BOARD MEETING DATE: February 6, 2009
AGENDA NO. 12

PROPOSAL:

Terminate Guaranteed Investment Contract and Escrow Agreement with MBIA Insurance Corporation; Establish Debt Service Fund with AQMD Treasurer

SYNOPSIS:

The Board, at its December 1, 2006 meeting, authorized the execution of a Guaranteed Investment Contract (GIC) and Escrow Agreement with MBIA Insurance Corporation (MBIA), an AAA-rated provider. Changes in the financial markets over the past several months have led to a ratings downgrade of MBIA by rating agencies Moody’s and Standard and Poor’s. The GIC provides several remedies that a provider (MBIA) may take to mitigate such a downgrade. This action is to authorize the Executive Officer to terminate this investment agreement with MBIA at no cost to AQMD and establish a Debt Service Fund with AQMD Treasurer.

COMMITTEE:

Administrative, January 16, 2009, Recommended for Approval

RECOMMENDED ACTIONS:

1. Authorize the Executive Officer to terminate the Guaranteed Investment Contract and Escrow Agreement with MBIA at par plus accrued interest at no cost to the AQMD.
2. Establish a Debt Service Fund with AQMD Treasurer (LA County Treasurer) for the deposit of principal and interest from the termination of the GIC agreement with MBIA and authorize the continued payment of up to $3,000,000 annually from this Debt Service Fund to defease Pension Obligation Bonds debt service payments through 2014.
    

Barry R. Wallerstein, D.Env.
Executive Officer

Background

Guaranteed Investment Contracts or GICs are the most common type of investment agreement for state and local agencies. In essence, a GIC is a promise to pay a state or local agency a specific interest rate over time for a specified investment amount. State and local agencies typically use GICs for investing in debt service reserve funds, construction funds, debt service funds and defeasance funds.

At the September 8, 2006 Board meeting, the Board adopted Resolution No. 2006-25 authorizing AQMD to enter into a Guaranteed Investment Contract with an AAA-rated provider for the purpose of economically defeasing a portion of AQMD’s current debt service through 2014 with one-time penalty/settlement moneys. An economic defeasance uses securities other than U.S. Treasury securities.

On December 1, 2006 the Board solicited bids from several AAA-rated providers. MBIA won the bid, and on December 12, 2006 the Board entered into a $19.1 million GIC and Escrow Agreement with MBIA for the defeasance of a portion of the 2007 through 2014 Pension Obligation Bonds (POBs) debt service payments.

The GIC contract recites the basic information about the reason for the investment, the maturity, the interest rate as well as the parties to the agreement. In addition to the AAA credit rating of the provider itself, the investment agreement requires that the GIC be over-collateralized with U.S. Treasury or Agency securities at all times. The securities are held by a third party Custodian (Wells Fargo) and must be maintained at a minimum value of 104% of the GIC. The collateral value is verified and reported weekly by the Custodian.

As additional protection, the agreement included a GIC downgrade provision that requires the provider to either assign the collateralized GIC to another qualifying GIC provider; increase the collateral percentages; or terminate the agreement if the provider’s credit ratings falls below A3 and A- as determined by Moody’s and Standard & Poor’s respectively.

On November 10, 2008 MBIA experienced an Insurer downgrade from A2 to Baa1 (medium investment grade) by Moody’s Investors Service. MBIA has met the GIC downgrade provisions by increasing its collateralization of the Investment Agreement from 104% to 108% with U.S. Agency securities and cash.

Staff therefore believes that it is appropriate for the Board to consider whether it wishes to continue with the current agreement or pursue another investment option.
 

Proposal

While MBIA has successfully delivered additional Collateral pursuant to Article 4 of the Investment Agreement and is under no obligation to terminate this Agreement, MBIA has recently agreed to termination at AQMD’s request at the par amount plus accrued interest to the termination.

AQMD staff has discussed with its financial advisor, Sperry Capital, and its legal counsel, Stradling, Yocca, Carlson & Rauth, the risk associated with this investment. While the AQMD investment is over-collateralized at 108% with securities backed by the U.S. government and cash, staffs view, due to the uncertainty in the financial markets and the potential for delay in the return of its investment should the provider enter into bankruptcy, that an appropriate course of action would be to terminate this investment agreement and place the proceeds with its Treasurer in a new Debt Service Fund.

Placement with its Treasurer would give the AQMD several investment options including: (1) the Los Angeles County Treasurer pooled investment portfolio; (2) State of California, Local Agency Investment Fund; (3) US Treasury and Agency securities; and (4) re-bidding of the GIC with another AAA-rated provider after the markets settle.
 

Resource Impacts

Notwithstanding the potential for change in the investment markets over the next six years and the various investment options available to the AQMD, this action will result in an immediate reduction in investment earnings to the AQMD. Using an assumed annualized return of 2% (currently its 2.54% for December) from the Treasurer’s pooled investment portfolio compared with the 4.88% return guaranteed in the contract, the AQMD could see its total investment earnings decrease by an estimated $1.474 million for the six years remaining, thereby reducing the final funds available from this investment to reducing AQMD’s debt service in 2014 from approximately $1,965,000 to $491,000. Nonetheless, staff recommends termination of the existing agreement.