Future of Malachi swap unknown

Published 12:39 am Sunday, March 25, 2012

NATCHEZ — The City of Natchez has received $325,160 to date from a complex 2006 financial transaction agreement with a Georgia company and is hoping to get another $300,000 in cash from a recent modification to that agreement.

The original interest-rate swap transaction was executed in 2006 with Malachi Financial Products and refinanced the 1999 bond the city issued to build the Natchez Convention Center.

The Bank of New York is the lead agency in the swap, and New York-based Rice Financial Products is also involved in the swap. The city’s outside legal counsel is Tony Gaylor of the Jackson-based Chambers & Gaylor firm.

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After paying all transaction and legal fees to all parties involved, the city received approximately $170,000 of the $400,000 generated from the swap in 2006 to pay toward debt service.

City officials originally thought when Malachi presented the city with a ceremonial check for $400,000 in 2006, they would receive all of the $400,000. Mayor Jake Middleton, an alderman at the time, said he was disappointed with how the transaction was handled.

A bond swap is a complicated financial transaction in which one entity, in this case the city, agrees contractually to “swap” a payment usually based on a fixed-rate interest index, with another entity whose payment is usually based on a variable rate.

In this case, the city agreed to pay the interest equivalent to the Bond Market Associations index. The bank agrees to pay a percentage of another interest index, the London InterBank Offered Rate, or LIBOR.

Historically, this swap will yield profits for both since the new bond agent assumes the city’s bonds, which are originally issued at a relatively low, municipal rate, the agent can generally earn a higher rate on its money. The difference is split between the two parties.

Since the swap is tied to the difference between those two interest indexes, changes in the interest rates will affect the payments and the potential profits.

That gap could also shrink if federal tax code were to be drastically changed, and municipal bonds lose their tax-exempt status. If marginal tax rates decreased, revenue from an interest-rate swap could dip.

Natchez City Clerk Donnie Holloway said if interest rates increased, the city would have to start paying the entity that purchased the bonds.

Holloway said, fortunately, a “collar” the Natchez Board of Aldermen recently elected to place on the most recent swap modification locks in the current interest rate for three years and will take away the city’s risk of losses in the event interest rates fluctuate. The city would also have the option of reviewing the swap every six months and deciding whether it wanted to continue it.