The crisis in the world’s financial markets is being felt by local Colorado governments that borrowed money for projects by using variable- interest-rate financial instruments.
Like homeowners stuck with a floating-rate mortgage, chief financial officers are closely watching interest rates and making contingency plans to keep up with increasing debt payments.
In the past five weeks, Aurora has seen the interest rate it pays on variable-rate bonds increase to 6.5 percent, from a low of about 2 percent earlier this year. Last week, it was reset by the market at 3 percent.
Mike Shannon, finance and debt administrator for Aurora, said the city has paid about $100,000 extra since September because of the fluctuating market. In one week alone, the fluctuations cost Aurora $55,000, he said.
“It’s not a lot, but we don’t like it,” Shannon said. “We’re watching the market very closely, given the volatility.”
About 8 percent of the city’s $800 million debt is in variable-rate bonds, he said.
Denver Public Schools officials expect to deplete a $3 million reserve fund set up for financial contingencies after the district refinanced its pension debt earlier this year.
The lack of liquidity in the credit market is to blame, said Tom Boasberg, DPS chief operating officer.
“The nature of this credit crunch is worse than we expected,” Boasberg said. “There was a $3 million reserve that came out of the money that we borrowed. I expect we will tap that full reserve and potentially go a little bit more.”
The district in April sold $750 million in short-term notes — money that helped DPS fully fund its pension plan.
Specifically, the district paid off a $400 million pension shortfall and refinanced about $300 million of debt at a lower interest rate.
The district said the transaction would generate more than $20 million for schools and classrooms. Over the 30-year life of the transaction, DPS’s pension debt, as a percentage of its budget, will decline to about two-thirds of what it was.
However, the district chose a variable rate — which Boasberg said in the long run will be a better deal for the district.
“A fixed-rate bond would have cost us an additional $10 million more a year for 30 years,” he said.
Those same calculations are being made in government offices across the state and nation.
Most local governments choose to finance at least part of their debt with variable-rate bonds. When rates are favorable, they can save taxpayers millions.
But they hold some risk too. If the pool of buyers for the bonds dries up, the interest rates reset higher, and governments must pay additional interest, usually from a reserve set aside for the contingency.
The current credit crisis came on with such speed and ferocity that government financial officers and investment bankers were taken by surprise. In the space of two weeks, the Municipal Swap Index — an average interest rate paid by governments with solid credit on variable-rate bonds — shot from 1.79 percent on Sept. 10 to 7.96 percent on Sept. 24. It has since settled closer to its 52-week average of 2.65 percent, though still slightly above.
But while the settling of the rate has given CFOs hope, the volatility of the market still leaves them limited options, even if they wanted to convert the variable-rate bonds to potentially more expensive but reliable fixed rates.
The E-470 Public Highway Authority has seen its rate nearly double in recent weeks. Its bonds were carrying an interest rate of about 3 percent to 4 percent, said finance director John McCuskey. Last week, the rate was reset to 7.8 percent, he said.
“We could be doing better,” McCuskey said. “It bounces around, as high as 9 and as low as 7. It varies week to week.”
He said one option is to convert all the variable-rate bonds to fixed rates, but even those would be a hard sell to investors in these economic times.
Tom Hemmings, chief financial officer for the Colorado Housing and Finance Authority, said $2.7 billion of the authority’s $3.5 billion debt is in variable-rate bonds. He estimates the authority has had to pay less than $1 million extra so far because of the rise in the variable rate.
