S.F. Airport Restructuring No Laughing Matter

SAN FRANCISCO - As the auction-rate securities market meltdown raged this spring, San Francisco International Airport rushed to restructure hundreds of millions of dollars of ARS with variable-rate demand obligations, trying to beat other issuers to the market before liquidity dried up.

Airport officials sold Series 37A on May 23, using a simple, well-tested weekly VRDO structure for the $205 million deal. They bought liquidity from a bank with a solid investment-grade rating to handle any puts. They backed the deal with insurance from one of the last two triple-A rated, stable bond insurers. And they hedged interest rate risk with a swap from a 158-year-old Wall Street titan.

The results look like a proof for the new Murphy's Law of municipal finance: Whatever can go wrong, will go wrong, because your counterparty will be downgraded.

"Issue 37A was backed up with liquidity from Depfa, insured by FSA, and hedged with a Lehman Brothers swap," said Kevin Kone, the assistant deputy airport director for capital finance.

Moody's Investors Service put Financial Security Assurance Inc. on watch for downgrade on July 22. Lehman Brothers Holdings Inc. went bankrupt Sept. 14. And Standard & Poor's cut Depfa Bank PLC's rating to BBB-plus on Sept. 29.

The bonds have been unmarketable since Depfa's downgrade because investors are unsure if the Irish bank can back up its liquidity commitment. Of course, that means the bonds got put back to the bank, drawing on the standby bond purchase agreement and forcing San Francisco to pay 6.5% penalty rates that will increase to 9.5% over the next few months. About 98% of the bonds were bank bonds last week.

"That's about as bad as it can get," said Kone, who admits that even he had to laugh at his predicament. But he didn't have much time to chuckle. Last week, he terminated his Lehman Brothers Special Financing swap, along with another from Bear, Stearns & Co., paying a $5.7 million termination fee, and he is once again rushing to restructure the bonds.

San Francisco International, of SFO for short, the West Coast's second-biggest airport, plans to bring $224 million of short- to intermediate-term debt to market Wednesday in the first big airport deal since the current round of the credit crisis began in mid-September.

The uninsured, fixed-rate notes and bonds are preliminarily structured with maturities from 2009 to 2013. Banc of America Securities LLC is the senior manager of a syndicate that also includes JPMorgan and RBC Capital Markets as co-managers. Orrick, Herrington & Sutcliffe LLP and Ronald E. Lee Esq. are co-bond counsel.

While the airport has suffered less than many competitors in the air traffic slowdown this year because of its strong international business, Kone said he knows the debt will be a tough sell in the current market because it is subject to the alternative minimum tax.

"It's not really the preferred way, but there aren't a lot of alternatives here," he said. "There have been really no AMT airport deals done in the market."

That's why he is seeking a short-term solution that will allow him to revisit the problem in a year or two, when he anticipates the market will have found a new equilibrium. He doesn't want to lock in current rates for longer than he must, and he's not sure he could if he wanted to.

"Investors want to stay short right now, and so this is kind of an exploratory effort because we're going to go out and see what kind of interest we can get," Kone said. "If I can do a note, I'm hoping I will do better than my bank rate."

In the meantime, he's seeking authority from the San Francisco Board of Supervisors this week to refund another $2.5 billion of the airport revenue bonds "to have the authorization in place to act as necessary" on the bulk of the airport's $4 billion of outstanding debt. That includes $629 million of VRDOs that will remain outstanding after this week's deal.

Most of the variable-rate portfolio is remarketing successfully, but some of the VRDOs - including bonds backed by Landesbank Baden Wurttemberg and Dexia Credit Local - continue to perform inconsistently. While some of the Landesbank bonds were placed with rates as low as 2.25% this week, other LBBW debt continues to reset in the 5% range, he said.

The portfolio "is still resetting higher than where we were trading five weeks ago, but it's continually getting better," Kone said. The airport's average variable rate fell to 4.54% last week from 5.14% a week earlier.

Kone said he remains committed to keeping a percentage of SFO's debt in variable-rate structures and continues to see very low rates in the 2% range on debt backed by solid letter of credit and liquidity providers like Union Bank of California and Wells Fargo Bank.

SFO currently has about 21% of its debt in variable-rate mode. That percentage will drop to 16% after this week's deal.

"I'm not going to fix all this stuff out just because there's a little bit of turmoil in the market," Kone said. "If we can continue to enjoy the short end of the yield curve, we're going to do it."

Airport deputy director for business and finance Leo Fermin estimated that variable-rate debt has saved SFO $100 million over the past three years at an Airport Commission meeting earlier this month. That has allowed SFO to cut costs per enplaned passenger to $13 from $20.

But costs are rising with debt service payments, finance director Ben Kutnick said in testimony before the Board of Supervisors last week. He said debt service costs make up about 47% of SFO's $658 million operating budget and will increase by about $10 million to $12 million this year.

"The additional debt service costs are certainly going to impact our budget," he said, adding that the airport is trying to cut its budget to avoid increasing fees for airlines that are already struggling with slumping demand and high fuel prices.

He said that the airport intends to continue with plans to renovate Terminal 2, its former international terminal, at a cost of $383 million, but has no plans to accelerate capital projects, as recently proposed by Mayor Gavin Newsom.

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