BRADENTON, Fla. - A Kentucky lawmaker said he will raise questions today about whether a lease transaction to finance the purchase of a hospital exposed a flagship state university to risks posed by an underlying swap and letter of credit.
The issue involves potential risks to which the University of Kentucky may have become exposed when it entered a $35 million, 20-year lease deal with the Kentucky Association of Counties. The situation will be discussed at the state Capital Projects and Bond Oversight Committee meeting today.
The university's payment obligations "are likely to change over the life of the lease with additional rental payments" for increased administration fees, increased costs for an underlying letter of credit and change in trustee fees, and any cost associated with terminating an underlying interest rate swap agreement, according to a committee analysis obtained by The Bond Buyer.
"The concerning part about this is the method [the university] used, especially with everything going on around the country with regard to derivatives and swaps," said state Rep. Robert Damron, who is one of eight lawmakers on the legislative bond oversight committee.
"We're starting to see all the problems in Tennessee that popped up with regards to the swap program there where local governments are coming back saying, 'We didn't know we had exposure,' " said Damron, who also is a licensed financial adviser with Ross, Sinclaire & Associates LLC. He does not represent clients in Kentucky.
Damron was referring to recent reports in neighboring Tennessee where some issuers, mostly small communities, have said they face increased interest payments or large swap termination payments on deals they did not understand despite attending a state-required education program on derivatives.
Tennessee officials now are considering sweeping changes to the state's municipal finance guidelines, including a proposal that would prohibit interest rate swaps tied to bond deals smaller than $50 million or forward bond-purchase agreements for deals less than $25 million.
Problems with variable- and auction-rate rate debt and derivatives, inability to renew or obtain letters of credit, bond insurer downgrades, and the extraordinary meltdown of the credit markets are not unique to Tennessee or Kentucky, but they have raised awareness about the risks involved, particularly if users are unsophisticated or do not use an independent financial adviser.
University of Kentucky officials reportedly will be at today's bond oversight committee meeting to answer questions about the lease deal. The university could not be reached for comment for this story or whether the university had its own financial adviser review the lease.
The lease was financed as part of a $75 million variable-rate revenue bond deal that was sold in December with Trimble County, Ky. as the conduit issuer for the Kentucky Association of Counties Leasing Trust Program. The association established the lease program in 1989 to assist governmental entities with financing various projects, according to the bond oversight committee's analysis.
The bond transaction included a swap between the Kentucky Association of Counties Leasing Trust Program and U.S. Bank NA. U.S. Bank also provided a letter of credit and serves as trustee. JPMorgan was the underwriter on the bond sale and is the remarketing agent. Laurenson Services Inc. served as financial adviser, according to bond documents.
The deal was rated Aa1/VMIG-1 by Moody's Investors Service based on the bank's credit rating.
Association officials could not be reached for comment about its program, or how many entities in Kentucky used it.
However, the association's bond counsel, Roger Peterman, a partner at Peck, Shaffer & Williams LLP, said that the University of Kentucky is not a party to the swap transaction. If the university wanted to restructure the lease before maturity it would be responsible for any termination payment, if one is owed, he said.
"The university is only a party to the lease and they are only required to make payments on the lease schedule," Peterman said. "There is a swap involved in the structure of this particular financing but it is not an obligation of the university itself."
Any default on the swap would be the liability of the letter of credit provider and not the university, according to Peterman.
While the university signed a lease agreement with a fixed payment and interest rate schedule, it also is responsible for some additional costs, such as the letter of credit, which is scheduled to renew every year. If that cost goes up, the university must pay for it, Peterman said.
On March 10, the university approved placing the lease under its general receipts bond resolution, which was required under terms of the lease agreement, Peterman said. That placed the lease payments on par with some or all of the university's outstanding bond payments.
While the university's bond transactions are subject to review by the state oversight committee, the lease was not, Damron acknowledged.
However, he said that when the Legislature granted Kentucky entities the authority to enter into leases the intent was to focus on smaller deals such as those related to equipment leasing.
But now that the University of Kentucky deal has closed, Damron said all lawmakers can do is review it and "see that we provide statutory guidance for future deals."
"Part of the problem from an oversight standpoint is making sure large leases are reported just like bond issues are," he said. "The other issue is how we make sure all issuers are protected before entering into these types of financing mechanisms. I have concerns about swaps."
