The New Jersey Economic Development Authority Tuesday approved refinancing up to $3.69 billion of variable-rate school construction debt that will help the state terminate about $1.7 billion of derivatives tied to the floating-rate debt.
The state anticipates issuing $1.5 billion to $2 billion of school construction refunding bonds in early January, according to Andrew Pratt, spokesman for the state's Treasury Department. The EDA serves as a conduit issuer for New Jersey's school construction debt and the debt is state appropriation bonds paid from the the general fund.
"The entire purpose of this deal is to get us out of some swap agreements," Pratt said. "In particular, we want to get out of the swap agreements that require us to renew letters of credit in 2011."
The EDA's board authorized refinancing up to $2.94 billion of bonds and up to $750 million of notes.
While refinancing outstanding floating-rate bonds into fixed-rate bonds or floating-rate notes will generate debt-service savings, officials anticipate the transaction will have a net-cost of $18.2 million. The Treasury Department calculates that the state will gain $277.7 million of interest savings over the life of the bonds but will pay $295.9 million to terminate $1.7 billion of swaps, leaving a net payout of $18.2 million.
Treasury officials are looking to reduce the state's derivative portfolio and lower its exposure to the risks associated with hedging. As of Nov. 30, New Jersey has $4.14 billion of outstanding swaps in notional value, with a negative mark-to-market value of $695.8 million, according to a November swap report compiled by Lamont Investment Advisers Corp.
Of its outstanding derivatives, the state has $3.62 billion of swaps in notional value attached to school construction bonds. As of Nov. 30, the mark-to-market value of the school bond derivatives is a negative $658.4 million.
"This prudent transaction marks the beginning of the end of New Jersey's ill-fated foray into exotic financial engineering, state Treasurer Andrew Sidamon-Eristoff said in a statement. "This transaction will save taxpayers far more than $18 million by cleaning up our books and eliminating much of our open-ended legacy exposure to complicated and risky derivative agreements."
While derivatives can reduce an issuer's exposure to rising interest rates on variable-rate bonds, issuers also take on counterparty risk and basis risk when entering into swap agreements.
Bank of America Merrill Lynch is senior manager on the school construction bond deal. Wolff & Samson PC is bond counsel. Lamont Investment is the swap adviser.
Along with reducing its derivative portfolio, the transaction will help address $1.1 billion of letters of credit attached to school construction debt that will expire in 2011. Fewer banks are issuing LOCs and many issuers are looking to replace expiring letters, resulting in higher costs for such liquidity enhancement. In spring 2011, the Treasury's search resulted in $1 billion of offered LOCs with an average price of 118 basis points, according to an EDA board memo from Tuesday's meeting.
The transaction will include advance and current refinancings. The state anticipates issuing $1.7 billion of fixed-rate debt and $284 million of SIFMA-based floating-rate notes, according to the board memo. It will cancel $1.8 billion of LOC needs for school-construction debt, including all letters of credit up for renewal in 2011.