Auction Rate Bond Meltdown Spells Trouble For Lucas Oil Stadium

The IBJ's Peter Schnitzler, who is running circles around the Star's business reporters these days, has another great story today on how the meltdown of the auction bond market recently could have a huge, negative financial impact on the debt funding for the Lucas Oil Stadium. Schnitzler writes:

The debt strategy Gov. Mitch Daniels’ top financial officials developed to save the state money on major projects like Lucas Oil Stadium has turned sour. To pay for construction, the administration over the last few years issued $810 million in “auction-rate” bonds—a form of variable-interest-rate debt that once promised to shave costs. But this month’s unexpected meltdown of the U.S. auction-rate securities market has opened the state to risk of sudden spikes in interest.

And now, to avoid extraordinary payments for debt service, Indiana may have to spend millions of dollars on fees to issue replacement bonds.

As far as Wall Street credit rating agencies are concerned, the sooner Indiana addresses its problem, the better.

“We’d expect for a state as highly rated as Indiana, in this situation, that they would take some sort of action relatively quickly,” said Nick Samuels, a vice president for New York-based Moody’s Investors Service. “The state certainly understands what this issue is. And my understanding is they’re working on finding a solution.”

Auction-rate bonds are long-term securities that behave like short-term debt. Interest rates on the debt are reset through auctions staged no more than 35 days apart. The Daniels administration turned to the burgeoning auction-rate market in a bid to keep interest costs low on major projects.

But over the last month, the once-obscure auction-rate market has become the latest victim of the global credit crunch. Recent auctions have failed to generate sufficient investor interest, raising the specter that interest rates on state projects could soar from the low single digits to 15 percent or more.

In other words, we'll soon be paying double-digit credit card interest rates on the construction debt for Lucas Oil Stadium if something isn't done right away. But to hear Daniels' budget director describe the situation, it's no big deal. "Ryan Kitchell, director of the Indiana Office of Management and Budget, downplayed the state’s challenges, saying it intends to refinance," Schnitzler writes. "And because early interest costs on Lucas Oil Stadium bonds were below expectations, he said, the state now is positioned to absorb higher-than-expected rates." Other experts Schnitzler talked to advise their clients against using such a high-risk strategy. Schnitzler notes that the person in charge during the previous Democratic administrations avoided the use of auction rate bonds. “These things change in the market a lot, and typically with auction-rate debt, you need to purchase bond insurance," Diana Hamilton said. "And also the ... fees paid to the investment banker were higher.” That latter statement is the key. "Fees paid to the investment banker were higher." Go back and check how much campaign money Gov. Daniels has collected from investment bankers who have done business with his administration and start putting two and two together.

Ironically, the same self-serving people who got us into this mess are likely to make a lot more money at our expense fixing the problem. According to Schnitzler's story, the fees alone for refinancing this debt could easily top $10 million. "[John Reed] said the biggest problem he had with auction-rate debt was that 'borrowers took all the risk, and the investment banker crowd made a lot of money off of it," Schnitzler writes. "And in many cases, they sold it to people who had no basis being in it to begin with. I hate to be a cynic, but that’s the way it is.”

The timing on this fiasco couldn't be worse. The CIB still has to figure out how to come up with the more than $10 million it will take annually to operate and maintain Lucas Oil Stadium once it opens up later this year, a small matter overlooked by the Peterson administration. Anyone heard what Bob Grand's plan is to fix that problem?