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New York Pays $247 Million to Exit Swaps as Benefits Dwindle

New York Governor David Paterson
New York Governor David Paterson Photographer: Ramin Talaie/Bloomberg

New York has paid $247 million to firms such as Goldman Sachs Group and Citigroup Inc. to exit $3.35 billion of interest-rate swaps, according to a report by the state Division of the Budget.

Savings on the swaps have dropped 82 percent in two years to $37 million, the division said. The payments, almost equal to the savings Governor David Paterson sought from state employees before announcing plans to dismiss 898 workers before year-end, were paid mostly from proceeds of new fixed-rate bond sales, so no specific appropriation was required by lawmakers.

The state’s analysis holds that the $247 million paid to terminate swaps cost the state $66 million instead because it sold new fixed-rate bonds in the past two years at lower rates than the 4.59 percent fixed yield it would have had to pay in 2002-2005, when instead it sold floating-rate bonds with swaps attached.

“A performance analysis should be comparing the costs of their swaps and related floating-rate bonds, with their floating-rate assets,” not with the cost of fixed-rate borrowing, said Robert Brooks, professor of finance at the University of Alabama in Tuscaloosa. “That’s what the banks have been doing for decades.”

By using swaps to convert the floating rate debt to a fixed rate New York and other local governments have incurred high costs and bank fees “and are burning through millions every month while they are getting virtually zero on their floating rate assets,” such as cash, Brooks said.

Swaps Performance

The budget division’s analysis said the state had savings of $103 million, down from $207 million in a 2008 swaps performance report. The savings in both reports were mostly from the difference between the assumed cost of fixed-rate bonds at the time it arranged the swaps, and the cost of the variable-rate bonds, including bank fees. At the end of March, the state had $3.37 billion of swaps remaining from a peak of more than $6 billion in 2008, before the collapse of credit markets.

Under the state’s fixed-rate swap agreements, it receives a floating rate equal to 65 percent of the one-month rate for bank deposits in the London wholesale market, known as Libor, and pays fixed rates that average 3.34 percent. The floating rates the state received on the swaps and what it paid on variable bonds “are expected to be roughly the same,” the report said, leaving the state paying the fixed swap rate.

Variable-Rate Bonds

The cost of variable rate bonds, beyond the yields paid investors, has increased because of higher fees paid to banks for acting as a buyer of last resort of the debt. The cost of the bank agreements averaged 0.62 percentage points as of June 30, up from a 0.29 percentage point average in the 2002-2008 period, according to the Division of the Budget. About $299.6 million of bank agreements costing 0.43 percentage point are scheduled to expire in July, 2011.

Public Resources Advisory Group, a consultant to the state on its borrowing, helped prepare the savings analysis, according to the report. Officials at the company weren’t immediately available for comment.

Since March 31, the end of the year covered by the report, the state received payments of $43 million in September from liquidating variable-rate swaps, according to the updated budget published Nov. 1. In May it paid $47.6 million to exit fixed-rate swaps, associated with bonds issued by the Empire State Development Corporation, according to Budget spokesman Erik Kriss.

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