Low Interest Rates : Refinancing Fever Grips Government

The fast-growing New Haven Unified School District in Northern California was on a building binge last summer when the money started running out.

After building a new gymnasium, constructing a baseball complex and expanding the music room, it looked like the district would have to drastically scale back its plans to break ground on a new science center at the high school in Union City, south of Oakland.

Then, school administrators discovered a little trick. Like thousands of homeowners, they decided to cash in on declining interest rates by simply refinancing the district’s $25-million “mortgage”--the amount in tax-exempt bonds it had issued to pay for the building binge.

The result: An immediate savings of $1 million. And today construction workers--paid in large part with that windfall--are hammering away on the eight classrooms and four laboratories at the new high school science center.

Refinancing Magic

“It is out of thin air,” Pat Gibbons, New Haven Unified’s deputy superintendent, said about the million-dollar miracle.

Enchanted with the magical promise of getting something for nothing, state and local governments are stampeding in record numbers to refinance their streets, sewers, libraries and power plants.

The pay-off has amounted to freebies for governments--millions of dollars that are paying for new classrooms and subway cars. And the extra bonus for government officials is that they can do all this without raising taxes or utility rates one penny.

In 1985, governments and quasi-public agencies like housing commissions and hospital districts refinanced an unprecedented $67 billion as interest rates dipped to a six-year low of 8.4%, according to statistics provided by Securities Data Co., a firm that monitors all refinancings.

And the stampede has continued into 1986, with governments refinancing $49 billion through June. That compares to the $24 billion they refinanced in all of 1983, Securities Data statistics show.

Federal Concerns

The phenomenon is not without its downside. U.S. Treasury officials are concerned that to overcome certain barriers to refinancing, government agencies are borrowing more money than they actually need. As a result, the treasury officials say, federal tax collections have suffered because too much money is locked up in tax-exempt government bonds.

But despite these concerns, refinancing by cities, counties, school districts, water districts and utilities continues unabated. It has paralleled the recent rush by individuals to refinance their homes and lower their monthly mortgage payments.

Governments, too, have their mortgages--the tax-exempt bonds or certificates of participation that they issue, at a cost, to pay for everything from water mains to garbage trucks.

Typically, the bonds are issued for 20 to 30 years and are sold to institutional investors like insurance companies, corporations and banks, as well as individuals.

Just like a bank, the bondholders give the government a large sum of money for immediate use. And just like the homeowner, the government pays back the bondholders over time with semiannual “debt service” payments.

Refinancing, however, allows the governments to cash in on the lower interest rates. That means there is money--in some cases, enormous amounts--left over for other things.

Such a prospect is proving irresistible for the cities and school districts that have had to grit their teeth and issue bonds during the early 1980s, when interest rates were bouncing around in the double digits.

A savings of two points on a bond interest rate is enough to persuade a city or school district to hit the refinance market, government officials say.

It has also provided enough incentive for some states--such as Texas--to do away with laws restricting their cities and school districts from refinancing bonds. After the restrictions were lifted in Texas, for example, cities and school districts there grabbed at the lower interest rates and refinanced $10 billion in 1985, 15% of the nationwide total last year.

‘It Is Real’

“We are saving millions of dollars. It is real,” said Sherri Greenberg, manager of capital finances for Austin, Tex., which has refinanced nearly $1 billion in a variety of bonds over the last 10 months.

Greenberg said the new bonds translate into a $48.8-million savings for the state capital during the next two decades. The money will be used to pay for new public projects and will forestall future electric rate increases.

“I want to stress that it doesn’t mean there won’t be an increase, but it won’t be as great,” Greenberg said.

One refinancing success story belongs to the Municipal Assistance Corp. for New York City, the nonprofit corporation that was established in 1975 to help pull the city out of its financial tailspin. Because the city’s credit was so poor, the corporation issued its own bonds and provided money to the city.

So far this year, the corporation has refinanced $935 million of those bonds--issued during high-interest periods of 1981 and 1982--for a savings of $60 million over the next decade.

