SAN FRANCISCO — San Francisco International Airport this week converted most of its floating-rate private-activity bonds subject to the alternative minimum tax into tax-exempt debt.
The airport may be the first in the nation to take advantage of the American Recovery and Reinvestment Act of 2009 to convert the tax status of outstanding variable-rate debt.
The airport remarketed four series of variable-rate demand obligations with a total par amount of $266.7 million as tax-exempt VRDOs this week. Interest rates on the debt fell as much as a third from the last reset. The airport plans to convert two more series worth $175 million, which is the balance of its AMT VRDOs, on June 22.
“We’re very pleased with the results,” said Kevin Kone, assistant deputy airport director for capital finance. “Moving from AMT to non-AMT opens up the buyer base for these types of securities.”
The savings were largest on tranches that were incurring relatively high interest rates because they’re backed by insurers or banks that have faced credit rating downgrades over the past year.
For instance, the airport’s $89.9 million Series 37C bonds are weekly VRDOs backed by a standby bond purchase agreement from Dexia Credit Local and insurance from Financial Security Assurance Inc. When E.J. De La Rosa & Co. remarketed the bonds as AMT debt last week, they yielded 1.5%. After the conversion to tax-exempt status, the yield fell to just 1%.
Based on its initial savings, the airport could save about $1.6 million in annual debt service, said Vincent McCarley, chief executive officer of Backstrom, McCarley, Berry & Co., the airport’s financial adviser. “This is totally as a result of the stimulus package.”
Tapping those provisions wasn’t easy. The airport’s financing team started thinking about the conversion as the stimulus bill worked its way through Congress, hoping to be ready for a conversion when the ARRA was signed into law in February.
Airport bonds are usually classified as private-activity bonds, and before the ARRA, the interest earned on the bonds was subject to the AMT. The result was higher rates, especially since the financial crisis worsened in September 2008.
The ARRA exempted all tax-exempt bonds issued in 2009 and 2010 from the AMT and allowed issuers to do refundings of bonds issued within the last five years. But the law had some quirks that have vexed bond lawyers and have made refundings almost impossible, according to William Doyle, a lawyer with Orrick, Herrington & Sutcliffe LLP, the airport’s bond counsel.
The tax law that governs AMT bonds doesn’t include the language that covers refundings in the tax-exempt area, and lawyers weren’t sure whether the stimulus act provisions could be squared with existing laws and rules on arbitrage — which are only applicable to tax-exempt bonds — in a way that would allow them to give a clean tax opinion on refunding bonds.
Refundings seemed more possible for VRDOs, said Doyle. But a full refunding of VRDOs would require issuers to call the bonds at a terrible time.
Much of the debt is synthetically fixed with swaps that require the issuer to pay a fixed rate in return for a variable-rate payment.
With the Federal Reserve holding short-term rates at record lows, those swaps are generally deep underwater. A refunding would trigger the termination of the underlying swaps and require issuers to make large termination payments.
Even if the VRDOs weren’t synthetically fixed, issuers would have a hard time keeping the debt in variable-rate mode right now because bank liquidity remains expensive and hard to get.
That meant San Francisco International Airport had to figure out how to refund the existing bonds without reissuing them. The continuity of the existing bonds mattered a great deal, but the bonds had to be changed in a way that would be recognizable as a refunding under ARRA.
“You have to find a way to keep the old bond issue intact and still do a 'refunding’ from a tax law standpoint,” Doyle said.
Doyle’s solution was a complex maneuver that required the airport to issue a notice of mode change on the bonds — triggering a mandatory tender that allows for changes in the bond documents and creates a “refunding” within the letter of the stimulus act — but to rescind the mode change notice before changing interest rate modes.
“What happens when you rescind a notice is that the bonds are still subject to mandatory tender,” said Doyle, clearly pleased by this little quirk in the existing bond documents.
Kone and McCarley convinced each of the airport’s insurers and liquidity providers to sign off on the deal by arguing that tax-exempt VRDOs would be less likely to be put back to the banks because they are marketable to a broader audience.
“This is an enormous opportunity for certain types of issuers,” Doyle said, noting that many cash-strapped ports and airports have variable-rate AMT debt outstanding that’s been performing poorly for months.