February was a bad month for Stephanie Doughty, the chief financial officer for Poudre Valley Health System, as interest rates on most of its $215 million in auction-rate bonds climbed steeply, adding as much as $140,000 to weekly interest costs. Posted on 03/09/2008 1:03:23 AM PST by TigerLikesRooster
Bond debt rates surge
The auction-rate bond market has collapsed, with Colorado hit hard.
By Aldo Svaldi and Jeffrey Leib
The Denver Post
Article Last Updated: 03/08/2008 03:54:45 PM MST
February was a bad month for Stephanie Doughty, the chief financial officer for Poudre Valley Health System, as interest rates on most of its $215 million in auction-rate bonds climbed steeply, adding as much as $140,000 to weekly interest costs.
On Monday, things are expected to get worse when $50 million of that debt goes to auction to face higher rates.
"It was just unbelievable, to see such a dramatic change in a debt vehicle that has been so sure for 20 years," Doughty said. "We said what can we do to remedy this as quickly as possible."
Poudre Valley, which operates hospitals in northern Colorado, is one of 14 Colorado institutions facing sharply higher interest rates because of the collapse of the auction-rate bond market.
The market's failure — there have been no buyers at hundreds of bond auctions — is fallout from the subprime mortgage crisis and huge losses posted by Wall Street investment banks.
"This is a 25-year-old market, worth $350 billion. Who would have thought," said Kirsten Volpi, chief financial officer at the Colorado School of Mines, which had $43 million in auction-rate bonds.
Denver International Airport, Children's Hospital, the CollegeInvest Student Loan program and the E-470 toll road are among the other institutions slammed by higher interest payments.
In all, $4 billion in bonds in Colorado are at risk and if the issuers do not get out of the failed market, they face paying an extra $103 million a year in interest compared with what they paid last fall, according to a Denver Post estimate.
The auction-rate bond market started failing on a large scale four weeks ago, forcing financial executives to scramble to convert or refund their debt.
The School of Mines already has refunded its auction-rate bonds, and DIA is moving out of about $750 million in similar debt.
"The whole industry is looking to convert out of auction-rate securities," said Leonard Dryer, chief financial officer for Children's Hospital. "No one believes the auction-rate market will settle itself back down."
Children's has $325 million in auction-rate bonds, sold in 2004 and 2006 to build its new campus in Aurora.
These institutions used auction- rate bonds for the same reason homeowners picked 1-year adjustable-rate mortgages instead of 30-year mortgages — short-term interest rates, while they can fluctuate, are usually lower.
"Financing long-term assets with short-term borrowing is at the heart of the problem," said Christopher Johns, manager of the Tax Free Fund of Colorado, which avoided the bonds.
For years, the market worked, saving issuers large amounts of interest as the price of the debt reset at auction every seven, 28 or 35 days.
Buyers came to consider the securities as safe as holding cash.
The Colorado institutions also bought bond default insurance, which gave the debt a triple-A rating.
The Wall Street investment banks, which arranged the marketing of the bonds, served as a buyer of last resort if no other investors bid in the auctions.
From 1984 to 2007, only 44 auctions failed, according to Bloomberg News.
But the subprime mortgage crisis, where high-risk mortgages were packaged and widely sold as securities, rocked even this once-stable market.
Bond insurers, such as MBIA Inc. and Ambac Financial Group, who guaranteed Colorado bonds, also branched into insuring mortgage securities.
As losses on mortgage securities mounted, the credit ratings of bond insurers came under pressure, raising doubts about the protection the insurers could really offer.
Investment banks supporting the auctions also ran into trouble because of their investments in mortgage- backed securities.
The world's largest banks have written off more than $181 billion in bad mortgage-related investments, leaving them less able financially to step in and support the auctions.
"Wall Street is not in a position to take that debt on their balance sheet," said Ken Harris, a co-manager of the Westcore Colorado Tax Exempt Fund.
Auction-rate bonds suddenly lost their luster and liquidity.
In February, thousands of bond auctions, including those of Colorado institutions, failed as no investors or banks bid on the bonds.
