Collapse of auction-rate bond market affects some school districts
California, Florida schools, and the owner of John F. Kennedy International Airport joined a growing list of municipal borrowers exiting the U.S. auction-rate bond market as record failures push taxpayer costs higher. Thousands of auctions run by banks to set rates on the debt failed this month as investors shunned the securities and bankers refused to submit bids, sending interest costs to 10 percent or higher on some bonds. Florida's Palm Beach County Schools converted $116 million of the securities into fixed-rate debt this week. Rates in the more than $300 billion auction market, where local governments, hospitals, museums, student-loan agencies and closed-end mutual funds borrow, are determined through a bidding process every seven, 28 or 35 days. Auctions fail when there aren't enough buyers. That's left bondholders who wanted to sell stuck with the securities and taxpayers or other backers of the debt such as fund holders with higher interest costs. About two-thirds of auctions have failed per day since Feb. 15, according to data compiled by Bank of America and Bloomberg. Borrowers must pay the penalty rates until buyers support future auctions or they can modify the bonds to another kind of variable-rate debt or apply a fixed rate. Palm Beach school officials started working on a conversion plan in December when rates exceeded 4 percent. They reached 9.75 percent this week, short of the 15 percent penalty rate. The district's interest payment for this week's auction was about $220,000, up from $107,000 in December. “As a public entity, that's an unacceptable level of risk for us,'” said Leanne Evans, treasurer of the 170,000-student district, one of the five largest school systems in Florida. After converting the debt, the district will pay 4 percent through a mandatory buyback in 2011, compared with 2.63 percent for top-rated three-year fixed-rate bonds. The bonds still carry insurance from downgraded insurer FGIC Corp.
Source: Bloomberg.com, 2/22/08, By Jeremy R. Cooke
[Editor’s Note: A more recent article at the first link below reports that “[a]uction-rate bond failures show no sign of abating.” The second story below reports that another Florida school district managed to escape the collapse of the market.]
Financial Week, 3/5/08, By Bloomberg
Southwest Florida News-Press, 2/28/08