Scrambling to recover from a collapse in the high-risk bond market and a sudden surge in interest rate payments, the D.C. government will soon convert $550 million in tanking variable-rate debt to another, more stable security, city finance officials said.
The District holds roughly $1.2 billion in auction-rate securities, a long-term debt with variable interest rates that reset every time they go to auction – in D.C.’s case every 35 days. Until recently, the securities were a popular though risky financing tool for municipalities, universities and other institutions.
But the auction-rate market collapsed in recent weeks as several large bond insurers were downgraded, causing auctions to fail and interest rates to reset as high as 15 percent. Roughly $900 million of the District’s auction-rate securities were downgraded. And D.C. will pay more than $1 million extra a month in interest until it can get out.
“The District is moving quickly to take action to replace some or all of the auction-rate securities and variable rate bonds that are currently, or may be, exposed to higher than average short-term interest rates,” Chief Financial Officer Natwar Gandhi told the D.C. Council Wednesday.
He said later: “We have the situation under control.”
The average interest rate on D.C.’s auction-rate securities was 3.63 percent, Gandhi said, and the lower rates saved the District roughly $15 million a year in interest payments.
D.C. Treasurer Lasana Mack told The Examiner the District in May will convert nearly half of its auction-rate securities to variable-rate demand obligations, which “will resolve the issue of the high interest rates.”
Stanley Provus, bond training director with the Council of Development Finance Agencies, said VRDOs are typically backed by highly rated, bank-issued letters of credit. Smaller institutions may have trouble dumping their auction-rate securities, Provus said, but the District, with its strong bond rating and stable cash flow, shouldn’t have any problem convincing a bank to bail it out.
“The letter of credit covers the risk,” said Mark Jinks, Alexandria‘s deputy city manager.