Such a "failed auction" triggers payment by the bond issuer of a maximum interest rate — often as high as 12 to 15 percent — to holders of the bonds.
Auction-rate municipal bonds now have higher yields than government treasuries — even though they are tax-exempt. This rarely happens.
"When you see short-term muni rates spike up because of the penalty rates, it carries through the rest of the market," Johns said.
Higher rates have brought out some buyers who see little risk of defaults on the bonds.
"We never participated in the auction-rate markets over the last 20 years," said Westcore's Harris. Now, his fund is loading up on auction-rate bonds.
New buyers helped bring down rates from maximum levels, but issuers aren't expecting interest rates to return to where they were last fall.
One of the hardest-hit issuers in Colorado is the E-470 toll road, which in June converted $422.1 million of fixed-rate debt to auction-rate bonds.
Interest rates on those bonds soared from an October low of 3.5 percent to a February high of 11.95 percent.
On Thursday, E-470 experienced its first failed auction, and the interest rate hit the 12 percent maximum.
The soaring rates mean the toll highway authority faces a $24.43 million increase in annual interest costs if it stays in the auction-rate market. It is looking at ways to exit the market.
"We never expected the market would go completely dysfunctional," said John McCuskey, E-470's finance chief.
E-470, he said, has reserves and a "rainy day" account to cover the short-term impact of sharply higher interest rates.
In Colorado Springs, Memorial Health System saw two failed bond auctions in mid-February drive rates from the 3 percent range to the maximum rate of 12 percent.
Memorial Health, which operates city hospitals, sold about $272 million in auction-rate bonds in 2002 and 2004 for hospital expansion.
More recently, the hospital's bond interest rates dropped to between 9 and 6.5 percent as some investors came back into the market.
Still, chief financial officer Gary Flansburg said, if the interest rate stays at 6.5 percent, Memorial Health will pay an extra $800,000 a month on its debt. At 10 percent, the extra monthly tab would be $1.6 million.
"We're working as diligently as we can to transfer these bonds to a different mode," he said.
Student aid provider CollegeInvest is Colorado's largest issuer, with $980.4 million of its $1.6 billion debt in auction-rate bonds.
The student-loan lender is paying $1.8 million more in interest each month than it did last summer, said spokeswoman Jennifer Robinson.
If sustained, those higher interest rates could ripple through to higher costs on some types of adjustable-rate student loans, something the student aid provider is trying to avoid, Robinson said.
Meanwhile, Poudre Valley Health System — which operates Poudre Valley Hospital in Fort Collins and the Medical Center of the Rockies in Loveland — awaits Monday's bond auction.
It issued $215 million in bonds in 2005 primarily to build the Loveland facility.
The bonds are rebid every 35 days and until recently were paying at auction an average of about 3.37 percent interest, said Poudre Valley's Doughty.
Then, on Feb. 19, with auctions failing all over the country, investors bid up the price on $82 million of the Poudre debt to 10.55 percent, suddenly loading the hospital system with an extra $140,000 in weekly interest.
The system so far has paid the the extra interest costs out of cash reserves and has not reduced staff or otherwise cut operations, Doughty said.
The hospital system, however, will restructure the debt. Going to fixed-rate bonds will probably add about $2 million in annual interest payments compared with $7 million if it stays with auction-rate bonds.
"Instead of paying investors the extra money," Doughty said, "we would rather have that cash available for capital equipment and other hospital needs."
A guy falls off a 100-story building.
He passes story 99. Us: "He's going to die." Permabulls: "He's still fine, he's only fallen one floor."
He passes story 90. Us: "He's going to die." Permabulls: "There are many instances of people who fell ten stories and lived."
He passes story 80. Us: "He's going to die." Permabulls: "Boo hoo! The sky is falling! We're all gonna be living in cardboard boxes!"
He passes story 70. Us: "He's going to die." Permabulls: "Got a link?...Uh huh, your 'link' demonstrates that you have been duped by the MSM."
He passes story 60. Us: "He's going to die." Permabulls: "You've been saying that for 40 stories and you haven't been right yet."