Most of it will be put into a large pot of money for New York City to help pay the city’s budget and, beginning in 1989, rehabilitate the city’s beleaguered subway system.

“Within four years, this will be seen as new subway cars are rolling and stations are redesigned and modernized,” said Stephen J. Weinstein, the corporation’s executive director.

Trickle-Down Results

Not all results are as visible or impressive by the time they trickle down to the average citizen. Although refinancing has yielded a new high school science center in Union City, the savings will probably mean mostly intellectual satisfaction to the millions of taxpayers whose states, cities and school districts have obtained lower bond interest rates.

The Los Angeles Department of Water and Power, for example, is saving about $24 million a year in electric costs because it is buying the energy from a power plant in Utah that has been refinanced.

For the average Water and Power customer, that savings amounts to only 40 cents a month on his bill, a department financial analyst said.

Los Angeles County is saving about $1 million a year because it refinanced its 1984 debt on 24 public buildings, including the Hall of Administration and court buildings downtown.

Yet that is only 0.02% of the $5-billion county budget. And the savings is overshadowed by the loss of $80 million a year in federal financing.

Still, county officials are gung-ho for refinancing.

“What you buy is $1 million more in programs--jail overcrowding relief, court congestion relief, child-abuse programs and aid to the homeless,” said Sharon Yonashiro, a county assistant division chief. “If we had not done the refinancing, that would not have been available.”

Pennies Add Up

One financial manager from the Metropolitan Water District, which has plans to refinance $150 million in bonds for an estimated yearly savings of $750,000, observed: “Heck, if you can save almost a million, you’re going to do it. The pennies add up.”

Despite glowing reviews like these, the U.S. Treasury Department is nervous about the stampede, and it is asking Congress to crack down on the number of times a local government can reissue bonds for a street or water main. Local governments have responded to the request by stepping up the stampede even more.

The reason for the Treasury Department’s opposition strikes at the heart of how government refinancing deals are put together--a complex, arcane process that involves a network of local governmental officials, bond attorneys and underwriters.

A homeowner who obtains a second mortgage can use it, in most cases, to immediately pay off his first. In one stroke, he replaces his higher interest rate with a lower one.

Governments cannot.

They must wait to pay off a bond issue until it reaches a designated “call date,” a maturity deadline that is typically 10 years from the day the bonds were offered for sale.

The call date is a strong selling point for government bonds, a guarantee to the institutions and people who buy them that their investments will not be disturbed before the deadline. Yet it can become a hurdle for a city that, say, wants to refinance $10 million in high-interest 1984 bonds to pay for a new water main.

Financial Tactic

So to get around that, the city will use a technique called “advanced refunding.” It allows the city to issue slightly more than $10 million in new bonds--with a lower interest rate--and deposit the proceeds into a special investment account.

The money will be used to make payments on the first bond issue. And the city will begin using its own money to make the new, lower debt-service payments on the second bond issue.

What bothers the Treasury Department is that the city now has more than $20 million in bonds outstanding to pay for a $10-million water main. Multiply that hundreds of times over, and it adds up to a glut of tax-free investments that is depriving the federal government of taxes, said one Treasury official, who asked not to be identified.

One government economist, who also asked not to be identified, estimated that the federal government will lose $1.9 billion this year because of the amount of tax-free bonds on the market.

“It doesn’t make any sense for a state to save $1 and it costs us $5,” said the Treasury official.

Meanwhile, the people who have invested in government bonds with high interest rates are registering only mild surprise that the stampede will claim their holdings.

Most investors knew they couldn’t hold onto the high-interest investment much longer than the call date, said John Markese, research director for the American Assn. of Individual Investors, with a membership of 95,000.

“They found out the party’s over,” said Markese, who conducts investment seminars throughout the country. “The tremendous rate of return on bonds couldn’t go on forever.”

In effect, the falling interest rates have proven to be a two-edged sword, added Tom O’Hara, chairman of the National Assn. of Investors.

“A person who is seeing their interest rate refinanced on the bonds is often the same person who is getting his home refinanced so he can get a good interest rate on his mortgage,” O’Hara said. “So it works both ways.”