Turnpike economics
The roof caved in on a turnpike tunnel after massive bolts, held in place with super glue, failed. The question now: Is the financing of the Massachusetts Turnpike Authority any more secure?
As those who follow the administration of ex- turnpike chairman Matt Amorello dig into the numbers, it is what they don't know that they fear the most. It's early, but one transaction -- involving $800 million of turnpike debt -- is drawing considerable scrutiny. The deal is not unwinding as the turnpike anticipated, and the implications could be costly.
The deal is painfully complicated, and involved two transactions, one with the investment house UBS and a subsequent one with Lehman Brothers. Like many financial transactions, these seemed attractive at first: They yielded the turnpike $55 million in early payments to fund operations. But only now, five years after the first deal, are the downside costs coming due.
In 2001, with interest rates low, the turnpike wanted to refinance its debt, just like any homeowner would. At the time the authority had $2.2 billion of fixed-rate debt for the eastern part of the turnpike, and the authority arranged an option that gave UBS, beginning in 2007, the ability to force the authority to swap $800 million of debt, with the turnpike paying UBS a fixed rate and receiving a floating rate. For this option, or ``swaption," UBS paid the turnpike $22 million, or $3.3 million annually through 2008.
A year later the turnpike executed a second option with Lehman -- a deal brought to the turnpike by Lehman executive Paul Haley, former chairman of the House Ways and Means Committee. In this case, however, Lehman would pay the authority a fixed rate and the authority would pay Lehman a variable rate on the same $800 million. Lehman paid the turnpike $35.2 million, or $5.4 million annually through 2008.
The turnpike saw the two transactions as complementary, with one swap offsetting the risk of the other. ``It is highly likely that both swaptions will be exercised simultaneously," the turnpike's financial adviser, Lamont Financial Services, wrote at the time.
It hasn't worked out that way. Given current rates, UBS is signaling it is highly likely to exercise its option next month or soon after. Lehman is not likely to exercise its option. In fact, say financial analysts, it was never likely UBS and Lehman would exercise their options simultaneously.
The situation could leave the turnpike with 31 percent of its debt in unhedged variable-rate debt -- not good for an agency that relies on a pretty steady stream of income. The Commonwealth, by comparison, has only 6.7 percent of its general obligation bonds in variable debt. Hoping for low short-term rates isn't much of a strategy. In addition, the turnpike faces a huge termination payment -- about $50 million -- to Lehman if its debt rating falls below certain levels.
A turnpike spokesman declined to comment.
Rating agencies have been warning about these risks almost from the time the turnpike did the Lehman deal. Most recently Mary Connaughton, a turnpike board member, and Joseph M. Giglio, a member of the state's Transportation Finance Commission and a Northeastern business professor, have questioned the risks. Said Giglio: ``I didn't think they caught the joke as to what the risks were attendant to the Lehman transaction. There were risks and you had to mitigate those risks."
That deal is a window into how turnpike finances were managed -- for today, not tomorrow. Maintenance costs and debt service are up, the contingency fund is down, and revenue from the swaptions and money set aside from the sale of Allston property to Harvard is running out. Tolls are scheduled to rise 25 percent in 2008 along with the end of the toll discount program. That's just what we know -- so far.
Steve Bailey is a Globe columnist. He can be reached at bailey@globe.com or at 617-929-2902. 
