Fitch Comments on Massachusetts Turnpike Auth MHS Swaptions

Business Wire, Dec 19, 2002

Business Editors

NEW YORK--(BUSINESS WIRE)--Dec. 19, 2002

Swaption transactions executed by the Massachusetts Turnpike Authority's (the authority, or the turnpike) Metropolitan Highway System (MHS) provide a near term cash benefit to the authority. Fitch Ratings, however sees the potential for greater financial pressure in the longer term resulting from the MHS' exposure to variable rate, basis and termination payment risks. The manifestation of these risks may also accelerate the deterioration of credit quality during a period of fiscal stress. The authority's approach to manage its risk exposure includes the execution of two offsetting swaptions, which include a Dec. 2, 2002 fixed to floating rate transaction with Lehman Brothers on a notional amount of $800 million and a floating to fixed rate swaption executed on May 31, 2001 with UBS AG involving the same notional amount, and the establishment of a hedge fund reserve, which is expected to equal $14 million by 2007.

The swaptions, which involve 35% of the authority's $2.2 billion in outstanding MHS bonds and include some maturities for the series 1997A senior bonds ($207.7 million), series 1997B subordinated bonds ($126.7 million) and series 1999A subordinated bonds ($465.6 million), give Lehman Brothers and UBS AG separate rights to activate their respective swaps with the authority during a ten-year period beginning January 1, 2007, or January 1, 2009 depending upon the particular bond. The maturity of the swaps is tied to the anticipated maturity schedule of the floating rate refunding bonds that the authority could issue upon exercise of the UBS swaption. In consideration for these transaction, Lehman is paying the authority a cash benefit equal to approximately $35.2 million paid out annually through 2007, UBS AG is paying to the authority $22 million in annual installments, plus premiums for a forward commitment to issue bond insurance upon issuance of the floating rate refunding bonds.

The authority entered into these transactions as a strategy to address the near term financial constraints facing the MHS resulting from the effects of the economic downturn, the aftermath of Sept. 11, 2001, a delayed toll increase and an unexpected toll discount program. In the longer term the MHS will be contending with increased debt service and operating expense obligations associated with the completion and operation of the Central Artery/Tunnel (CA/T). As a result of these near term and long term challenges, Fitch downgraded the MHS' senior and subordinated bonds to 'BBB '/ 'BBB', respectively, from 'A'/ 'A-' on Oct. 23, 2002.

However, the MHS may face the prospect of additional financial pressures if its variable rate and basis risk exposure associated with the potential exercise of the swaps is greater than expected, or the offsetting swaps are not simultaneously exercised. The turnpike's ability to address these risks could be limited, given its increasing debt service and CA/T obligations. In addition, the presence of these risks could lead to a further decline in credit quality during a period of downward financial pressures. For example, one of the events where the Lehman swap could be terminated is if the rating on the MHS' senior bonds falls below 'BBB' by Fitch, or the rating on the subordinated bonds falls below 'BBB' by Fitch and the comparable rating by another agency rating the subordinated bonds. If the swap were to be terminated, the authority may be required to make a termination payment.

Given the current and expected financial constraints facing the MHS, Fitch expects the authority to closely monitor and manage its swap program. Fitch will also monitor the status of the swap program as part of its ongoing surveillance of the MHS bonds.