If it’s anything like those Auction Rate Securities that rely on daily or weekly market liquidity to set the rate, then it’s a recipe for disaster.

That is exactly what David and I have been talking about for more than a month. Williams and many other colleges have Variable Rate Demand Bonds that reset interest daily or weekly based on secondary market auctions. With the credit freeze, the market for these bonds dried up and/or spiked interest rates to 12%.

Should there be no buyers for a college’s bonds in a given day’s auction, the college can be called upon to repurchase the entire bond in a matter of hours. Therefore, all colleges that have issued these bonds must have either sufficient cash and/or a secondary bank line of credit to repurchase $10, $20, $40 or however many million worth of bonds.

Williams has signficant Variable Rate Demand Bond exposure. This is not an issue that be life threatening for Williams, but it could be literally the end of the road for colleges further down the food chain. I believe that issues related to these bonds may have been the impetus for Morty’s first, rather breathless, e-mail. A spike in daily rates would have been an unexpected jolt to this year’s operating budget.

Risks for Higher Ed from variable rate debt revealed by credit crisis

PRESS RELEASE
New York, December 22, 2008 — For U.S. colleges and universities, the credit risks associated with variable rate debt have been exacerbated by the ongoing credit market and municipal bond market disruptions, says Moody’s Investors Service in a new report that highlights the importance of careful and proactive management of variable rate debt by colleges, especially those with lower credit ratings.

“Monitoring an institution’s management of its variable rate debt portfolio has become increasingly crucial as colleges and universities use variable rate debt more frequently, heightening their exposure to short-term risks associated with the debt structure such as volatile interest rates, accelerated bond payments, or collateral posting on swaps,” said Margot Kleinman, author of the report.

She said that the troubling characteristic of most of these risks is the severity of the impact should the event occur. “The credit quality of a Baa-rated college with limited liquidity could deteriorate rapidly–essentially overnight–and lead to a multi-notch downgrade if the college is required to make accelerated payments on bank bonds or is unable to rollover a bank liquidity agreement.”

“As a result, understanding of the detailed terms of counterparty agreements is critical to successfully manage the risks,” said Kleinman, whose report also outlines Moody’s approach to credit analysis of institutions with variable rate debt. Key areas of focus are: budgeting and cash flow, balance sheet liquidity, terms of bank liquidity agreements, and management’s assessment of debt structure risks.

Moody’s reports that, as of last year, 73 percent of Moody’s-rated private colleges and universities were issuers of variable rate debt, and 29 percent of those institutions issued at least 50 percent of their bonds in a variable rate mode.

The report, “Risks of Variable Rate Debt No Longer Hidden,” is available at moodys.com.

In general, though, variable rate debt was a big part of what got us into this mess, and I hope the share of Williams’ debt that is variable-rate is not too high.