Presidential hopeful New Jersey Gov. Chris Christie has terminated all of the states interest rate swap agreements. The state decided to pay banks $720 million which will unravel $4.2 billion of swaps from its records.
Many states and cities use these types of derivative deals to lower financing costs by hedging interest rate changes. This is a common procedure, but some cities, including Chicago and Detroit, have faced financial difficulty when rates changed unexpectedly or large termination fees were levied when credit ratings were lowered.
Gov. Christie’s administration has weathered nine downgrades and may have faced another because of underfunded public pensions and financial weakness. This was the first time the state Treasury department released the full amount.
Swaps “have been considered to be toxic by market participants and the administration. The state saw an opportunity to clean up its balance sheet and did so,” Treasury spokesman Christopher Santarelli said in an e-mail.
When Christie took office in 2010 the state had a balance of $4.2 billion swaps. The administration has slowly whittled those down to $1.15 billion in swaps remaining with the New Jersey Economic Development Authority (NJEDA).
New Jersey is likely doing their best to remove their state’s finances from swaps largely because of the lessons learned from Chicago and Detroit. Recently swaps led to Detroit becoming the largest U.S. municipality to declare bankruptcy, and Chicago has seen their credit rating downgraded to Baa2 and they had to renegotiate deals to avoid $60 million in termination fees.
By borrowing to pay off a portion of the swaps New Jersey is trading short-term unstable debt to get in to a long-term financial situation that is more stable.
New Jersey “put itself in the driver’s seat. It eliminates the potential liquidity call if the swap should be terminated at a time when New Jersey doesn’t have the cash to do so,” said Lisa Washburn, a managing director at Municipal Market Analytics.
On August 31 New Jersey will sell $2.2 billion worth of bonds which will be used to pay off swap terminations, fund school construction, and refund some outstanding debt.
Fitch Ratings on Tuesday revised its outlook to stable from negative on New Jersey, saying “near-term budget risks have abated.”