Credit crunch hits Raleigh for $730,000 and more

The construction of Raleigh's new convention center may be complete, but the cost continues to rise because of the worldwide credit crunch. In recent weeks, the bonds issued to pay for the convention center have become unmarketable because they are affiliated with a bank, Depfa, whose German parent company has been near collapse since September. Through no fault of its own, Raleigh now finds itself paying for the bad bets made by a bank on another continent. "It's all because of Depfa," said Perry James III, Raleigh's chief financial officer. The city of Raleigh is one of many state and local governments, including the New York City Metropolitan Transit Authority and the Michigan State Building Authority, that face rising finance bills because they hired Depfa as the buyer of last resort for their bonds. The bank wrote $1.7 billion worth of such policies in 2007, making it the third-largest provider to U.S. municipalities last year, according to Municipal Market Advisors. Although Depfa was highly rated by credit ratings agencies, the bank was also highly leveraged. Its business was premised on having access to low-cost, short-term loans. Depfa's troubles have cost Raleigh an estimated $730,000 in additional interest so far. While that number is likely to rise, it's not clear by how much. Raleigh officials say they are confident the city will be able to replace Depfa with one or more other banks. They also say the additional costs will pale in comparison to how much the city saved by structuring the convention center deal the way it did. The city used variable-rate bonds to borrow at much lower interest rates than it would have gotten on fixed-rate bonds. "Those benefits still far outweigh this one downside," City Manager Russell Allen said. Who'll replace Depfa? But others say Depfa's woes represent a large problem for municipalities. Matt Fabian, managing director of Municipal Market Advisors, a research firm, said municipalities are finding it "almost impossible" to find banks to replace faltering firms such as Depfa. If Raleigh's bonds remain with Depfa beyond 90 days, the bonds' payoff schedules changes from 30 years to seven years. If that happens, Fabian said, the municipality and the bank are usually forced to negotiate and come to lending terms that Raleigh could afford. "But it's really not a good situation," he said. "You're depending on their willingness to engage in some sort of forbearance." City, county approved The financing plan for the convention center was approved by both the Raleigh City Council and the Wake County Board of Commissioners. The city issued $243 million worth of variable-rate bonds for the center between February 2004 and January 2005. Variable-rate bonds have their interest rate reset every seven days. Raleigh hired Citigroup to market the convention center bonds and Depfa to be the liquidity provider. A liquidity provider agrees, for a fee, to buy the bonds from investors if another buyer cannot be found. Fabian said liquidity providers such as Depfa assumed that there would always be a market for municipal bonds and that their services would never be needed. "It was rare that it ever happened at all," he said. But as the global credit crisis deepened this fall, Depfa's financial problems became so acute that they threatened to bankrupt the bank's German parent company, Hypo Real Estate Group. When Hypo asked for a bailout from the German government, many municipal bond investors got nervous. When Fitch Ratings downgraded Depfa in late September, investors began rejecting any bonds that had Depfa as the liquidity provider. Fabian said municipal bond investors no longer trust any transaction that involves Depfa. "Anyone with Depfa will have to replace their liquidity provider," he said. Depfa has had some Raleigh convention center bonds on its balance sheet since Oct. 6. That means Raleigh has until the first week of January to find another liquidity provider if it wants to avoid having its lending terms radically changed.