COUNTY OF SAN MATEO
County Manager/Clerk of the Board
August 1, 2008
BOARD MEETING DATE:
August 12, 2008
Honorable Board of Supervisors
Reyna Farrales, Deputy County Manager
Appropriation Transfer Request - Youth Services Center Bonds
Approve an Appropriation Transfer Request transferring $11,800,000 from General Fund Non-Departmental Reserves to Other Financing Uses-Operating Transfers Out, and increasing Other Financing Sources-Operating Transfers In and Other Charges-Retirement of Long-Term Debt by $11,800,000 in the Debt Service Fund for the purpose of refinancing the 2003 Youth Services Center bonds.
Commitment: Responsive, effective and collaborative government
Goal 20: Government decisions are based on careful consideration of future impact, rather than temporary relief or immediate gain.
This Board action contributes to this goal by removing the existing Youth Services Center bonds from the auction rate securities market, where the County is currently paying 6.28%, and refinancing them to fixed rate bonds, which is anticipated to keep ongoing annual debt service at approximately 4.75%.
In November 2003, the County issued $155 million in lease revenue bonds to build the Youth Services Center (YSC). As a means to lowering borrowing costs, the County chose to structure the financing as “synthetic” fixed rate bonds. To accomplish this, the County issued variable rate bonds known as Auction Rate Securities (ARS) and entered into interest rate swap agreements with Citibank and Lehman/AIG. This effectively changed the variable interest rates on the bonds to a fixed rate approximating 3.33%. To date, this swap structure has produced $6.2 million in present value savings to the County when compared to the 4.78% fixed rate the County would have paid if traditional fixed rate bonds were issued back in 2003.
The ARS market began to show signs of weakening in late 2007 as the subprime mortgage crisis unfolded and a lack of confidence in the credit quality of bond insurers grew. Nearly 98% of the municipal ARS market is supported by bond insurance. These credit concerns soon sparked a “liquidity crisis” in the ARS market; investors began to fear that they would not be able to find new investors to purchase their ARS bonds in the weekly and monthly auctions, which are the vehicle for trading ARS bonds.
The YSC bonds were insured by Ambac, which was first placed on negative credit watch by Fitch Ratings in late December. At that time, the County began to look for alternatives to the ARS market for its YSC bonds. Subsequently, both S&P and Moody’s have downgraded Ambac to their current ratings of AA/Aa3. At the request of Ambac, Fitch has withdrawn their ratings. The County started putting together a plan with California Financial Services, Citigroup and Lehman to restructure the YSC bonds. In mid-February, the municipal market experienced a significant number of “failed” auctions, including the auctions for the County’s YSC bonds. A failed auction occurs when new investors cannot be found to replace investors who wish to sell bonds and triggers an indexed rate on the County’s bonds. As a result, the County is currently paying a combined swap and bond rate of more than 6%. If allowed to continue, the County would pay an additional $3 million per year in YSC debt service, which is currently budgeted at $9 million.
The Joint Powers Financing Authority approved the refinancing parameters at its May 13 meeting. Updates were provided to the Finance and Operations Committee in March and June.
At its July 22 meeting, the Board authorized the YSC bonds to be refinanced to more stable variable rate demand obligations (VRDOs). This would remove the bonds from the failed ARS market but retain the synthetic fixed financing structure, which was projected to keep the County’s total annual borrowing costs below 4%. The County secured a commitment from Assured Guaranty to insure the bonds. In addition, liquidity support in the form of a standby bond purchase agreement was to be provided by a bank in the unanticipated event that the County is unable to make payments. In April, the County pursued and was able to obtain the highest credit rating for a California county from Moody’s (Aa1) and one of the highest ratings from Standard and Poor’s (AA+). These ratings will help reduce borrowing costs. Given continued uncertainty in the financial markets, additional flexibility was provided in the Board resolution, which authorizes a fixed rate financing to refund the ARS, if the VRDO financing could not be completed.
After the July 22 Board meeting, the County was notified that Assured Guaranty was being reviewed by Moody’s for a potential downgrade below Aaa. A downgrade would trigger an increase to the County’s borrowing rate, similar to the effect of the Ambac downgrade. The County was advised, given this latest information, and the continued instability of the financial markets, to convert the bonds to a fixed rate. Staff recommends the termination of the swap structure, the refinancing of the bonds to fixed rate, and the issuance of the bonds without insurance, relying on the County’s good credit ratings to obtain a favorable borrowing rate. In order to keep annual debt service as budgeted around $9 million, the County will pay off approximately $6.8 million of the Youth Services Center debt.
Based on the most current rates, the swap termination fee and the retirement of a portion of the Youth Services Center debt will cost approximately $11.8 million, which will be paid from General Fund Non-Departmental Reserves. (This amount can fluctuate up or down based on the market at the time the bonds are priced.) There are sufficient reserves in the Debt Service Fund to cover these costs. As part of September final budget adjustments, the General Fund will be reimbursed from the Debt Service Fund. Annual debt service of $8,871,500 has been included in the FY 2008-09 budget adopted by the Board in June. Debt service will be included in subsequent years based on adjusted debt service schedules. The Financing Team expects to sell the 2008 Refunding Bonds in early to mid- September.