After headlines earlier this year about Tennessee local governments suffering losses after getting involved in interest rate swaps for their municipal bonds (see New York Times on April 8 and April 10, the Associated Press on April 8, and the Memphis Commercial Appeal and Chattanooga Times-Free Press on April 10 ) people are talking about which other cities and counties are affected and “can it happen here?” The media have reported that Tennessee municipalities were “educated” about this form of derivatives by means of state-authorized gobbledygook that did not effectively inform them. Blame for the situation was directed at Morgan Keegan and its First Cumberland Securities subsidiary (municipal bond underwriters), and Bass, Berry and Sims (law firm acting as municipal bond counsel), which conducted the state’s education programs on municipal derivatives, advised local governments, and brokered the deals that got local governments involved with the derivatives market. News reports name Claiborne County and the municipalities of Lewisburg and Mt. Juliet as local governments that got hit with hefty bills when their derivatives involvement went sour.
City Council members have learned that Oak Ridge is exposed to the derivatives market, so “it can happen here,” but staff expresses confidence that we will be OK. Knox County and Blount County governments have made similar assurances.
The Daily Times of Maryville reported that the City of Oak Ridge was approved to issue $91 million in derivatives and the Oak Ridge Utility District (the natural gas utility) another $4 million. The City’s actual current exposure is less than that — a bit less than $26 million of City borrowing is covered by “interest rate swaps.”
As I now understand it (and I probably don’t understand everything correctly), with “interest rate swaps” the city issued bonds with a renegotiable variable rate (subject to the market), but also signed a deal with a bank to guarantee that the city would pay a predictable rate of interest for the entire term of the bonds. If the market rate of interest was higher than the range specified in the contract, the bank would pay the extra interest for us. Also, if the interest rate fell below the guaranteed rate range, the city would continue to pay the higher interest and the bank would pocket the difference between our payments and the amount currently due on the bonds.
An interest rate swap deal ensures predictability in loan payments as long as the bank is a solid financial partner that can hold up its side of the contract. Last year, however, chaos hit the financial system and a lot of banks no longer looked so solid. Although the City of Oak Ridge was still a good credit risk, our variable-rate bonds were “wrapped up” in the securities of the bank that had issued the interest-rate swaps, and that bank was suddenly no longer considered a good credit risk. As a result, it might have been difficult to get investors to buy the city’s bonds for the next variable-rate period. At the same time, if the city had tried to cancel the interest-rate swaps, we would have had to pay a big premium to buy them back — because the current low interest rates made them a valuable investment for the bank that holds them.
Oak Ridge has avoided crisis by finding another bank (in Belgium, of all places!) to provide a letter of credit (at a cost of 0.9% interest) to make our variable-rate bonds marketable again. Our good credit rating helped us escape the dilemmas that some Tennessee local governments faced when they discovered that their bonds were being treated as “junk,” even though the bond issuer was solvent. I feel like we “dodged a bullet” this time, but I see this is a lesson on why elected officials like me need to dig for information and try to fully understand whatever we are being asked to approve — and what we might be getting ourselves into.
What would have happened if the Mall Bonds or the Crestpointe Bonds were issued?
Oh, also what does this $26 Million in bonds cover?
The city’s total debt is over $100 million, including bonds for the high school, electric system improvements, water and wastewater projects, and various other capital projects. Bonds for the mall or Crestpointe would have added to the total debt.
Seems to me we are on very shaky ground when citizens allow a $47 Million High School, but $61 Million is spent. All city council members seem to be is the city manager’s cheerleaders, not the investigative and questioning people we elect them to be. No wonder voting here is a very low turnout, you cannot make a change by changing council members, unless we voted for the whole slate at one time.
Back to the money, out of the $100 Million, which I was just told it is closer to $200 Million than $100 Million, we were only able to move $26 Million of it. How did this city get so locked down with their finances, and why would anyone want to lock down payments and not interest? This is crazy that our interst rates are not locked by the payments are. Is all of this James O’Connor and Charles “Bones” Seiver’s financial dealings?
Oak Ridge voters authorized a sales tax increase for the ORHS project, the City Council authorized borrowing money for it (before I was on Council), and the city (not the school board) actually borrows the money. The actual project was the school system’s affair (school board and school administration).
I don’t understand all of your points about the debt, Ray, so I’ll respond with some more facts. The total city debt is over $150 million, including borrowing for utilities. Most of this is fixed-rate borrowing, except for (1) about $26 million that is covered by interest rate swaps and (2) a similar amount that is in other variable-rate instruments — mostly borrowing through the Tennessee Municipal Bond Fund that you allude to in your comment about Charles “Bones” Seivers. The conventional wisdom among Tennessee municipal governments is that borrowing through the bond fund costs less than other forms of borrowing, but the media have raised legitimate concerns about the way the fund is managed. Regardless of who does the lending to the city, I’d feel a lot better if the city got out of the business of variable-rate borrowing.
Thank you for working our city away from questionable financing. It just goes to say, if we cannot afford, we shouldn’t be selling off future residents to pay for it.