Rhode Island Agency Refunding $94M Of Auction Rates for School of Design

The Rhode Island Health and Educational Building Corp. tomorrow will current refund about $94 million of auction-rate debt for the Rhode Island School of Design.

When RISD recognized the crisis in the market was driving up interest rates on auctions, it decided to take action.

"We quickly got together and just started looking at all the different options that would give us a better opportunity to address this from a position of strength rather than just responding," said RISD controller Kelly Morra. After they were already conducting several analyses as to how to proceed, the school's first auction failed on Feb. 7, she said.

"We're changing the debt structure from auction-rate to variable-demand bonds," said managing director Jay Bellwoar of UBS Securities LLC, the underwriter for the deal.

Bank of America NA will provide the letter of credit for the debt. Partridge Snow & Hahn LLP is bond counsel, and Public Financial Management Inc. is financial adviser.

Bellwoar said the bonds will price tomorrow, the initial interest rates will be set and a bond purchase agreement signed. UBS will serve as the remarketing agent. The deal will close on Thursday, and the rates will reset every week from April 1 on. Rates are expected to reset each week roughly based on the SIFMA index, he said.

RISD plans to synthetically fix the interest rate on the bonds by amending outstanding fixed payor swaps with UBS, the swap counterparty, according to a Fitch Ratings report.

"Outstanding swaps contain standard risk mitigants including collateral posting requirements in the case of credit deterioration," the Fitch report said. The agency said it reviewed the proposed amendments to the swaps and they appear to be "standard."

Proceeds from the bonds will be used to refinance RISD's Series 2004A and B and 2006A and B auction-rate securities.

"This takes out all of their auction-rate debt that they incurred in 2004 and 2006," said Rhode Island HEBC executive director Robert E. Donovan. After this deal, the school will no longer have any outstanding auction-rate debt.

RISD's auction-rate debt is insured by XL Capital Assurance Inc. and CIFG Assurance NA. XLCA insured the $28.5 million of debt from the 2004A Series, $26.3 million from 2004B Series, and $6.5 million from the 2006B. CIFG insured the $31.6 million from the 2006A series.

Two of RISD's four series of auction-rate debt have maximum rates of 12%, while the other two series' maximum rates are determined based on a formulas from various taxable and tax-exempt indexes. Since the Feb. 7 auction failure, all auctions have failed for the 2004 auction-rate debt. Rates for those failed auctions have been between 7% and 11% based on the formula. The 2006 B bonds have had just one failed auction, and the 2006 A bonds have not yet failed, Morra said.

Donovan said that RISD took advantage of the auction-rate market in 2004 and 2006 because, at that time, it was the "deal de jour." Issuers could "take advantage of the variable-rate market-place without having to obtain a liquidity facility, so it helped on average to reduce the cost of the financing," he said.

That has all changed as the auction-rate market has been swamped by liquidity issues stemming from the credit crisis and the rating issues afflicting bond insurers such as XLCA and CIFG. Many issuers of auction-rate securities are now scrambling to refinance the debt.

"We feel that the variable-rate auction debt was the right market for us to be in until dramatic increase in volatility began to unfold," Morra said. "The 2004 bonds have been out there for four years, and for the most part it was a solid investment and a solid choice to be in the auction rate. It was only when the overall auction-rate market began to fail that we decided we needed to investigate other options."

Because RISD is a strong credit, it had a lot of options as to how to address its auction-rate debt, including refinancing to either fixed-rate or variable-rate debt, according to Bellwoar.

"They decided to replace the broken auction-rate structure with the variable-rate structure that wasn't broken," he said.

Moody's Investors Service gives RISD an underlying rating of A1, and it assigns Bank of America its Aaa long-term rating. A short-term letter of credit by Bank of America carries a VMIG-1 from Moody's. Fitch assigns its A-plus rating to the design school, and AA to Bank of America. Its short-term rating for Bank of America is F1-plus.

A Moody's report said that the long-term rating of the bonds is supported by the Aaa rating of Bank of America. If Bank of America should be downgraded below Aaa, Moody's may apply the joint support rating between Bank of America and RISD to determine the long-term rating of the bonds at that time.

"Given the strong unenhanced rating of RISD, combined with the strong credit ratings of Bank of America, UBS expects strong demand for the bonds," Bellwoar said.

"For a school of art and design, this is a really good rating," said Fitch senior director Douglas J. Kilcommons.

The rating reflects "RISD's premier reputation as one of the nation's leading colleges of art and design; strong demand and highly selective admissions; sound levels of liquidity resulting from strong investment returns and increased institutional development activity; and minimal future capital needs coupled with no additional debt plans," according to Fitch.

"It is a solid rating," Moody's analyst Karen Kedem said. "They are higher-rated than some of the other art and design schools that we rate."

Kedem said RISD is larger and better endowed than other design institutions. According to a Moody's report, RISD has a "strong market niche providing fine arts education in a liberal arts context, highlighted by 31% freshman selectivity, 50% [matriculation] on admitted students in fall 2007 and high net tuition per student of $27,451."

Kilcommons noted that RISD has "above-average funding for a school of design" and it has a "liquidity profile that is appropriate for this rating quality."

Under the most conservative assumptions regarding liquidity, fiscal 2007 available funds equaled a strong 177.9% of operating expenses and 100.2% of debt, Fitch said.

RISD has a history of solid operating cash flow supported by ongoing growth in tuition revenue, Moody's said. Still, dependency on student charges - which makes up 80% of RISD's total revenue - stresses the "continued importance of successful recruitment and retention of students as further demand and market position could be pressured given the competitive higher education environment in the New England area," according to Moody's.

Both Kilcommons and Kedem noted that RISD's debt burden is relatively high compared to other peers rated in the same category. Annual debt service consumes 10% of operations and expendable financial resources covering pro forma debt by 1.96 times, the Moody's report said. RISD has about $181 million of outstanding debt. On a positive note, no future debt issuances have been planned for RISD, both Fitch and Moody's point out.

RISD, founded in 1877, is a private, non-profit corporation in Providence, which provides education in visual arts, design, architecture, and art education, according to the preliminary official statement. Since 2003, undergraduate enrollment has been at or about 1,900 students, and the admission process has become increasingly more stringent, said Fitch.

"It's a very good credit story, and it fits appropriately in our A-plus rating category," Kilcommons said.

"We're looking at simply to get in front of the curve here with the volatility in the market place and make the best decision possible that will favorably impact the school and reduce our exposure, while still trying to get the maximum benefit for the school," Morra concluded. "We believe that our solution at this time will do that for us and will reduce the exposure we're experiencing from the auction-rate market."

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