WASHINGTON - The District of Columbia Tuesday will begin converting $524.7 million of auction-rate securities that are insured to variable-rate demand obligations backed by letters of credit.
All of the auction rate securities are multimodal general obligation debt. About $373.8 million of them are insured by MBIA Insurance Corp. and $147.2 million are insured by XL Capital Assurance Inc., according to district Treasurer Lasana Mack.
The district will convert the ARS to variable-rate demand obligations in a negotiated transaction that takes place over several days.
Letters of credit will be provided for the $60 million of Series 2008A debt by Allied Irish Bank PLC, for the $125.8 million of Series 2008B by Bank of America NA, and for the $224.3 million of Series 2008C and $114.6 million of Series 2008D by Dexia Credit Local.
The preliminary official statement for the transaction says the long-term debt will have ratings of double-A or higher from Moody's Investors Service, Standard & Poor's, and Fitch Ratings.
The financial advisers on the deal are Public Financial Management Inc. and Phoenix Capital Partners LLP. The underwriters are Bank of America Securities LLC, Morgan Stanley, and Wachovia Securities. Orrick, Herrington & Sutcliffe LLP is bond counsel.
The transaction will follow by about a week an earlier deal in which the district refunded $252.5 of variable-rate demand obligations that had been insured by Financial Guaranty Insurance Co. The district secured letters of credit for the refunding bonds from JPMorgan and Dexia Credit Local and dropped the insurance. Mack said the district obtained interest rates on the bonds of between 1.9% and 1.65%.
Pauline A. Schneider, a partner at Orrick who is working on the district's upcoming transactions, said that while the upcoming rates cannot be predicted, the lower interest rates the district obtained on Wednesday with its VRDO refunding, the district should expect a positive market reaction.
"Given [Wednesday's] experience, it looks pretty good for the district," Schneider said.
Mack said that when the auction-rate market was doing well, the district's interest rates were often as low as 1%, but the rates peaked at 15% when the market collapsed.
While the demand of obtaining LOCs following the downgrades of bond insurers has driven up the price, Mack said yesterday, "we think we got a good deal, all things considered."
"The [LOC] rates were higher than they were before all of this started to happen, and of course, with the increased demand for these letters of credit, the laws of supply and demand produced higher rates and fees, but all things considered, we think we got reasonable rates and reasonable pricing," he said. "The pricing on the LOCs combined with the interest rates that the bonds will be trading at will be very favorable for the district."
Mack said that even though the city has faced high rates on the ARS, it still save more than $10 million annually in variable-rate mode than if the bonds were fixed rate.
"This is why we do these variable-rate bonds in the first place," he said. "This fiscal year, what we would have paid if we were all in fixed-rate bonds versus what we end up paying using variable-rate bonds makes it worth it."
The district still has about $50 million of ARS that are insured by Financial Security Assurance Inc., 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, Mack said. However, he said he will monitor the ARS to see whether a conversion will be necessary in the future.
While FSA's parent company, Financial Security Assurance Holdings Ltd., reported a first-quarter net loss of $421.6 million on Wednesday, but market sources say the loss is unlikely to hurt the bond insurer's rating.
Next week's conversions, combined with the other conversions and refundings of ARS that the district has done total about $800 million, or 13% of the district's total debt, according to Mack.
District officials began to work on refundings or conversions of its ARS soon after its first failed auction in February.
ARS are essentially variable-rate bonds whose interest rate is reset periodically through a Dutch auction. However, because they 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 historically was 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.
