on concern over its exposure to mortgage-backed securities backed by home equity loans.
The district has about $408 million of VRDOs backed by Dexia LOCs, not including the upcoming transaction, and it also has about $330 million of VRDOs and auction-rate securities that are insured by FSA.
But Mack said regardless of the negative news, the city is comfortable with the interest rates they are getting and they have no plans to get out of FSA-insured or Dexia LOC debt "unless something were to occur where having them on the bonds was causing the rates to really spike."
"We looked at how that has affected trading in the marketplace, and we haven't seen a major increase in the rates of securities backed by Dexia," Mack said.
Srinath also said the district will continue to monitor the debt closely.
"We have not seen any adverse impact thus far on the few other series of the district's VRDOs which are backed by Dexia's letters of credit - the interest rates on them at the present time are at or below" the Securities Industry and Financial Markets Association index, Srinath said.
Srinath said that the interest rates on the variable-rate bonds insured by FSA have been slightly higher compared with variable-rate bonds backed by letters of credit, however, that "in absolute terms" the rates are still "very attractive." Mack said in an earlier interview that "as long as we're getting good rates, even if they're trading a little more off the SIFMA index, they're still low rates," and the district would be comfortable with the banks.
In addition, the district is monitoring more than $250 million of its VRDOs that have letters of credit from Bank of America after Fitch downgraded the bank's long-term senior debt to AA-minus from AA in mid-July, along with a list of municipal bonds that are backed by letters of credit from the bank.
But Mack said even with the chaos that unfolded with auction-rate securities during the course of this year, the district still saw savings.
"The way we've been looking at it ... some unprecedented things have happened in the market, but we have made prudent use of this type of security and the district ultimately benefited" from VRDOs, Mack said.
Lehman Brothers Inc. will remarket the $125 million of VRDOs in a weekly mode.
Squire, Sanders & Dempsey LLP is bond counsel to the district. Disclosure counsel is Hawkins, Delafield & Wood LLP. Underwriters' counsel is Orrick Herrington & Sutcliffe LLP and McKenzie & Associates.
Public Financial Management Inc. and Phoenix Capital Partners are the financial advisers to the district on the upcoming transaction.
