N.C. County Readies First 'Window' Variable-Rate Debt

WASHINGTON - Mecklenburg County, N.C., today will become the first local government to issue "window" variable-rate debt, a new product developed by Citi.

The county plans to issue $120 million of window VR general obligation refunding bonds, which have interest rates that are reset weekly. Holders can optionally tender the bonds at any time.

Following notification of a tender, the remarketing agent will have 30 days to try to place them. If the bonds cannot be remarketed, no event of default will be triggered, and instead all of the bonds outstanding will become subject to a "windows mandatory tender date."

The product gives issuers access to the variable-rate debt market without paying the high liquidity fees charged by banks. For months, issuers have been locked out of the variable-rate market because of the high fees. Now, some higher-rated issuers can provide their own liquidity and can avoid terminating out-of-the-money swaps with the product, according to market participants.

Triple-A Mecklenburg has a large exposure to variable-rate debt with liquidity facilities. The county has 10 standby purchase agreements that will expire by August 2010. To diversify its debt, the county is refunding some of its variable-rate debt and certificates of participation to fixed-rate debt.

But two of Mecklenburg's variable-rate deals have swaps associated with them that have a negative mark-to-market value for it and would be costly to terminate if the county refinanced.

"We didn't want to unwind them but we still wanted to get out from under the bank liquidity," said Dena R. Diorio, Mecklenburg's director of finance, who described the product as a "home run" for the county.

The solution is self-liquidity. Mecklenburg will have a seven-month window to tender the bonds. In a traditional variable-rate deal, bonds that are tendered and cannot be remarketed would automatically be put back to the liquidity facility provider.

In Mecklenburg's deal, the underwriter, Citi, has 30 days to remarket the bonds. If the tendered bonds cannot be remarketed the county has 180 days to pay the bondholder.

Investors are compensated for this potential illiquidity. Unlike traditional variable-rate bonds, Mecklenburg's deal offers investors a spread above the SIFMA swap index. The spread will be determined at pricing.

The Series 2009D bonds are rated Aaa/P-1 by Moody's Investors Service and AAA/F1-plus by Fitch Ratings. Ratings from Standard & Poor's were not available at press time.

The product allows issuers "to avoid the cost of liquidity but still maintain some flexibility in the short-term market," said Amy Laskey, an analyst with Fitch who rated the Mecklenburg deal. The credit ratings do not cover the potential conversion to another interest rate mode and do not reflect the likelihood of a failed remarketing.

Moody's noted Mecklenburg has strong cash coverage in the "unlikely" case investors will need to be paid with county resources.

Robinson, Bradshaw & Hinson will serve as bond counsel and Parker Poe Adams & Bernstein will represent the underwriter.

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