Representatives from Modesto City Hall and the Modesto Irrigation District have negotiated a tentative deal with JPMorgan Chase that may keep the city from having to post collateral for a 2007 bond that helped finance a $77 million water treatment project.
The Wall Street firm informed the city on June 17 it would exercise the terms of a swap agreement, which at current interest rates would require Modesto to post $18 million in collateral.
City staff urged the City Council to deal with the notice at Tuesday night's meeting, even though it was too late to be posted with the session's published agenda.
The council agreed and authorized taking $18 million from the water fund if JPMorgan makes an immediate demand for collateral this week.
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Peter Miller, the city's financial adviser, said Wednesday the investment bank has agreed to postpone the demand until July 7. The council on July 6 will be asked to approve a revised swap agreement raising the interest-rate threshold for requiring collateral.
The city won't have to post collateral if interest rates remain static. A drop in rates could trigger a demand for collateral, but rates are expected to trend upward, Miller said.
The 2007 bond issue raised tens of millions of dollars for building the second phase of the water treatment and delivery system in coordination with the Modesto Irrigation District.
The debt issue included a swap agreement with Bear Stearns designed to hold each party harmless to changes in the variable interest rate. JPMorgan acquired Bear Stearns after the investment firm's collapse in 2008.
With interest rates at rock bottom, the financing is saving city ratepayers about $360,000 a year, Miller said.
JPMorgan was able to demand that the city post collateral with a third party, because bond insurer MBIA's credit rating has fallen below AAA status and MID's revenue bond rating is below AA.
Eric Reimer of the Stanislaus Taxpayers Association said the group has urged the city to use fixed-rate bonds for public works projects because they are safer. The credit crunch of 2008 sent city officials scrambling to restructure bonds with rates determined by weekly bank auctions.
"A swap is a bet on the direction of interest rates," Reimer said. "It's the Wall Street people who know more than their customers. Therefore, they are going to win the bet."
Miller said the swap agreement with JPMorgan doesn't put the city at risk.
JPMorgan can terminate the agreement only if the city fails to make payments or violates the contract, and it would have to make a payment to the city if interest rates are up. The city can end the agreement at any time, without cause, but would have to make a payment to JPMorgan if interest rates are lower than when it entered the agreement.
Bee staff writer Ken Carlson can be reached at firstname.lastname@example.org or 578-2321.