LOS ANGELES — Bank downgrades and looming changes to bank collateral requirements under Basil III compelled San Diego-based Point Loma Nazarene University to sell its bonds directly to Bank of America rather than renewing a letter of credit due to expire this month.

School officials at the Christian liberal arts college decided they no longer wanted the risk of having a bank LOC backing $31.72 million in outstanding bonds in view of the bank downgrades that have occurred, particularly since the bonds were trading at a weekly variable rate, said George Latter Jr., Point Loma’s vice president of finance for administrative services.

“We began the process in late spring to renegotiate away from the LOC,” said Latter, who described their efforts as “probably behind the pack” of issuers who are making similar moves.

The deal that Point Loma has negotiated with Bank of America, which is expected to close on Dec. 20, fits a trend that market-watchers have been seeing this year for issuers to move away from variable-rate debt obligations and auction-rate securities into direct loans.

“We have seen a huge switch this year,” said Nat Singer, managing director of Swap Financial.

It’s also a trend that Matt Fabian, managing director with Municipal Market Advisors, expects to carry into 2012.

“We assume banks will continue to make their balance sheets available in this way and convert existing VRDOs and ARS into direct loans,” Fabian said in an email. “And direct purchases will reinforce scarcity in the new-issue market generally next year, keeping municipal yields relatively low.”

Wells Fargo, which held the university’s LOC, has been downgraded twice over the past two months, Latter said.

“Interest rates can move around from week to week, because these are weekly remarketed bonds,” he said. “We did not want the risk of having to do payouts to bondholders if the bank was downgraded lowering our overall rate.”

The university, which enrolled close to 3,000 students in 2010 at its four Southern California campuses, had not seen a noticeable impact on the rates, but at “some point people will say we want more interest, because we are taking more risk,” Latter said.

In November 2010 Moody’s Investors Service affirmed the university’s Baa2 underlying rating on the bonds issued through the ABAG Finance Authority for Nonprofit Corporations. Moody’s also maintained a Aa2/VMIG1 rating on the bonds based on support provided by the Wells Fargo LOC.

If the deal closes, Point Loma would be paying Bank of America a variable rate based on a percentage of one-month London Interbank Offered Rate plus a credit spread in a five-year deal with an option to renew. Latter wouldn’t reveal the exact pricing on the deal.

Latter also considered looming regulations from Basel III. When the regulations take effect in 2015, banks will be required to hold Treasuries or cash-equivalents that equal the amount committed to in LOCs. The looming regulations make it more favorable for banks to do direct purchase deals because the new collateral requirements do not apply to loans carried on their books.

“We did not want to have to renegotiate in three years” when the regulations go into effect, Latter said.

Fabian thought it was a little soon to be worrying about Basil III, because the regulations could change based on what has been occurring in Europe, but added that the bank downgrades do put VRDO repricings more at risk.

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