He passes story 50. Us: "He's going to die." Permabulls: "Very few people have ever fallen more than 50 stories, therefore he must be at the bottom."
He passes story 40. Us: "He's going to die." Permabulls: "But what about all those other guys on the roof, none of them have fallen. You're cherry-picking your data."
He passes story 30. Us: "He's going to die." Permabulls: "I see that you're being very careful not to mention that he has life insurance, so why the long face, Mister Gloom And Doom?"
He passes story 20. Us: "He's going to die." Permabulls: "Why do you think that the government's efforts to intervene against the force of gravity in the next 500 milliseconds will fail? You're actually pretty happy about this, aren't you?
He passes story 10. Us: "He's going to die." Permabulls: "There are plenty of his parts that will still be triple-A rated, even IF what you claim will happen, happens."
He lands. Us: "He's dead." Permabulls: "You can't say he's dead until we see a death certificate saying he's been dead for the previous two quarters."
Two quarters pass. Us: "Ok, he's been dead for two quarters." Permabulls: "Even a stopped clock is right once in a while."
Von Mises is really unappreciated isn’t he? I’ve read and purchased several of his books and thankfully some are available online.
LOL!! LOL!! LOL!!! and that, my FRiend is exactly what people have bought in to.....the people that make the killing in the markets never ever really make decisions based on ‘government’ defined stats. or th definitions of Liberalville professors that have never had a real job other than the socialization of our youth.
Ummm, I hope you like government cheese, powdered milk & eggs. You’ll have a nice side dish of enriched pasta with, rationed by the U.S. government. In 2008 you will see this quarter and next in deep recession. Stimulus will ehlp in the second two quarters with GDP slightly positive. By Q3 of 2009, expect to see multiple banks going bust. Wall Street will collapse along with many, many small businesses and dozens of larger businesses. Oil will be at $120 a barrel in 2008 and then decline in 2009, but the damage/fleecing of our financial & energy system by the greedy elites and speculators on the middle class will create a 12%+unemployment rate depression. This will likely last through 2010 and then a long-term recovery shall ensue.
Good summary.
Very funny in a wish it wasn’t so true way.
Anyone expect the Feds to put a cap on interest rates sometime soon? BTW, who was president in the 1990s?
Simple fact of economics: the more government gets involved to “fix” a problem, the worse the problem becomes and the longer it will take to correct itself.
If the government allows the market to fully correct itself, this could be over in less than a year.
Builders are already dropping the construction of new homes, and so the available supply of homes is falling. The demand for new homes is also falling, so there is still a surplus, but the net number of new homes built is falling dramatically.
The loan system failed because of the inaccurate ratings of the loans that were packaged into securities. When buyers buy the packages of loans, they are relying upon a bond agency’s rating for the risk level. When the risk ratings are not reliable, as we have found them to be, no one will purchase the loans.
We do not have a lack of money out there to buy the loans, but people won’t buy the loans if they don’t know the risk. This is why the auction-rate security rates are jumping up. If you can’t price the risk, you assume the worst and demand high rates of return.
The government’s only appropriate role in this is to, through the SEC, demand accuracy in the rating agencies. Other than that, get out of the way.
Markets work every time. It may be painful to go through, but it will correct itself.
Want to see things get really bad? Allow Fannie Mae and Freddie Mac to buy out the jumbo loans. Bail out individuals who bought stupid loans they couldn’t afford. It might take a decade or more to dig out of things if the government really sticks its nose in there.
You left of the important one, which has not been operative since Alan Greenspan sped up the government printing press:
The availability of money
With the collapse of credit due to intertwined cascading defaults, no one has the money to finance these things.
A second question for everyone. 1 in 7 dollars in the US economy goes to health care. With that much money sloshing around, the health care system should be able to finance its own expansion needs. That it cannot is a symptom of how broken the financial system is.
No, not all markets correct that quickly. It took well over a decade to work out the problems from 1929 and the financial excesses in the run-up.
Municipal bond prices are falling. Might be some buying opportunities.
bump
"The nine most terrifying words in the English language are: 'I'm from the government and I'm here to help.'"
