Banks come to rescue of Philadelphia schools

The School District of Philadelphia is among thousands of government and nonprofit borrowers that have scrambled in recent weeks to escape from high interest rates caused by bond insurers' subprime-mortgage troubles.

So far this month, the turmoil in the municipal-bond market has cost the district $2 million more than it had budgeted to pay interest payments on $700 million in bonds, said Christina Ward, the school system's director of special finance.

But relief is in sight.

The School Reform Commission yesterday authorized Ward and other Philadelphia school finance officials to pursue their plan to convert the $700 million in so-called auction-rate bonds into a form of debt backed by banks that will guarantee repayment and buy the bonds if there is too little demand from investors.

The commission must give final approval before the new bonds can be sold in an estimated six to eight weeks.

Bank of America Corp. and Wachovia Corp. are leading a consortium of banks tentatively issuing letters of credit to back the $700 million in school district bonds in place of bond insurance.

Each of the two banks is offering a $200 million letter of credit that substitutes its own credit rating for the school district's, helping to reduce interest costs. Commerce Bancorp Inc. and PNC Financial Services Group are offering $100 million each, Ward said. Wachovia and Bank of America will syndicate the remaining $100 million to other banks.

"They have so many requests [for letters of credit]. We're very thankful that they were willing to extend it to us," said Ward, who has worked on every school district bond issue since 1982. "The market is crazier than I've ever seen it," she said.

Ward said she had anticipated trouble at the end of December or in early January, when rumblings began that insurers of tax-exempt municipal bonds would lose their top ratings because of their exposure to complicated securities backed by rapidly deteriorating subprime mortgages.

When the downgrades came, many buyers of auction-rate securities - such as institutional investors, wealthy individuals and corporate cash managers - stayed away.

The risk for borrowers in the auction-rate market is that they are borrowing in the short term to fund long-term obligations. That costs borrowers less as long as the market operates smoothly, but can be debilitating if it does not.

Three weeks ago, the day Ward made her first presentation to the SRC on the problem, the district had its first auction failure. That caused the interest rate to shoot from 4 percent to the maximum of 12 percent.

Since then, rates have settled down. Ward said the average for February had been about 6.5 percent. That is more reasonable than 12 percent, but "we're budgeted at 4.5 percent," she said.

The school district has plenty of company with the auction-rate problem, but few bond issuers have said what they plan to do about it.

The City of Philadelphia is considering options for its $198 million in auction-rate securities, including switching to fixed-rate debt, city Finance Director Rob Dubow said.

Rowan University's most likely option is to refinance its $34.7 million in auction-rate securities into fixed-rate bonds, said Joe Scully, associate vice president for finance.

Officials at the University of the Arts in Center City, with at least $8.5 million in auction-rate securities, and the University of the Sciences in Philadelphia, with at least $8.1 million in auction-rate securities, have not been willing to discuss their plans.

As the Philadelphia School District moved closer to a solution, the Pennsylvania Higher Education Assistance Agency said it would temporarily stop making loans from its own funds because of failures in the auction-rate bond market. It will continue to provide federal guarantees, origination and payment-collection services for loans by other lenders.