Real Estate Lender Implosion

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Nonprofits fight debt costs, bond insurers

Firms balk at helping colleges pay lower rates

Globe Staff / February 21, 2008

Universities and other institutions with rising debt costs are grappling with an unexpected problem: insurers who won't let them off the hook.

At Bentley College in Waltham, treasurer Paul Clemente expects he'll soon have to pay $500,000 to refinance a debt with soaring interest costs. If his bond insurer would let him convert from an auction-rate bond to a different type of variable-rate date, however, his cost would drop to around $50,000. He says the insurer, XL Capital Assurance of New York, first assured him there was no problem and then stopped returning his calls.

"Frankly, I'm disappointed they've essentially abandoned their clients," Clemente said yesterday.

Executives at XL and another insurer wouldn't discuss specifics but said they are working toward new arrangements with their clients. The problem is the latest manifestation of how problems with subprime mortgages have spread to nonprofit institutions such as hospitals and universities whose bonds previously were considered to be safe, conservative investments.

In fact, many of these institutions paid millions to XL and other big bond insurers to make their bonds more appealing to investors.

Since last month, the largest insurers have been downgraded or put under review by major credit rating agencies because of the subprime holdings in their portfolios. This in turn spooked many borrowers who stopped bidding on what are known as auction-rate bonds because their interest rates are set in periodic auctions.

In many auctions recently, no bidders have stepped forward at all. When no one bids, interest rates reset at levels specified in contract documents, as high as 20 percent in some cases. Bentley, for instance, had to pay 7.8 percent interest last week on bonds that paid around 3.5 percent in November, adding an extra $60,000 a week to the school's interest costs.

Yesterday, Massachusetts Secretary of State William F. Galvin launched an investigation into auction-rate bonds, asking several mutual-fund firms that hold these bonds for information. "The failures in these auctions cause many and diverse problems," Galvin said, and the impact "can be daunting for the investor who has sought a safe and dependable harbor for life savings."

To lower Bentley's rates, Clemente would like to switch the borrowing to what are known as "variable rate demand bonds." The market for those bonds has continued to function, because they can be held by institutional investors such as public-sector pension funds. But without XL's permission to convert, Bentley's refinancing costs will be much higher.

Officials at other schools, including Worcester Polytechnic Institute, have had similar concerns. "You could expect that they're upset and angry that the creditworthiness of the insurers is what's causing the cost of their borrowing to go up," said Robert L. Culver, the president of MassDevelopment, a quasipublic agency in Boston that issues bonds for companies and nonprofits.

Last week MassDevelopment approved several applications to restructure auction-rate borrowing. Many clients, Culver said, "are frustrated and seeking alternatives."

In a statement, another large bond insurer, MBIA Inc., said that "We are working closely with MBIA-insured issuers and their advisers to address liquidity concerns and achieve the most efficient cost of funding available." Representatives of a third insurer, Ambac Financial Group, didn't respond to questions.

Ed Hubbard, the president and chief operating officer of XL, said in a statement yesterday that "We understand the difficulties issuers are facing due to the current market conditions. Over the past few weeks we have been working to develop solutions to assist our clients. These possible solutions include terminating the insurance policy and working with certain clients to switch from auction rate to variable rate demand notes with or without a letter of credit."

XL put its intentions into practice in at least one case yesterday involving Bryant University in Smithfield, R.I. Like Bentley and WPI, officials at Bryant are considering how to switch about $50 million in debt out of the auction market and into variable-rate bonds. Fees on the transaction would be $212,000 with XL's permission and $350,000 without, estimated Barry F. Morrison, the school's treasurer.

In an initial interview yesterday afternoon Morrison said XL so far hadn't given him the approvals, which he called "a bit disappointing." But later he spoke with an XL representative and said he was told the transaction had been given the go-ahead - likely because the company wants to keep its reputation.

Ross Kerber can be reached at [e-mail]