WASHINGTON - The District of Columbia plans by the end of next month to convert about $550 million of its auction-rate securities to variable-rate demand obligations backed by letters of credit, Treasurer Lasana Mack said in a recent interview.
The transaction will allow the district to join the ever-growing flock of issuers getting out of the beleaguered auction-rate market because their auctions have failed and their interest costs have soared. The district's ARS interest rates peaked at 15%, Mack said.
According to the treasurer, the district has a total of about $601 million of insured auction-rate securities, of which $24 million are baseball stadium revenue bonds whose interest rate jumped from 4.75% to 14% and remains at that level.
About $50 million of the ARS are insured by Financial Security Assurance, which has so far has managed to keep its triple-A ratings in the aftermath of the subprime mortgage crisis. The securities are performing well and will not be converted, he said, adding that he will monitor the debt to see whether a conversion will be necessary in the future.
In addition to the ARS conversions, the district also is planning to refund about $250 million of a variable-rate demand obligations that were insured by Financial Guaranty Insurance Co., which now has ratings that are below investment grade as a result of its exposure to the subprime mortgage market. The city plans to switch out the insurance for a letter of credit.
The conversions and refunding will total about $800 million, or 13% of the district's total debt.
Mack said the district benefited from auction-rate securities for several years because its interest costs were so low.
When the district's interest rates at some auctions were around 1%, then it was worth it, according to Mack.
"We were saving lots of money," he said. "We've estimated that over the past four or five years, at least, we've saved approximately $15 million annually."
But after the ARS market turned sour, about 43 of the district's auctions failed and its interest rate payments increased by about $4 million to $5 million, Mack said.
Specific dates have yet to be set for the conversions and refunding, but they are expected to occur before the end of May. The city has solicited letters of credit and has been able to secure "sufficient LOC capacity at reasonable costs to execute these transactions" from Allied Irish Bank PLC, Bank of America NA, Dexia Credit Local, and JPMorgan, Mack said.
He would not name the financial advisors or underwriters due to the preliminary status of the transactions, which will all be negotiated sales.
But Orrick Herrington & Sutcliffe LLP and Squire Sanders & Dempsey LLP will serve as bond counsel, he confirmed.
The district plans to convert $149.5 million of its Series 2002A auction-rate bonds and $224.3 million of its Series 2002B bonds, both of which were insured by MBIA Insurance Corp.
It also plans to convert $147.2 million of Series 2004C debt, originally insured by XL Capital Assurance Inc. All those bonds were issued as multimodal general obligation debt.
Also to be converted are about $24 million of its Series 2006B-2 baseball stadium revenue bonds, which were insured by FGIC.
The city will refund $184.5 million of its Series 2001C VRDOs and $68 million of its Series 2001D VRDOs. Both series are insured by FGIC.
District officials began to work on transactions to refund or convert the securities shortly after its first failed auction, which occurred in February. Like most issuers, the district did not expect turmoil in the market would be so damaging, and Mack said that complex transactions, like "normal" bond issuances, take months to put together.
Pauline A. Schneider, a partner at Orrick, who is working on the district's upcoming transactions, said her firm is dealing with issuers across the country that are experiencing auction-rate market failures.
"I think the district is in no worse, or perhaps, no better position than others," Schneider said. "Almost every municipal issuer that is a pretty regular issuer of debt has in the last few years entered into the auction-rate market because it was, or it has been historically, a more favorable market from the interest rate perspective than the typical variable-rate market."
"That favorable market has now gone away," she continued. "We're actively working on a refunding that we hope to get done in the next 40 days. These are prudent steps that the district needs to take."
Auction-rate securities are essentially variable-rate bonds whose interest rate is reset periodically through a Dutch auction. However, because ARS do not carry a put feature like VRDOs to guarantee liquidity, the debt is highly sensitive to changes in the issuer's credit ratings and normally requires the highest ratings to make them marketable, which is usually achieved with bond insurance. An auction failure results when there are not enough orders from investors to purchase all the shares being sold and typically leads to above-market rates for the bonds.
"I know it is scary if you have a document that permits the interest rate to go up as high as 15% if there's a failed auction," Schneider said.
"It's costing them and they're jumping through hoops and they're paying more interest rates now to get these refundings done," when they could have been focusing on other bond transactions, she said.
"I love this business." Schneider continued. "I love what I do. I like doing everything I can for my clients. But I hate it that my clients at this moment are having to spend money to hire me and other firms like mine to fix a problem, which really wasn't of their making."
