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Santa Clara Deals With Its ARS

SAN FRANCISCO - Santa Clara County, Calif., plans to refund its $257.3 million of tax-exempt auction-rate securities with two deals that will come to market in the coming weeks.

The county - home to Google Inc., Intel Corp., and Stanford University - will bring $115 million of fixed-rate lease revenue bonds to market May 8 and follow with about $142 million of variable-rate demand obligations two weeks later.

Santa Clara County has five outstanding ARS issues in weekly mode with penalty rates as high as 12%. Its interest costs jumped in mid-February, when the county paid as much as 10% on one series. Auctions on another series, with a penalty rate of about 4%, continue to fail. Altogether, the rates on the ARS have averaged 5% to 6% in recent weeks, up from less than 4% before the credit crunch.

"We've got five series of auction-rate securities and we're refunding all five," said finance director John V. Guthrie. "Auction-rate securities are a thing of the past. The market is going to move on. It's a dinosaur."

The extra interest on auction-rate debt will cost the county about $1 million more this year than expected when the securities were functioning properly.

The fixed-rate refunding bonds - Series 2008 L from the Santa Clara County Finance Authority - will be backed by lease payments on a variety of county facilities, including the main county jail, court house, and crime lab.

The county expects to pay an interest rate between 5% and 5.5%, Guthrie told the Board of Supervisors earlier this month. That's more than the ARS cost when they were functioning properly, but well below the rates the county faced when the auction market blew up in February.

Banc of America Securities LLC and JPMorgan are the underwriters, and KNN Public Finance is the financial adviser. Hawkins Delafield & Wood LLP is bond counsel.

The original ARS issues were backed by Ambac Assurance Corp., but the refunding bonds will not be insured. Fitch Ratings has downgraded Ambac to AA, while Moody's Investors Service and Standard & Poor's have a negative outlook in place for their triple-A ratings for the monoline bond insurer.

Ambac's parent company, Ambac Financial Group Inc., on Wednesday announced a net loss of $1.66 billion in the first quarter driven by losses on subprime-related securities the insurer guarantees, including nearly $1 billion dollars set aside by the company for claims it is likely to pay.

Standard & Poor's rates the county's lease revenue bonds AA. Moody's rates the bonds Aa3, just a notch below Santa Clara's Aa2 issuer rating. Moody's usually rates lease debt two notches below general obligation debt because lease-backed bonds require government appropriations each year.

"The atypical one-notch distinction ... reflects the county's still above-average financial flexibility relative to other California counties and prudent financial management, which positions the county well for potential near-term financial pressures arising from the still soft economy, as well as funding reductions from the state," Moody's analyst Kevork Khrimian wrote in a report.

Santa Clara County, which has about $1.3 billion of debt outstanding, was hit hard when the dot-com bubble burst in the early part of this decade. The jobless rate surged from a low of 2.2% in December 1999 to a high of 9.1% in January 2003. Local payrolls plunged 18.6% from peak to trough.

The county's reaction to the weakness is actually a credit strength now, according to Moody's. The agency said county officials showed "discipline" and cut their payrolls by 1,200, or 2.1%, to conserve reserves and ensure financial stability.

The economy has bounced back since then. Santa Clara County now boasts the highest average weekly wages in the nation, edging out Manhattan, according to a federal Bureau of Labor Statistics report published April 9. Wages surged 11.8% in the year ended September 2007 and were 93% higher than the national average.

While the county is not immune to the current slowdown, its jobless rate fell to 5% in February from 5.1% the month before. That's up 0.4 percentage points from a year ago but below California's 6.1% unemployment rate. The data are not seasonally adjusted.

Currently, the county faces three major pressures: growing costs at its public hospital, a weak housing market, and the possibility of state budget cuts. Santa Clara spent $91 million to subsidize Valley Medical Center in 2007, Moody's said, adding that the subsidy could grow to $152 million this year. That forced the county to draw down its general fund balance to $202 million, or 9.2%, last year.

Guthrie said the county plans to continue to subsidize its public health system, but it has hired an outside consultancy to make sure that costs stay on budget. Moody's said it expected the county subsidy to decline in the coming year.

At the state level, lawmakers are trying to figure out how to cut a $16 billion projected shortfall for the upcoming budget year, and counties across the state are preparing for cuts in state aid.

And like other jurisdictions in California, Santa Clara homeowners are defaulting on mortgages at record rates. Lenders sent 3,074 default notices to county borrowers in the first quarter of this year, according to DataQuick Information Systems. That's up 191% from a year earlier.

That said, the county's wealth helps buffer it against any downturn, and California's Proposition 13 blunts the impact of home price declines on local government budgets. Rising existing-home values didn't bring in much revenue during the boom because the law only allows valuations to rise 2% a year. The flip side is that the market values of older homes remain well above their assessed values even as property values fall.

Guthrie said property tax receipts should increase 6.5% next year, which is slightly slower than the 7% gain projected for this year.

"The county's financial position is notably stronger than that of many of the large urban counties in the state," Khrimian said in his report.

The county has not yet set an exact date and size for the roughly $142 million variable-rate portion of its ARS refunding, but administrators did sketch out the broad outlines of the deal - Series 2008 M - in a report to the Board of Supervisors earlier this month. Banc of America and JPMorgan will also underwrite this deal.

The county plans to issue the bonds in a variable-rate mode so that it can match an outstanding swap on two series of ARS sold in 2005. The swap was underwater by about $3 million earlier this month. Citi is the counterparty. It was also underwriter on the ARS.

Under the swap agreement, Santa Clara pays Citi 3.185%, and the bank pays the county a floating rate of 56.5% of the London Interbank Offering Rate plus 0.33%. The initial notional amount of the swap was $142 million, and the agreement expires in 2035.

Guthrie said the county is negotiating with Bank of America NA for a letter of credit for the VDRO issue, but it has not yet agreed to pricing terms.

"It will cost us a little more for a letter of credit, but overall, the interest costs would still be substantially less than going fixed right now," he said.

He said Santa Clara is restructuring the first portion of the ARS with a fixed rate in part because it would have a hard time finding a letter of credit provider with the capacity to offer liquidity for the whole $250 million of ARS.

Guthrie said the county does not plan any other major issuance this year, having recently completed a 10-year capital plan. He said the Board of Supervisors will, however, begin working on a new capital plan this year.

 

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