The subprime mortgage crisis is claiming more victims, adding millions of dollars in borrowing costs to Massachusetts universities, hospitals, and public agencies.
In Waltham, Brandeis University borrowed $62 million in March to pay for a new science center and a dorm. University officials spent $500,000 on insurance to assure investors the bonds were safe, and opted for a variable rate to lower borrowing costs.
The arrangement worked through the fall, but Brandeis officials had no way of knowing that bond insurers were about to be hammered by the subprime mortgages in their portfolios. As investors have grown concerned about the financial health of the bond insurers, their insurance has boomeranged on many nonprofits - and shown how problems stemming from subprime lending have spread to other parts of the financial system.
At Brandeis, weekly borrowing costs on the bonds have risen from around $40,000 last year to as much as $80,000 for two weeks in January. Spooked by the troubles of bond insurers, investors buying the Brandeis bonds in weekly auctions that determine the variable rates have demanded to be paid interest rates above 7 percent, far above the roughly 2 percent the school estimates it would be paying if its bonds weren't insured.
"It's amazing how this has penetrated to the schools," said Peter French, Brandeis's chief operating officer, who plans to restructure the notes to lower their interest payments. "I don't think anyone could have contemplated that these bond insurers would be dabbling in subprimes and have their credit rating affected."
Organizations across the state face the same problem. Data from two Massachusetts financing agencies show at least 17 cases since 2006 in which institutions bought insurance to enhance the appeal of their variable-rate bonds to investors. Many now find themselves stuck with rising interest costs - in much the same situation as homeowners who are facing costly adjustable-rate mortgages.
On Wednesday, the board of the Massachusetts Water Resources Authority approved a measure aimed at removing the insurance on about $575 million in variable-rate debt. Officials estimate the insurance has cost them $1.5 million in additional interest payments, compared to what they would be paying if the borrowing was not insured.
In Medford, Tufts University associate treasurer Darleen Karp estimates it faces an additional $200,000 or so a month because of the sudden spike in interest rates. "I haven't seen anything like this before," she said.
Rating agencies Moody's Investors Service and Standard & Poor's have threatened to downgrade bond insurers such as MBIA Inc. and Ambac Financial Group, both of New York, because of subprime mortgages they held.
The possibility of downgrades has created turmoil in the bond world because the insurers market their credit ratings to others. Brandeis, for instance, wasn't rated on its own but was able to market its bonds under the AAA rating that insurer XL Capital Assurance held in the summer.
Now the subprime holdings have made the bond insurance less appealing, and many investors are demanding higher interest rates to hold notes or are avoiding them altogether.
Variable-rate bonds sold at auction have interest rates determined by bidding that occurs every seven, 28, or 35 days. When there aren't enough buyers, the auction fails and bondholders who wanted to sell are left holding the securities, though they may receive higher interest payments on those bonds. Rates at failed auctions are set at a level spelled out in statements issued at the initial bond sale. An estimated 80 percent of the auctions held Wednesday failed, according to Bank of America Corp. analyst Jeffrey Rosenberg. Among them was an auction in which $565 million in Massachusetts bonds failed to find a buyer, say state officials. As a result, the interest rate on those bonds will increase to 4.5 percent, from 3 percent, adding about $30,000 in costs for the week. "It appears this market has completely failed," said assistant state treasurer Colin MacNaught.
MacNaught said the bonds were just a fraction of the state's total borrowing and the extra payments won't pose a problem. But for many smaller institutions the rising costs could become quite a burden, said Thomas Doe, chief executive of Municipal Market Advisors, a Concord consulting firm.
Some variable-rate insured bonds are identified in records kept by MassDevelopment and the Massachusetts Health and Educational Facilities Authority, which help nonprofit organizations in the state sell securities to raise capital. Many escaped trouble by selling debt at fixed rates or without buying insurance.
The Museum of Fine Arts in Boston, for instance, is paying about 3.8 percent interest on $185 million it raised through a bond issue in December. Chief financial officer Mark Kerwin said he was concerned that paying several million dollars for bond insurance might not have sustained an AAA rating through the current turmoil. "Right now we would not have gotten any benefit," he said.
Other institutions say they're looking to reconfigure their borrowing. Options include renegotiating with bondholders or replacing bond insurance agreements with letters of credit from banks guaranteeing debt payments will be made. A spokesman for the Dana-Farber Cancer Institute in Boston said it may restructure $280 million in debt that paid for projects like its new Yawkey Center for Cancer Care because of higher interest rates projected to add $2.8 million to its interest payments a year.
Officials at hospital operator Partners HealthCare System say they may change the terms on about $300 million worth of variable-rate insured borrowing to save about $300,000 a year. That represents the higher interest rate many individual investors demand to own the securities, said Michael T. Manning, the system's deputy treasurer. He plans to restructure the securities so they can be sold to institutional investors.
The flip side is that investors can benefit. Cathryn Steeves, who runs several Massachusetts bond funds for Nuveen Investments in Chicago, said she bought several million dollars worth of Brandeis's notes recently since they paid so well compared to other variable-rate bonds averaging 1.73 percent lately. Rates on municipal bonds in other states have gotten so high they are starting to conflict with local usury laws, Steeves added. "I don't think anyone foresaw this happening," she said.
Ross Kerber can be reached at kerber@globe.com. Material from Bloomberg News was used in this report.
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