Modesto bond interest rate jumps; restructure options given

The nationwide lending crisis driving some Modesto homeowners into foreclosure hit City Hall this month.

The interest rate Modesto pays on $46.3 million in municipal bonds shot to 8 percent from 3.5 percent, costing the city an extra $107,000 a month, according to the city's financial consultant.

Modesto is moving to restructure the bonds within the next two months. It issued the bonds in late 2006 to finance water system improvements.

Modesto is one of many cities that financed bonds through rates determined by weekly bank auctions. They offered a better rate than traditional, fixed-rate bonds, and were backed by insurers with pristine reputations.

Doubts about the lenders who insured the bonds are keeping buyers away from the auctions, driving up interest rates for cities from coast to coast, consultant Peter Miller told the City Council's Finance Committee on Monday.

"The market's perfectly comfortable with the city of Modesto," Miller told council members Brad Hawn and Kristin Olsen. "We need to get you out of the (auction-rate) securities."

The interest rate hike is in keeping with increases other cities and counties are paying, according to Bloomberg News.

Monthly payments on $250 million in bonds from the Sacramento Regional County Sanitation District, for example, doubled to $343,000 this month.

New York-based MBIA, the nation's largest bond insurer, backed Modesto's bonds. The insurer since has suffered from buying repackaged subprime mortgages, though it maintained its top credit rating this week after raising $2.6 billion by issuing new shares and debt.

"We're just seeing a penalty being charged because of the affiliation with MBIA," Finance Director Wayne Padilla said.

Three choices

Miller offered Hawn and Olsen three ways to restructure the water bonds.

One would cost $1.3 million upfront, and it would get the city a fixed-rate bond at 4.79 percent. It would cost Modesto $93.7 million over the life of the bond.

The other options do not require termination payments. They involve a new bond insurer -- Bank of America -- and keep the original financing structure with an interest rate of about 3.48 percent.

They would cost the city $82.8 million to $83.2 million over the next 29 years, about $4 million more than the city planned to spend when it took out the bonds.

Hawn and Olsen favored the latter options, but they said they would consider the first course with the $1.3 million payment if the other two fall through.

The City Council will have the final say on what Miller and Padilla do to restructure the bonds.

Leaving the bonds as they are likely would cost Modesto an extra $40 million over time, Miller reported.

Modesto last year refinanced its debt for Tenth Street Place through auction-rate securities. Those bonds are scheduled to reset in September, giving Modesto time to adjust the financing plan before the rates increase.

Bee staff writer Adam Ashton can be reached at aashton@modbee.com or 578-2366.