BRADENTON, Fla. - If a local government's experience with a swap makes headlines, typically it's because of a bad and costly outcome.
The story is different in Miami-Dade County, which structured three swaps so solidly it would take losing the tax exemption on existing municipal bonds and sharply rising interest rates for the county's cash flow to turn negative, according to Swap Financial LLC president Peter Shapiro.
The "tactically" timed transactions with counterparty Loop Financial Products I LLC and Deutsche Bank as credit support provider, associated with convention development tax revenue bonds sold in 1996 and 1997, have paid off for the county, he said.
The county began work on unwinding the swaps about 18 months ago with concern about losing the municipal bond tax exemption among the primary reasons.
Instead of terminating all three swaps, Shapiro has advised the county to restructure them - terminating one for an upfront payment to the county of $30 million, and extending the maturity date of two others by 15 years.
Restructuring the swaps "allows us to get the amount we originally thought we would get terminating all three," Office of Management and Budget Director Jennifer Moon told commissioners at a June 10 meeting. "It allows us to continue to get swap receipts moving forward that had increased net present value beyond what we thought we would get.
"We can still terminate in the future if it looks like there will be tax law changes and we're at risk," she added.
In advising the county to restructure the swaps, instead of terminating them, Shapiro told a county finance committee last week there is a "very remote chance" that the muni tax exemption will be repealed.
The Miami-Dade swaps are based on the difference between taxable and tax-exempt rates, rather than fixed versus floating rates.
Even if Congress and the Obama administration adopted a flat tax of 15%, the county would still receive positive cash flow, he told The Bond Buyer in an interview Tuesday.
And abolishing the tax exemption without protecting outstanding bonds, or grandfathering them, is a "somewhat hard to believe scenario," said Shapiro.
"We have had more than 30 years of debate on this in Congress going back to the Bradley-Gephardt proposal in early 80s where there have been proposals around major tax reform to abolish the municipal bond tax exemption, and they've never mustered more than a small number of votes in Congress," he said.
"There were more recent proposals to look at this, and they went nowhere," he added.
Miami-Dade's swaps are unusual, according to Shapiro, who did not advise the county on their creation in the 90s.
"You read in the press when things are not functioning as planned," he said. "It typically is the case with one of those swaps when termination has to be made and government pays a cost to terminate."
Year-over-year, the swaps being restructured by Miami-Dade have produced a "strong stream of positive cash flow," said Shapiro.
They also have a large, built-in cushion called a "constant" to protect against reduced cash flows.
The county pays an amount based on the Securities Industry and Financial Markets Association index, and the counterparty pays an amount based on the London Interbank Offered Rate index.
The difference between the SIFMA tax exempt rate and the LIBOR taxable rate is structured so payments should offset each other.
If payments don't offset, the county receives a constant that is 170 basis points on a bonded basis, according to Shapiro.
"The county was very smart about the points of entry into market, always entering in the market for swaps at times when conditions were such they could get paid a higher constant," he said. "The county was very smart tactically timing transactions that way."
The county also wanted to make sure there was a significant margin of protection with a cushion.
"So what they did in the early years was rather than realize cash flow off the constant they banked that - they left money in the swaps to increase the interest," Shapiro said.
That gave the county even more flexibility, and enabled commissioners to use $30 million in excess shortfall reserve savings to shore up its budget during the last two years.
With the current plan to restructure the swaps, the county hopes to use the $30 million payment to replenish the excess in the reserve fund so it will be available in coming years when debt service payments on the underlying obligations rise significantly, according to Moon.
Replenishing the reserve will also protect the general fund because it's a backup pledge on those payments, she said.
The restructuring plan is expected to be considered by the full County Commission on July 1.
Pricing will take place this summer.
"Here, very prudently, the county entered these transactions taking risk in a small way for a financing benefit that turned out to be large and cushioned its risk, which has paid off well," Shapiro said. "And now they will be able to look at it for an additional benefit."
Risks to the tax-exemption are outweighed by the benefit the county receives from the swaps, Shapiro said.
Tax-exempt bonds are a fundamental part of the market place supporting state and local infrastructure needs, he said.
"Unless the federal government figures out a way to replace that to deal with trillions of dollars of infrastructure needs, it's overwhelmingly likely [that the tax exemption] survives," he said.
Still, market experts are concerned about the future for a number of reasons, including recent events.
Last week's surprise primary result in which House Majority Leader Eric Cantor, R-Va., lost to lesser known ultraconservative Tea Party member David Brat could be a sign of a resurgence in the populist movement, Municipal Market Advisors said in a comment on the status of the tax exemption Monday.
Cantor's loss will "likely bolster the prospects of anti-tax, anti-debt policies in the near term, to the detriment of the tax exemption's prospects for surviving this decade intact," MMA said.
Another recent development is the June 10 signing of the Water Resources Reform and Development Act, which provides credit enhancement and loans for flood control, drinking water, and waste water projects.
The program is supposed to steer federal funds to aid privately constructed water infrastructure improvements but it "contains a debilitating ban" on the use of tax-exempt financing, MMA noted.
Potential caps on the value of the muni exemption and a surtax on muni interest for high earners, among others, also have been proposed in tax reform measures proposed by members of congress and the Obama administration.
Those issues remained a concern as recently as last month's Government Finance Officers Association's annual conference where attendees were urged to keep on top of efforts to preserve the muni exemption.
At the same time, GFOA speakers also said they believe that tax reform is unlikely to occur this election year and with ongoing gridlock in Congress.
Miami-Dade has two other swaps structured the same way as the 1996 and 1997 derivatives.
Other governments have similarly structured swaps, though Shapiro said he did not know how many.
"These have been swaps that have worked extremely well for the county, and the county has benefited from them year in and year out," he said. "If you went around the country where swaps worked the best, Miami-Dade County would be one of the places where they worked the best."
