Commissioners approve debt restructure

Jan. 09, 2013 @ 06:27 PM

The Union County Board of Commissioners unanimously approved the county finance director's request to restructure some of its debt.
County Finance Director Jeff Yates proposed the county refund its bonds to move it from riskier debt formats to a fixed-rate structure to stabilize payments and take advantage of current low interest rates. It is a transition that several other governments have made, Yates said. Even the N.C. Local Government Commission encouraged the move.
About $94 million in county debt is in a structure called an interest rate swap, Yates said. Such agreements were common when the county first sold the bonds. To protect the county from the market's volatility, it partnered with a bank in a debt format where the county paid a flat rate. The bank paid if there was a remaining balance between the market interest rate and the county's flat rate. When interest rates were high, the county was spared high payments. When rates fell, the bank kept the money that was that month's overpayment.
"Just as with a home mortgage, as the rate climbs, the payments climb with it," Yates said.
While it was a good option for the county at the time, it was not without strings, he said.
"In our case, the rates have dropped below 3 percent, so we're having to pay the bank to get out of that," he said.
Agreements with banks are short term and must be renegotiated every few years. The county is responsible for interest payments in the meantime, no matter how high the interest rates soar. For the last few years, fewer banks are participating in the swap agreements, meaning there is less competition for counter-parties and the bank can set rates that are beneficial to them. The bank can even choose not to renew the swap agreement with the county, causing the county to pay a large termination fee. And there are more risks developing as the federal government continues to deal with the fiscal cliff.
"The swaps that the county has in place right now, which is six of the nine we're looking at, have benefitted the county. We've saved right around $2.2 million over the life of those swaps," Yates said.
But the swap agreement has also caused large, unexpected payments. When the market fell in 2008, interest rates spiked and Union County scrambled to make a $2 million payment. That required the layoff of 88 employees.
"When we're talking about variable interest rates and the risks, this is a clear risk," Yates said. And because the market is becoming more unpredictable, spikes like those could happen again.
So, to make the county's debt payments less risky and more predictable, Yates suggested the county trade its variable and swap interest rates for fixed rates. To end the swap agreement, the county has to make a cash payment to the bank for the money it would have collected over the remaining life of the debt.
That cash payment will be about $21 million, and comes from the money Union County received last year when it renewed the hospital lease with Carolinas Healthcare Systems. The county can slowly repay itself most of the amount with the annual $1 million savings it will see from changing its debt structure.
"The total cost over the life of the bonds will be about $4 million," Yates said.
Normally, Yates said he would not recommend the county take a $4 million loss on changing its debt structure, but the risks of variable interest rates is growing. No one can predict how the market will change in the future, but if the market falls again, the county might pay more than $4 million in the long run if it stays with the swap agreement.
Yates added that the county will monitor the market and choose to terminate the current agreement only if and when the conditions are right.
The commission does not want to take on more debt, but Commissioner Todd Johnson broached the subject of needing to borrow for a jail or other major project.  
"By removing these swaps and going to more stable interest rates, does that make bond rating agencies look more favorably on us?" Johnson asked.
Agencies would see the change as a proactive step toward eliminating risk, Yates said.
"It demonstrates that you are paying attention to (the debt portfolio), that it is an issue, it's an ongoing issue that's constantly in front of you that you're trying to resolve and make better," Yates said. "And I think the bond market and the rating agencies would recognize that ."
Commissioner Frank Aikmus asked if the county would benefit more by paying down the debt with cash.
"Instead of paying to refinance all of these, why not pay off some of that debt and refinance what's left?" Aikmus said.
Chris Alexander with First Tryon Securities said the county faces a liquidity risk associated with outstanding variable debt. Over the years, banks consolidated into larger banks, some banks fell in underlying rating and fewer banks offered services to local governments.
"Whenever you decrease the amount of supply in the marketplace and the demand is at the same level, you're going to see a rapid increase in the cost of liquidity," Alexander said. And that liquidity cost will continue to rise in the future.
All that aside, the county's debts are too complicated to just pay down, Alexander said. There are agreements in place with the banks and companies that hold that debt.
"Now if the county wanted to, you could go out and pay down $15 million in change of variable rate debt. That is the county's opportunity. The problem currently is with all the costs associated with the swap," Alexander said.
In short, the county would spend more money by paying a large sum now, compared to the extra annual savings possible through bond refunding. And if the the county stayed in a swap agreement, the risk for an unexpected interest rate spike would remain.