The payment to Bank of America Merrill Lynch canceled a complicated and risky transaction called an interest-rate “swaption” that the authority agreed to in 2004, partly to reap a $9.5 million upfront windfall.
The payment was part of a $263.3 million refinancing bond issue that the authority completed on Tuesday.
The cost of the payment will be spread over Port Authority budgets starting next year and continuing to 2029, adding $2.3 million in debt service expense per year, authority officials said.
Because the authority pays debt service from its capital budget, the added cost will not impact operations or require service cuts, spokesman Jim Ritchie said. But it will reduce the amount available for longer-term projects such as bridge, busway and rail reconstruction.
“It’s essentially a refinancing. We’re trying to get out of an arrangement that was putting us in greater financial jeopardy,” he said.
The authority agreed to the swaption deal with Merrill Lynch in 2004, during the administration of CEO Paul Skoutelas. Bank of America bought Merrill Lynch in 2008.
Ellen McLean, the current chief financial officer, who joined the authority last October, said the swaption deal enabled the agency to cash in on anticipated future savings from debt refinancing. But it also exposed the authority to risks based on interest-rate fluctuation.
The collapse of the credit markets in 2008 and 2009 drove down rates and left the authority’s side of the swap at a considerably lower value than what it would be paying out.
It also gave Merrill Lynch the option to convert the authority’s debt to a variable interest rate starting March 1, she said. “What we knew was the volatility in the market would create such a difficulty in budgeting … it was impossible to budget for.
“It made absolutely no sense as a public agency to take on that volatility,” Ms. McLean said.
“We reached a point because of the market downturn where this clearly didn’t turn out the way anybody was predicting,” Mr. Ritchie said. “It does not make sense for us to continue down this path.”
This week’s refinancing extracted the authority from the deal and put all of its bonded debt at an average fixed interest rate of 5.29 percent.
The authority is not alone in being victimized by swap deals. Several Pennsylvania school districts and municipal governments lost big money on interest-rate swaps, deals that produced big upfront windfalls but exposed them to losses when rates fell.
State Auditor General Jack Wagner last year urged school districts to get out of such deals as quickly as possible, saying “interest-rate swaps are tantamount to gambling with taxpayer money.”
Bloomberg News, reporting on the Port Authority bond issue, said it has compiled data showing that borrowers across the U.S. have paid more than $4 billion to get out of swap contracts.
Randy Woolridge, professor of finance at Penn State University, said he was unfamiliar with the circumstances of the Port Authority’s deal. Generally, he said, “a lot of these [swaps] have turned bad because they’re all doing the same thing. They hedged against higher interest rates and the rates went down. As a result, these things are underwater.
“Everyone thinks interest rates and stocks are always going up,” he said.
If there was a bright side to the authority’s action this week, it was that the three big New York agencies raised its credit rating.
Fitch assigned the bonds an AA-minus rating, up from A; Moody’s assigned an A1, up from A2; and Standard & Poors gave them an A-plus, up from A.