Monday, July 07, 2008

about those SEA bonds.....

Just to state this up front, this may be a non-issue. But even if it is just a possibility it's important enough that someone ought to ask the question: are the SEA arena bonds in trouble? Also, this is clearly something that has Municipal Finance 102 as a prerequisite, but it's worth going through.....

A brief bit of background is needed first. The Sports and Exhibition Authority (SEA) is a public authority that is responsible for the building of the two sports arenas in town, namely PNC park and Heinz Field as well as the Convention Center. The SEA should not be confused with the Stadium Authority which has neither a stadium these days to call its own, nor much authority, but that is another story for another post. They also are the folks who will be building the new arena for the Penguins. Last year they issued roughly $315 million dollars in bonds to pay for constructing the new arena. Recent news from last week is the first major contracts that go with that construction are being let by the SEA. The bonds to pay for this were floated last year, so the SEA has the money in the bank and have been making required bond payments since November. While they have planned in a certain amount of reserves to make these payments currently, the plan is that $7.5 million/year of the required payments are to come from the yet to be opened Majestic Star Casino. The viability of Don Barden and the Majestic Star to make those payments is its own issue these days and not the point here. What I am wondering is whether the bond payments are going to cost a lot more than planned for given a lot of changes in debt markets of late. Diving into the muck, there are an awful lot of dots to connect to this......

Last week I pointed out that bonds issued by the Sports and Exhibition Authority to pay for the new Arena in town are variable rate bonds. I have the entire bond prospectus scanned here. Variable rate bonds are not that out of the ordinary these days, but its worth noting that a lot issuers of variable rate bonds have run into a lot of trouble of late. Many issuers of these variable rate bonds suffer from what has been described as bidders remorse at this point. Locally the biggest story was about UPMC which actually lost money last quarter for the first time in a long time in part because they had to unwind some variable rate bonds that were quickly becoming money pits.

The reason variable rate bonds (think adjustable rate mortgage... except with a few more zeros) are problematic of late has a simple and complex aspect. The simpler problem is that among all the other bad economic stories going on is that some interest rates are going up. Thus if you borrowed a chunk of change at a variable rate, you are finding out that the payments you owe on that loan is going up. The more complex story of some serious market failures in some of the markets setting these interest rates is a story unto itself.

Is the SEA bond in the same boat as the UPMC loan? Not necessarily. You can buy all sorts of financial instruments to 'hedge' your risk. The bond prospectus (linked above) and quotes I dug up from the SEA Executive Director all lead you to think the SEA was planning to buy some swaps to hedge their risk here. I don't have enough info to know if they did that thoroughly or not. Risk hedging is a lot more art than science and the question is whether they did it well is not a foregone question. Lots of the economic miasma in the country really comes from the top experts coming up with risk hedges that were worse than useless (remember Long Term Capital Management? or any of the billion dollar rogue traders of late?).

Even if they hedged their risk, what risk were they planning for? I was more than willing to give the SEA the benefit of the doubt that is all a non-issue, but got worried again when I saw this headline last week first in some trade publications and then in the Dallas Morning News on Thursday. See: "Dallas Cowboys stadium bonds rise in cost for Arlington". The circumstances sound awfully familiar at the very least.

Turns out the Dallas bonds were in trouble for a different reason than UPMC. Those bonds were being hit by the fact that they were variable rate bonds, but also that they were insured by MBIA, a company that sells bond insurance... or did until very recently. MBIA has really flatlined of late and recently has seen its bond rating pulled by some of the bond rating agencies. If you are in the bond insurance business, all you are really selling is your bond rating so to not have a rating is to essentially be out of business. As a company MBIA's equally near-death competitor AMBAC saw its stock fall below a dollar a share last week and was delisted from the NY Stock exchange as a result. If that is all gobbledygood to you, the bottom line is that its all bad news for both companies and anyone doing business with them.

Update1: MBIA has sent me an email to clarify that: "Fitch withdrew its ratings on MBIA in response to our request, we continue to be rated by S&P (AA, CreditWatchNegative) and Moody's (A2, Negative Outlook)". OK?

Thus in Dallas, bonds insured by a near-defunct bond insurer resulted in their variable interest rates going up. They were being forced to pay a lot more in their bond payments than they planned. Thus like UPMC they went to great effort and expense to call and refinance the debt in question to get out from under the rising bond payments.

But does that apply to the SEA here. Still no. Not yet at least. The SEA bonds are not insured by MBIA, as in Dallas, nor by the other bond insurer having similar problems: AMBAC. You might say, good job SEA for now.

Anyone still reading? Here is the punch line.

