The draft legislation which the Governor is trying to jam through the legislature in the next two weeks contains a provision to create a LIPA Refinance Authority. That is a LIPA for LIPA or, as I like to think of it, LIPA Squared.
During the dog and pony show on Wednesday night, there was a Power Point presentation which suggested that LIPA could refinance its bond to take advantage of lower interest rates. At the time I assumed that meant lower interest rates created because of Quantitative Easing by the Federal Reserve, I was wrong.
The draft legislation contains a provision to create a new LIPA Financing Authority that will issue new bonds.
7. Securitized restricting bonds are likely to be the most attractive to the investing public and result in the lowest possible yields if they are issued by a newly organized, special purpose public benefit corporation or other corporate municipal instrumentality of the state.
The bonds are going to be created as a “bankruptcy remote vehicle”.
6. If the securitized restricting bond were issued by a bankruptcy remote entity with an AAA or equivalent rating in current market conditions to finance a portion of the cost purchasing, redeeming or defeasing the outstand debt of the authority, and other associated costs, the debt service on the authority’s debt could be reduced and the cost of electric utility service could be lowered.
Sound familiar? That’s because it’s pretty much the same concept as the REMICs used by banks to securitize mortgages. Remember how that worked? The bank would bundle together great mortgages with not so great mortgages and the top quality mortgages made the top tranches of the Residential Mortgage-Backed Security (RMBS) attractive and glamorous. Additionally, the RMBS would also carry default insurance from some giant like AIG. The combination of some great mortgages plus the default insurance allowed the top tranches to attain a triple A rating. This, of course, means the lower tranches had worse ratings.
The problem is that the existing LIPA bonds which are to be bundled into the “bankruptcy remote” vehicle that would issue new derivatives do not have any “great” bonds to create the needed glamour.
5. As of December 31, 2012, the three major rating agencies generally rated the authority’s debt in the single-A range, though Moody’s Investors Services assigns approximately seven hundred million dollars of the authority’s debt slightly lower ratings of Baa1 and Baa2.
There is no New York state guarantee or other default insurance. So how the heck are you going to transform Single A, Baa1 and Baa2 rated bonds into Triple A rated derivatives? All of the elements you need to create a Triple A rating for the top tranche are missing, plus the increased borrowing costs for the lower tranches are not mentioned. The borrowing costs for the lower tranches with lower ratings are obviously much higher.
Those of you in finance, please give the draft legislation linked above a read, starting at Part B on page 29, and let me know in the comments if I have missed something. If this LIPA Squared idea is really as completely illogical and impossible as it seems, I’m going to have to raise a ruckus. However, I find it hard to believe that anyone would do something this obviously dumb and not expect to get caught, so am I missing something? Please, forward, tweet, etc. to your buddies in finance and get me some expert opinions.