Brown Echoes Harvard as Ivy League University Seeks Swap Exit: Muni Credit
One of eight elite Ivy League schools, Brown is joining an exodus from the municipal swaps market sparked by the credit crisis. States, cities and nonprofit organizations across the U.S. have spent more than $4 billion ending the agreements since 2008, paying exit fees to Wall Street banks that sold the derivatives as a way to lower interest costs on long-term debt.
“The basic assumptions were wrong,” said Andrew Kalotay, a debt-management adviser based in New York. “Under ideal circumstance they could have worked out, but what are the chances when you have a 30-year deal that everything would go exactly as predicted?”
Brown, whose trustees include alumnus Brian T. Moynihan, Bank of America Corp. (BAC)’s chief executive officer, began unwinding its deal with Goldman Sachs this week. It sold $70.6 million of bonds, refinancing debt from 2001 that was used for construction and renovation projects on its Providence, Rhode Island, campus. The refinancing includes converting $53.7 million of swap-linked variable-rate debt to a conventional fixed-rate security.
The cost to exit the swap contract, which changes with short-term benchmark lending rates, was about $5.1 million on June 30, according to a report from Moody’s Investors Service. The university hasn’t determined yet when it will pay the penalty, said Elizabeth Huidekoper, Brown’s executive vice president for finance and administration.
Bank of America
Bank of America led banks handling the sale. Michael DuVally, a spokesman for Goldman Sachs, declined to comment.
Ruth Simmons, Brown’s president since 2001, resigned from the Goldman Sachs board in February 2010 after 10 years. Calls seeking comment from her spokeswoman, Marisa Quinn, weren’t returned.
Brown, like other borrowers, is finding that swaps no longer produce savings. The university sold the variable-rate bonds in 2001 and has been exchanging payments with New York- based Goldman Sachs since 2006, leaving it with a fixed annual interest rate of about 3.9 percent, according to the offering document. Rating companies now require the school to keep more cash on hand to back variable-rate debt, Huidekoper said.
“There’s such a premium now put on having liquidity by the rating agencies that you have to have a pretty big portfolio to make it worth it,” said Huidekoper, the former vice president for finance at Harvard University in Cambridge, Massachusetts. “Over the long term, we want to be more invested and not be required to keep so much cash on hand,” she said.
Brown guarantees its own variable-rate debt against the possibility of market failure. Most in the municipal market pay banks to be buyers of last resort. Banks have lifted their so- called liquidity fees since the collapse of credit markets in 2008, which has also undermined savings from swaps.
California’s Water Resources Department paid more than $305 million to New York-based Morgan Stanley (MS) and other firms last year to terminate derivatives linked to $3.7 billion of its debt instead of paying the higher fees for liquidity.
Harvard, the world’s wealthiest school, paid $497.6 million in December 2008 to end $1.1 billion of swaps with JPMorgan Chase & Co. (JPM) and Goldman Sachs, and separately arranged to end another $764 million of the agreements at a cost of $425 million. Harvard is the oldest member of the Ivy League, a group of universities in the U.S. Northeast.
Brown, which charges about $53,000 a year for tuition, room and board, sold bonds on Aug. 10 through the Rhode Island Health and Educational Building Corp., paying a top yield of almost 3.8 percent on securities maturing in September 2032. The sale occurred as the yield on top-rated 20-year tax-exempt securities reached 3.5 percent yesterday, the lowest since November.
“You really have to do your work on all the universities because there are such differences between them,” said John Bonnell, who helps oversee $3.75 billion as a fund manager in San Antonio at USAA Investment Management Co. “We like to see ones that are dominant market players, with very strong student demand.”
The university, rated Aa1 by Moody’s and AA+ by Standard & Poor’s, one step below the top ranking for both, admitted 9 percent of applicants in 2010. Its endowment was $2.2 billion as of June 30, 2010, the smallest in the Ivy League and 27th largest in North America, according to the National Association of College and University Business Officers.
The university expects a double-digit return for the fiscal year that ended June 30, after a 10.2 percent gain the year before, according to the bond-offering document.
Brown, which has about $615 million of debt, has two more swap agreements outstanding, one with Goldman Sachs that has a notional value of $85.5 million and another with JPMorgan on $44 million in debt, according to its most-recent financial statement. It said in June 2010 that unwinding the larger deal would cost about $9.6 million, while the smaller would take $9.9 million.
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