Thursday, February 21, 2008

Nonprofits Face Staggering Interest Costs as Bond Insurers Balk

Today's Boston Globe reports that universities and other institutions are currently grappling with an unexpected problem: bond insurers who will not let them off the hook.  The Globe article specifically mentions Bentley College in Waltham, MA, where treasurer  Paul Clemente expects he will soon have to pay $500,000 to refinance a debt with soaring interest costs.  If his bond insurer would let him convert from an auction-rate bond to a different type of variable-rate bond, his cost would drop to around $50,000.  Alas, Clemente reports, the bond insurer has stopped returning his calls.

Other institutions identified by the Globe as having similar problems are Worcester Polytechnic Institute (in Worcester, MA) and Bentley University located in Smithfield, RI.  According to the Globe, like Bentley College, these two institutions would like to convert their auction-rate bonds into variable rate bonds.  This, though, is easier said than done.

This situation has resulted from the spread of the problems with subprime mortgages to nonprofit institutions such as hospitals and universities whose bonds were previously considered to be safe, conservative investments.  Many of these institutions paid millions of dollars to bond insurers to make their bonds more appealing to investors.

Since last month, however, the largest insurers have been downgraded or put under review by major credit rating agencies because of the subprime holdings in their portfolios. This in turn has caused many borrowers to stop bidding on auction-rate bonds (i.e., bonds whose interest rates are set in periodic auctions).  When no one bids on these bonds, their interest rates reset at levels specified in contract documents, sometimes to as high as 20 percent!  This requires the institutions to pay much more in interest costs than they had originally expected to.  The Globe reports, for example, that Bentley College had to pay 7.8 percent interest last week on bonds that paid around 3.5 percent in November, adding an extra $60,000 a week to the college's interest costs.

It appears that a solution will eventually be found to the current crisis.  According to the Globe article:

Yesterday, Massachusetts Secretary of State William F. Galvin launched an investigation into auction-rate bonds, asking several mutual-fund firms that hold these bonds for information. "The failures in these auctions cause many and diverse problems," Galvin said, and the impact "can be daunting for the investor who has sought a safe and dependable harbor for life savings."

Meanwhile, some of the bond insurers are reporting that they are working with their clients to find satisfactory solutions.

VEJ

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