By William Selway and Martin Z. Braun
July 3 (Bloomberg) -- MBIA Inc. and Ambac Financial Group Inc. lost their AAA credit ratings. The biggest hospital in Sarasota, Florida, is paying the price.
David Verinder, chief financial officer of the Sarasota Memorial Health Care System, received daily e-mail messages last month informing him that interest costs on an $83 million bond issue were rising to 1.45 percent, to 1.75 percent, to 3.25 percent, to 5.9 percent, and finally to 9 percent by June 24, a more than fivefold increase.
``When rates started going up as quickly as they were, it certainly caused a great deal of stress,'' Verinder said.
The daily increases by Wachovia Corp. had nothing to do with the financial health of Sarasota Memorial. Hospitals, airports, school districts and local governments around the country have been socked with spiraling interest bills on many of the $80 billion of insured variable-rate bonds. When units of MBIA and Ambac, the two largest bond insurers, lost the top ratings from Standard & Poor's and Moody's Investors Service last month, the institutions they insured did too.
The downgrades are the latest blow to the $2.66 trillion municipal bond market, which is on track to have its worst yearly performance since 1999, according to Merrill Lynch & Co.'s Municipal Master Index. The index fell 0.08 percent in the first half of 2008, taking reinvested income into account.
In March, the Sarasota health network had tried to escape high rates by converting the bonds from auction-rate securities. The February collapse of the $330 billion market where rates are determined through periodic bidding drove interest costs as high as 11 percent.
Band-Aid
``We really believed we would be able to put this band-aid on it,'' said Verinder, who is now grappling with $32,000 a day in unexpected costs that may force him to delay spending on new CT scanners and magnetic resonance imaging machines.
Losses suffered by bond insurers on securities tied to U.S. home loans have cascaded through financial markets to hurt local governments whose budgets are already being squeezed by the slowest pace of economic growth in five years.
``Why are you punished for having insurance, even if the insurance is no good?'' said Randall Walker, the director of Nevada's Clark County Department of Aviation, which oversees McCarran International Airport in Las Vegas. ``It doesn't make much sense, but that's the market.''
Threefold Rise
The rate on $240 million of the airport's bonds jumped to 9 percent on June 25, more than three times the 2.5 percent rate on June 4, threatening to saddle McCarran with $12 million in additional annual costs.
The higher rates on debt with downgraded insurance contrast with the 1.63 percent average on uninsured debt with AAA ratings, according to a Bloomberg index as of June 26.
The crisis is similar to the one that erupted in February, when Financial Guaranty Insurance Co. and XL Capital Assurance Inc. lost their AAA ratings. That prompted investors to shun the auction-rate securities they backed and Wall Street dealers to abandon support of the market. Thousands of auctions failed, resulting in penalty rates as high as 20 percent and leaving holders unable to get out of their investments.
Now, as then, the soaring interest burden isn't related to any increased default risk on the part of towns and schools, which have the power to raise taxes to meet debt payments. Instead, it stems from concern among investors that the tumbling credit ratings of the bond insurers will trigger clauses that allow the banks that act as buyers of last resort to walk away.
June Rating Cuts
Bond-insurance units of Armonk, New York-based MBIA and New York-based Ambac had their financial strength ratings cut to AA from AAA on June 5 by S&P. Moody's followed two weeks later, dropping MBIA to A2 and Ambac to Aa3.
In the first quarter, Wall Street brokers were already deluged with unwanted bonds, which boosted their holdings of municipal debt 32 percent to a record $66 billion, according to data compiled by the Federal Reserve.
Without assurance that the bonds can be turned into cash easily, the banks that set the rates on the bonds and find buyers need to turn to mutual funds and other long-term investors, who demand higher returns.
``Everybody's got to be a little leery if they get into these,'' said Robert Millikan, who manages $5 billion as director of fixed income at BB&T Asset Management in Raleigh, North Carolina.
Rates on $10 million of bonds sold by the Daniel Boone Area School District in Birdsboro, Pennsylvania, a 5,200-person town 50 miles (80 kilometers) northwest of Philadelphia, reached 9 percent on June 24, up fourfold from the start of the month and enough to add $608,000 to the district's annual bills.
`Budget Buster'
``That would be a budget buster for sure,'' said Robert Bruchak, the business manager for the school district, which has an annual budget of $47 million. ``We have to implement a game plan here.''
The district is being penalized because Ambac hasn't kept up its responsibility to maintain the credit rating backing the bonds, Bruchak said.
``We're not getting what we paid for anymore, bottom line,'' he said. ``We paid to have a very good rating and a very low interest rate, and we've lost that.''
The interest rate on $44 million of bonds for the San Francisco Ballet more than doubled to 12 percent last month as Financial Guaranty Insurance, which insured the debt, was cut below investment grade. In San Francisco, the Asian Art Museum's rate on $120 million of bonds jumped as high as 9 percent from 1.75 percent at the start of June before sliding back to 7.75 percent.
Borrowers' Rush
Just as the auction-rate breakdown caused borrowers to make plans to replace or change terms on at least $87 billion of the securities, schools and towns now are rushing to find banks to agree to act as buyers of last resort for floating-rate bonds. Fees for bank letters of credit have quadrupled to as much as 1 percentage point.
``It's the fire in the discotheque,'' said Peter Demirali, a vice president at Vineland, New Jersey-based Cumberland Advisors Inc., which has $1 billion of assets under management. ``Everyone can't get out all at the same time.''
The Las Vegas airport plans to line up a new letter of credit for its bonds, betting it will drive the rate back down, Walker said. If that fails, he'll refinance them into new variable-rate bonds without insurance, as he had to do with five separate bond issues battered by the other insurer downgrades earlier this year.
The Sarasota Memorial Health Care System is taking steps to push rates lower by working with its bank, Wachovia, over the next few months, said Verinder, the CFO.
``We certainly have our challenges,'' he said.
To contact the reporters on this story: Martin Z. Braun in New York atmbraun6@bloomberg.net, or William Selway in San Francisco atwselway@bloomberg.net.
