Like many issuers dealing with the deterioration of the bond insurance industry, the Erie County, N.Y., Water Authority found itself with a big headache in late February. Although it didn't have auction-rate debt, it did have two series of Ambac Assurance Corp. insured variable-rate demand bonds that investors suddenly didn't want.

"We believe they were put back because of concerns about Ambac," ECWA executive director Robert Mendez said.

At that time, investors began putting back the bonds. By the time the authority was able to come up with a temporary solution in the form of a waiver from their liquidity provider, puts had totaled $28 million. The remarketing of those bonds at higher interest rates cost the authority an additional $200,000, Mendez said.

The ultimate solution will come Wednesday when the authority goes to market with $47.7 million of fixed-rate refunding bonds that will get it completely out of variable-rate debt. It also does so with three ratings upgrades in the past two weeks. The refunding will take out two series of bonds issued in 1993.

Public Financial Management Inc. is the ECWA's financial adviser. Depfa First Albany Securities LLC will underwrite the bonds and Damon & Morey LLP is bond counsel. The bonds will have maturities out to 2018. The authority has left open the possibility of issuing the bonds with insurance but expects to market them uninsured.

Fitch Ratings put Ambac on negative watch in December and downgraded it to AA from triple-A in January. Standard & Poor's downgraded the insurer to AA from AAA earlier this month. Moody's Investors Service still rates the insurer Aaa.

In order to calm investors that were largely money market funds, the authority negotiated a 120-day waiver of automatic termination events with Depfa Bank which has a standby bond purchase agreement on the VRDBs that replaced an earlier agreement last year.

The waiver, which took effect on April 29, was set up so "the bondholders would have a period of time where they would be comfortable that there would not be an event where the standby bond purchase agreement would fall away so they would be able to be confident that they would have bonds that could be treated as money fund eligible," said PFM managing director Nancy Winkler.

The waiver covered several events. They included an event of insurer insolvency, default by the insurer in making a payment if required, and substitution of an insurer if the Ambac policy were surrendered, cancelled, terminated, amended, or modified without the bank's prior written consent.

"It's a win-win situation for everybody because the bank doesn't want to hold the bonds that have been put," Winkler said. "They're having to put their capital to work, and bondholders want to be confident that they're going to have the standby there and the issuer doesn't want to be paying the bank rate."

Matt Fabian, managing director of Municipal Markets Advisors, a bond consulting firm, said that the situation the water authority faced prior to negotiating its waiver was not unusual.

"Money markets [funds] who hold variable-rate paper are very cautious about the liquidity of the underlying bond, so that's a prime factor," Fabian said, speaking generally. "So with any kind of signs of trouble with bond insurers, the money markets want to be well out ahead of that, and they want to be putting them back prior to that happening."

The ECWA's approach appears to have worked, according to weekly interest rate data from Bloomberg. The two series started the year with interest rates at 2.99%. By March, after investors began putting them back, requiring remarketing, the weekly resets had spiked up to 5%. The week before the waiver agreement was put in place, those rates had come down to 4%. But the next reset came in at 2.5% and last week they had fallen to 1.65%.

However, since Ambac's downgrade earlier this month $3 million have been put back, Mendez said.

In refunding the bonds, the authority is terminating a swap with American International Group Inc. that will cost the authority an estimated $6 million. But Mendez said they expect to save money, even with the payment.

"We believe we're still going to have a savings due to the very great interest rates that are out in the market right now," Mendez said. "With our recent upgrades we believe it will result in a net savings overall."

The ECWA provides an average of 75 million gallons of water every day to about 550,000 people in the county, according to the preliminary official statement. Their service area does not include Buffalo, which has its own water system. Over the past 10 years the system has grown by 28%, Mendez said, though that growth is largely due to the acquisition of other water systems.

The authority is an infrequent issuer of debt, choosing to use pay as you go financing for most of its capital needs. After the refunding, the utility will have $111.9 million of debt outstanding. Last year it sold $35 million of bonds in its first issuance since 1993, according to Thomson Reuters data.

Fitch kicked off a round of upgrades two weeks ago, raising their rating to AA with stable outlook from AA-minus. Standard & Poor's followed last week, upgrading the credit to AA-plus with stable outlook from AA, and then Moody's joined in with an upgrade to Aa3 from A1.

"They've really had a steady operating trend we've seen good operations, healthy operations for the last few years and certainly consistency is a positive," said Lisa Cole, an analyst at Moody's. "Their cash position is strong, they have good proactive policies we like to see, their debt we expect to remain manageable because their debt ratio is fairly low, and they don't have any new debt anticipated in the next few years."

The large system serves the more affluent portion areas of Erie County and other counties which is a positive factor, Cole said.

John Sugden, an associate director at Standard & Poor's said the upgrade reflected strong management at the authority.

"We've seen the authority do what they need to do in terms of good [debt] coverage and their liquidity and this is in recognition of their maintenance of a strong system," he said. He also cited the system's steady expansion through acquisition and consolidation of other water systems as a positive.

"Having the larger customer base gives them an economy of scale and distributes the fixed costs across a broader base," he said.

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