SAN FRANCISCO - Fresno, Calif., next week plans to sell $161.2 million of subordinate sewer revenue bonds, including a $74 million refunding that will get it out of the variable-rate bond market for now.

California's sixth-largest city needs to refund its variable-rate demand obligations because interest rates on the Financial Guaranty Insurance Co.-backed debt spiked to as much as 11% from around 3.5% after the insurer was downgraded by the three major credit agencies. More than 95% of the debt has since been put back to the letter-of-credit provider, State Street Bank & TrustCo., triggering penalty rates in the 6% to 7% range.

In addition to the variable-rate refunding, the current deal includes $30.1 million to refund fixed-rate bonds issued in 1995 and $51 million of new money. The city plans to issue fixed-rate bonds that mature over the next 30 years.

"The fixed-rate market is doing well enough that eliminating the risk of variable-rate exposure was pleasing to us," said Phil Hardcastle, debt administrator for the city. "Our biggest concern was if we did a variable-rate again and our bond insurer got downgraded again, we'd be back in the same boat again."

The city refunded its auction-rate securities earlier in the year. After the current issue, Fresno will have no variable-rate debt outstanding. It was able to refinance the VRDOs with fixed-rate bonds because the outstanding debt was unhedged.

Hardcastle said he'll consider variable-rate bonds again when the market settles down, adding that the variable-rate sewer debt saved the city more than $2.5 million a year over the life of the bonds since issuance in 2000. Even after the recent rate spike, he thinks the city came out ahead with variable-rate bonds.

"We're not basically saying that variable rates are bad instruments," he said. "They're bad instruments at this time."

After the current issue - which is subordinate to $99.6 million of senior debt issued in 1993 and 1995 - the sewer system will have about $258 million of debt outstanding.

The new-money portion of this deal is the first financing in a $416.6 million capital improvement plan that will expand sewer capacity to meet an expected 64% surge in the Fresno's population by 2025. The population is currently just below 500,000.

The bonds will be insured by Assured Guaranty Corp., which has maintained its triple-A rating with a stable outlook from all three rating agencies. The underlying ratings on the subordinate sewer system bonds are A2 from Moody's Investors Service, AA-minus from Standard & Poor's, and A-plus from Fitch Ratings.

Citi is the lead manager, and De La Rosa& Co. and Merrill Lynch & Co. are co-managers. KNN Public Finance of Oakland is the financial adviser. Orrick, Herrington & Sutcliffe LLP is bond counsel.

The city plans to be back in the market with several smaller deals in the coming months, Hardcastle said. The Fresno Joint Powers Financing Authorityplans to issue $25 million for the city convention center in the next month or so, followed by two public safety lease revenue bond issues worth $55 million.

The city will bring a water revenue bond issue to market later in the year but has not yet set a size for the deal.

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