The answer is "yes". For the last several years, variable rate demand obligations (VRDOs) have become the bond financing of choice for not-for -profit borrowers because the rates have been more favorable than fixed rate offerings as investors (including money market funds) require investments which can be easily traded. Interest rate SWAPs have often been entered into in connection with these types of financings to alleviate the interest rate risk associated with VRDOs and create, in effect, a "synthetic" fixed rate debt structure for not-for-profit borrowers. The risks associated with interest rate SWAPs, in turn, have included performance by the so-called SWAP counterparty, a termination payment in the event the SWAP is terminated early and interest rates at the time of the termination are less than the interest rate of the SWAP, and collateral posting requirements if interest rates fell. These risks have often been considered manageable ones. Currently, rates for VRDOs are at historic low rates (the rates have dipped lower than 1%), as are the rates on interest rate SWAPs. Because of the economic crisis, however, and because risks that once seemed remote have transpired during the crisis, not-for-profits must also proceed with heightened caution and carefully weigh all factors before undertaking this type of financing.
As has been extensively reported, the current financial crisis began when the widely held securities backed by subprime mortgage loans began to rapidly decline in value. The effects of this decline were felt in the bond markets in early 2008 when the market for bonds whose interest rates were regularly reset through an auction process (ARSs) virtually disappeared overnight. These types of bond financings had been generally favored by municipalities because, similar to VRDOs, they provided the liquidity investors demanded. The ARS market disappeared because the investors, consisting largely of institutional investors and the investment bankers who typically stepped up when the institutional investors did not, failed to purchase these types of bonds because of rising concerns about capital preservation. The failed auctions resulted in sky rocketing interest rates to municipal borrowers and reduced liquidity and value of the investment to the institutional investors who could not remarket their ARSs. More recently, the market for VRDOs was disrupted in late 2008 when virtually no institutional investors could be found to purchase VRDOs. This latest disruption resulted in failed remarketings of these types of bonds. The result of the failed remarketings for some not-for-profit borrowers was high interest rates in cases where letter of credit banks which facilitated these bond issues were forced to repurchase the bonds. These market disruptions were accompanied by many other adverse events including the collapse or near collapses of investment banking institutions (who were often the counterparties in interest rate SWAPs), banks and insurers. All of these events led to passage by Congress of the Emergency Economic Stabilization Act of 2008 and the creation of the TARP program in an effort to return stability to the credit markets.
One of the first steps in undertaking a VRDO financing is obtaining a bank commitment for a letter of credit. This search can be facilitated by an investment banker; often it makes sense to start with the bank with whom the borrower has an existing relationship. Because of the credit crisis and because of diminished endowments, obtaining the letter of credit on acceptable terms can prove to be a daunting task. It is still possible, however, because not all banks invested in mortgage back securities and TARP funds have become available to banks. The risk of an interruption in the VRDO market remains real and requires increased diligence on the part of not-for-profit borrowers when it comes to choosing and contracting with a remarketing agent for the bonds. Additionally, borrowers must take a closer look at the entities with whom they enter into SWAPs. The very low current interest rates of SWAPs have, however, materially alleviated termination payment and collateral posting exposure. Not-for-profits which have existing outstanding bond issues must also take a careful look at the covenants and consents required under those obligations and termination payments under any existing SWAPs before proceeding.
The bottom line? We are advising our clients not to abandon plans for bond financings but to carefully consider their options in light of the current economic environment. As in the past, it is important that not-for-profits understand the opportunities and risks of entering into these types of financings and that their boards and management carefully consider both before proceeding. For those who choose not to go into the markets at this time, there still exist opportunities for private placement bond financings and other loan programs through which not-for-profits can take advantage of interest rates that are even lower than current market rates.
This article is intended to serve as a summary of the issues outlined herein. While it may include some general guidance, it is not intended as, nor is it a substitute for, legal advice. Your receipt of Good Company or any of its individual articles does not create an attorney-client relationship between you and Sheehan Phinney Bass + Green or the Sheehan Phinney Capitol Group. The opinions expressed in Good Company are those of the authors of the specific articles.
|
