Philadelphia Bonds Benefit Others

Philadelphia Bonds Benefit Others

Proceeds Needed to Get City Out of Money-Losing Rate Swap

By ROMY VARGHESE

Philadelphia sold $391 million in water and waste-water revenue bonds, but the money won't expand or improve infrastructure. Instead, it will refinance floating-rate debt and pay Citigroup $48.6 million to unwind an interest-rate swap that turned against the city.

Philadelphia, the nation's sixth most-populous city, thus becomes the latest municipality to pay millions of dollars to extricate itself from a money-losing interest-rate swap with a Wall Street bank.

The payment to Citigroup will exceed savings from the refunding, say Moody's Investors Service and Standard & Poor's, although the city disputes that. In any case, ending the agreement will eliminate risks posed by the variable debt and swap.

"Better to take the hit and move on, than to stick with a strategy" that isn't working out, said Evan Rourke, portfolio manager at Eaton Vance. Mr. Rourke said more municipal-bond issuers should end agreements no longer in their favor.

There are many such municipalities across the country. They issued variable-rate debt to lower borrowing costs, then entered into contracts, or swaps, to shield themselves from any rise in rates. When interest rates unexpectedly fell in the financial slump, cities were on the hook to compensate swaps partners.

Hundreds of municipalities entered into swaps that are now working against them, including Los Angeles; Chicago; Denver; Kansas City, Mo., and Oakland, Calif., as well as the states of Massachusetts, New Jersey, New York and Oregon.

In Pennsylvania alone, 107 school districts and 86 local governments hold swaps tied to at least $14.9 billion in debt, Jack Wagner, the state's auditor general, said. Not all of those swaps are losing money, but Mr. Wagner still supports a bill to ban municipalities from using swaps.

Philadelphia benefited from its swap and variable-rate debt issue in 2003 until the end of 2007, said Joe Clare, deputy water commissioner. The city received $25 million up front. It paid a fixed rate of 4.52% to Citigroup, which paid the city a variable rate.

And variable debt overall saved two to three percentage points compared with fixed-rate debt, he said.

But as turmoil spread to the variable-rate market in 2008, investors shied away from these securities; rates shot up as high as 10%, compared with around 3% before the meltdown, Mr. Clare said. Meanwhile, under the terms of the agreement, Citigroup was able to pay the city a much lower amount based on a short-term interest rate.

As a result, Philadelphia paid $10 million more in debt service in fiscal year 2009 than officials had projected.

The deal on Thursday sold at a top yield of 4.15% for the bonds maturing in 2019, according to preliminary pricing details. Mr. Clare said the refinancing would save the city more than the cost of terminating the swap agreement, which he said was $48.6 million. S&P had estimated the termination payment to be $54.7 million.

A Citigroup spokesman declined to comment on the Philadelphia matter.