The company that the SEA used to insure the bonds is called FSA and until recently it has not been talked about as being in the same miasmic condition of its competitors. The 'until recently' part comes into play when you read about financial analyst Bill Ackman's critique of FSA. He say FSA is next in line to suffer the fates of MBIA and AMBAC. Just a lone voice in the woods? The problem is that Ackman was the single wolf sounding the alarm about MBIA and AMBAC's shaky financial situation for years. So much the lone wolf that the companys attacked and sued instigated an investigation against (see update2 below) him for his analysis which was published in a report he himself put out "Is MBIA Triple A". So of all people, for Ackman to now be saying FSA is racing toward a wall, it gives you pause.

update2: an email from MBIA tells me that MBIA did not actually sue Bill Ackman. From news accounts, what they did was ask then NY Attorney General to launch an investigation at, and I quote, "at MBIA's request". That same news article describes the industry's response to Ackman's report as "Swift and brutal". I'm not sure it's worth arguing the semantics there but.....

So... even if the SEA fully hedged their variable interest risk in the bonds... something I wonder about but give the SEA the benefit of the doubt over.. the bigger wonder is if they hedged the risk to account for the potential that the bond insurer would run into trouble in the future. A swap that provided a hedge against general interest rate volatility in the municipal bond market probably does not provide much help for higher rates that would result from another failed bond insurer. The big question then is whether the SEA hedged against the risk of their bond insurer losing its credit rating? It's not the type of thing you normally plan for. If you thought your bond insurer would lose its credit rating in the near future, you would choose another bond insurer I hope. Until recently, failed bond insurance was considered a zero probability event.

Down the road is the SEA going to be in the same situation as Dallas and be forced to refinance its bonds? They would be in a tough spot to refinance what are essentially revenue backed bonds given that the revenue source (i.e. Don Barden and the Majestic Star) has its own problems these days.

Don't forget the first sentence. This might not be an issue. For a positive conclusion: if indeed this is not an issue it is because the bonds in question were fully hedged to account for these potential risks. If that is true than the SEA did a better job than a whole lot of other financial superstars did in similar circumstances. If so then I will be the first to say somebody at the SEA and their financial advisers deserve a big raise for not only saving the SEA a big chunk of change, but saving the region from an almost unquantifiable amount of heartburn if the bonds were to go south. Either way, its a big story I would say. Either there is a big problem completely under everyone's radar, or we have some of the best financial managers in the country right here that saved us from some big landmines going off in lots of other places.

So just to be clear, questions I think should be asked and answered on the public record are:

1) Are the SEA bonds for the arena construction auction rate bonds similar to what has been problematic for UPMC and other issuers in recent months?

2) Have changes in market interest rates impacted the payments made on SEA bonds?

3) Does the SEA expect the rating of FSA to go down in the future and

4) Are there potential impacts on interest rates and bond payments if the bond insurer FSA has its bond ratings downgraded at some point in the future.

While we are at it, I'll throw this in for good measure. I have no reason to believe anything improper, but given that the SEA is holding the bond proceeds... how have they invested the cash they are holding.

update3: While we are clarifying things. It's amazing how these things all connect to each other. I realize some may not know, but MBIA, the bond insurer that has taken the most interest in this blog post is also the company that once bought out most of the tax liens in the city of Pittsburgh causing innumerable problems until they were guilted into selling them back to the city for cents on the dollar last year. A long story I will append to a little later.


Postscript: while everything is connected one way or another, most of the above has little to do with the issues raised in the PG this morning about the fees and related costs to city related debt issuances in recent years. But if you want to look at a lot of the past , in addition to the SEA bond prospectus mentioned above, a lot of local debt documents are on my Pittsburgh Policy Document web page. It didn't occur t me until reading the PG story that some of the Water and Sewer Authority Debt is both variable rate and insured by FSA, which means the issues I mention above apply to them as well. See the PWSA's 2008 variable interest rate offering.


Happy Monday..


Blogger The Urbanophile said...

I'm too lazy to read your prospectus, but the situation sounds similar to what happened with arena bonds in Louisville, Kentucky. A special purpose authority has had a lot of trouble getting bonds issued. They had trouble finding an insurer, then were forced to take a variable rate. They have some sort of a hedging deal with Goldman that supposedly insulates them from extreme interest rate shifts.

This is the problem with these special purpose authorities. They don't have any sort of balance sheet or diversified revenue streams supporting their bonding. This means a lot of them are having trouble getting bonds issued. Pittsburgh could lend the authority its balance sheet and taxing authority by co-signing the loans, so to speak. This is often done to get lower rates for TIF bonds and the like. But my understanding is that Pittsburgh has its own credit woes.

Monday, July 07, 2008 9:03:00 PM  

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