When the Congress starts to meddle, they will only make things worse. They have done it before; they will attempt to do it again.
Insert Dennis Kneale for “permabull.” Or any one of a number of people on CNBC or Fox who keep claiming that this thing is still “contained” and “not so serious.”
What a bunch of tools these people are.
Here’s the simple truth of the matter folks: go read a DETAILED history of what led us into the Great Depression.
Most people think it was the market crash of ‘29. Most people are wrong. Most people don’t know what really happened to the US financial system from ‘28 to ‘33, because, well, most people didn’t understand it then, and the press mis-reported it.
Go look in DETAIL at what happened to the US banking system from 1930 to 1932. To do so, you’ll have to read some esoteric papers by economists, finance types, the Fed, et al. Long story short: what you see happening today happened back then - with a vengence, and a Fed that was mostly clueless because they were new at it (and they were constrained by a gold-backed currency). The banking system seized up by ‘32, and banks simply refused to lend.
That’s what led us downhill into the Depression, which was a deflationary spiral. Once a deflation really gets going, the central banks are powerless to stop it.
NB which way mortgage rates are going: they’re going up. Which way is the Fed taking interest rates? Down.
The Fed is pushing on a string. This is why they’re flinging $100 billion into the banking system this month through the TAF. The funds/discount rate agenda isn’t working.
And the Permabulls keep spreading rumors about Ambac getting a bailout. Three times they’ve spread this rumor. Three times they’ve been full of crap. Now the market is done with the idea of bailouts and white knights.
Now things are going to start getting really interesting.
Exactly. I had a conference call with my local bank and underwriter back in early July. The underwriter told me of the Central Bank’s ‘solvency crisis’ then. When I tried to warn friends and colleagues, they all scoffed at me. Now the economy will collapse and people can’t believe this is happening.
We laugh because it’s funny and we laugh because it’s true.
however,there must be some way for we simple peasants to take advantage of this.....anyone know how?....munnicipal bonds?...
Good, factual analysis and you’re right, let the free market correct itself. But that is NOT what is occuring. The Fed is bailing out the Central Banks (or trying to) but the banks are just sitting on their cash reserves to clean up their balance sheets and not lending to even credit-worth consumers. I know I am one of them but the bank won’t help increase my line of credit to expand the business until I have plenty of cash reserves (then of course I won’t need them).
Investors are cramming their dollars into commodities, the only safe investment these days, but the side effect is hyper-inflation of food and energy, further eroding consumer confidence and the middle class.
The U.S. economy is a service driven economy, 80% of it now in fact. I have owned businesses so let me ask you, what happens to middle men in a recession? Now think globally. The world is shedding their middle men, that’s US!!!
Any government assistance to the free market should all be poured into education, job creation and energy independance. But who and where does the Fed and Gov bail out? The vastly irresponsible portions of our country. In 4-5 years the broke middle class will vote in new, accountable leadership and if they can’t, I wouldn’t be a bit surprised to see a revolution with 2-3 million people overruning the White House and overthrowing the government.
Great point. Congress passed laws forcing lenders to loan to the lazy, mentally ill or incompetent. The lenders and Wall Street also took advantage of the lack of oversight (reminds me of S&L scandal). Shipping manufacturing overseas had a great net effect for larger corporations, but in the end it causes wage stagnation over the long haul and we’re seeing the pain in the middle class, that is competing hard and failing to obtain skilled jobs. The war in Iraq has created massive government spending and whoever is the next POTUS won’t have much of a choice of global drawdowns on overseas troop deployments, meaning you’ll likely see global military misadventure in the next few years. I hate being such a pessamist but I knew the party was over several months ago and prepared as best I could.
They'll be stopped by the "special status" immigrants from Mexico, imported by the elites to keep their own enclaves going, in the event of monetary collapse.
Besides, the problem is Congress, and more specifically, the Senate.
What useful thing has *any* U.S. Senator currently in office done with any part of their lives? (...and I explicitly include John McCain on that list.)
Cheers!
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