SAN FRANCISCO -Sacramento County plans to restructure $350 million of auction-rate pension obligations next week after seeing interest rates on the debt surge to 10.5% from 6.5% in the first two months of the year.

The county, California's eighth largest, aims to refund its taxable series 2004C-1 bonds on March 18 with floating-rate notes issued in monthly mode at the one-month Libor plus a premium. It expects to pay a 1% premium.

"We're trying to cap our exposure," said chief operations officer Navdeep Gill. "Our debt service costs have gone up over projected costs by over $6.5 million [this year]."

The county is combining the new variable-rate debt with an existing swap to synthetically fix its interest rate, which it hopes will equal about 6.9%. Under the swap agreement it entered with Merrill Lynch & Co. when the 2004 bonds were issued, Sacramento County pays Merrill 5.9%, and the dealer pays the county Libor.

All told, the current deal should increase Sacramento's annual cost by about $2.4 million more than it expected when it issued the pension bonds, according to the county Office of Management and Budget. If it failed to refinance and paid the 17% rate that it would face in a failed auction, its costs would surge by $36 million a year. It must remarket the auction-rate securities every 28 days. It fired Merrill as the remarketing agent on its ARS last month.

The 2004 bonds are backed by MBIA Insurance Corp., which is fighting to keep its triple-A rating amid credit agency concerns about its capital position in the face of expected stress from its exposure to structured finance products. The county hasn't decided whether to purchase insurance for the refunding.

The refunding bonds - which will mature over the next 23 years - will be callable in either three or five years.

Standard & Poor's and Fitch Ratings this week assigned the 2008 pension bonds an A-plus rating. Moody's Investors Servicerated them A2 with a negative outlook on its municipal scale and Aa1 on its global scale.

The county chose Morgan Stanley to underwrite next week's deal over Banc of America Securities LLC, Bear, Stearns & Co., and Goldman, Sachs & Co. because it proposed a structure that would fix the county's interest costs, said Chris Marx, debt manager. First Southwest Co. is the financial advisor, and Orrick, Herrington & Sutcliffe LLP is bond counsel.

Marx said the county plans to refinance another $76 million of auction-rate airport revenue bonds next month.

Fitch also downgraded $85.8 million of county certificates of participation to A-plus from AA-minus because the county is drawing down reserves to pay its higher interest costs and facing slower growth in its tax revenues because of a weak housing market. Sacramento home prices fell 22 percent over the past two years.

"The national housing downturn is beginning to slow the economy," Fitch said in a report, citing a 1.4 percentage point jump in the Sacramento jobless rate to 5.9% last year.

The county budget officer forecast last month that the upcoming fiscal year's revenues would be $40 million to $60 million less than expected.

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