Philadelphia to Refund $204M of Auction-Rate Securities Next Week

Philadelphia next Wednesday plans to refund $203.8 million of its auction-rate securities, which will eliminate all auction-rate debt from the city's portfolio.

"We're doing [the deal] as a reaction to what is going on in the market, and we wanted to react quickly and stem the problem as quickly as we could," Philadelphia finance director Robert Dubow said. He noted that the deal is "directly in reaction to the increase in the interest costs as a result of the failing auction-rate market."

Morgan Stanley,JPMorgan, and Ramirez & Co. are the underwriters for the fixed-rate deal. Blank Rome LLP is bond counsel, and Public Financial Management Inc. and Phoenix Capital Partners are financial advisers.

Philadelphia issued about $200 million of auction-rate securities in 2003 in Series 2003B-1 and 2003B-2. At the time of that deal, city officials said that because variable rates were about 200 basis points cheaper than fixed rates, the floating-rate piece in the form of ARS was attractive to the city. There was no swap involved in the deal.

Both of the 2003 series have now failed, according to city debt manager Rebecca Rhynhart. Series B-1 failed on Feb. 21 and March 27, and Series B-2 failed on March 6. Both have 35-day resets, so the Series B-2 will next reset on April 10. Both Dubow and Rhynhart said that the refunding is coming at a good time, because the city will not have to pay for too long any rate that comes from the April 10 reset.

XL Capital Assurance Inc. insures Philadelphia's auction-rate securities. While the failure rate for city's auction-rate debt was 175% of the London Interbank Offered Rate, it changed to 265% of Libor when Fitch Ratings on March 26 downgraded XL Capital to below-investment grade, Rhynhart said. Dubow said that Philadelphia in November was paying a rate of 3.6% on its auction-rate debt, and by Feb. 21, the rate was up to 5.48%.

While the savings of the upcoming refunding "won't be that large, it's really to eliminate our exposure to further [rate] increases," Dubow said.

Financial Security Assurance will insure next week's deal. The final maturity of the bonds is 2033.

Fitch assigns a BBB-plus rating to Philadelphia's general obligation debt, while Moodye_SSRqs Investors Service gives it a Baa1 rating, and Standard & Poore_SSRqs a BBB.

Standard & Poor's notes that its rating reflects a number of weaknesses, including "historically erratic" operating results, continued cost increases related to healthcare and pensions, and continuing "long-standing fiscal problems" at the Philadelphia School District and Philadelphia Gas Works, which in the past have required financial assistance from the city.

Still, Philadelphia's financial position has improved over the past three years, and the Pennsylvania Intergovernmental Cooperation Authority provides continued fiscal oversight, Standard & Poor's said. PICA's fiscal oversight has been in place since the early 1990s when the city encountered financial stress.

The city's overall debt burden also remains "very high," exceeding $4,000 per capita and 17% of market value, according to Fitch. The city has about $1.1 billion of outstanding GO debt.

Fitch notes that on the positive side, however, that the city performed better than its financial multi-year plan projections in each of fiscal years 2005-2007, as several tax sources performed at above-budgeted levels, leading to a favorable increase in reserves.

Also, the city's December 2007 unemployment rate, measured at 5.8%, has declined notably after peaking at 7.5% in 2003. The employment base is heavily weighted toward education and the health services sector, driven by the University of Pennsylvania's role as the city's largest employer, Fitch said.

Moody's said that its affirmation of its Baa1 rating reflected Philadelphia's "improving, although still weak, demographic and economic trends, modest property value growth, and a heavy burden of tax-supported debt." The rating agency also noted that the PICA oversight helped mitigate the city's weaknesses, along with its five-year planning and quarterly monitoring procedures in place.

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