September 3, 2010 Update: The Denver Post published an article yesterday exhorting the budgetary savings achieved by DPS this year. According to the story, DPS will hire 30 to 40 new teachers to help ease class size concerns across the District. DPS is committing $2.5 million to support these hirings, but claims to have saved $30 million. It seems important to ask, where is the other $27.5 million going?
The timing of this announcement is curious, as there is a DPS School Board Finance and Audit committee meeting scheduled for Tuesday, Sept. 7th at 4:30 PM. During this meeting the public will have an opportunity to interact with Board members related to the District's financial status.
Also of note, The Denver Post story reports, "The nation's two credit-rating services, Moody's and Standards & Poor's, Wednesday reaffirmed high ratings for debt issued by Denver Public Schools, saying its pension debt has a stable outlook."
However, in its analysis, Moody's states --
The assigned ratings reflect the district's higher than average debt burdens and large exposure to variable rate debt obligations. Given the near-term potential for increased costs associated with the district's variable rate obligations (as discussed below), Moody's will closely monitor the district's progress in securing a new liquidity provider over the next several months leading up to the April 2011 expiration of the current standby purchase agreement.
According to The Bond Buyer, "The district's ratings have not been affected [by the 2008 transaction]. Standard & Poor's and Fitch Ratings maintain a AA-minus on DPS, while Moody's Investors Service rates it Aa3. All three ratings have stable outlooks."
S&P uses the AA rating for quality borrowers with a bit higher risk than AAA. (AA-minus is the lowest rating for AA status bonds.) Moody judges obligations rated Aa to be high quality, with "very low credit risk", but the borrower's susceptibility to long-term risks appears somewhat greater than Aaa bonds. Aa3 is the lowest rating for Aa standard bonds.
The potential costs for entering into a new liquidity provider contract to support the 2008 transaction have not been disclosed to school board members at this time, despite repeated requests from Jeannie Kaplan and Andrea Merida.
August 31, 2010
The [New York Times] article is full of inaccuracies and misleading uses of data: I count at least 18 factual errors in this poorly researched and highly slanted article....
-- Jill Conrad, former Denver Public Schools Board of Education member,
I have been pondering the ramifications of the New York Times article, "Exotic Deals Put Denver Schools Deeper in Debt," since it was printed on August 5, five days before the Democratic primary election. While the Times largely agreed with what I have written here on the Huffington Post, several news reports and blogs have contradicted the Times' reporting since the story's publication.
Many of the arguments against the Times' piece have relied on information contained in a letter and blog written by former DPS school board member Jill Conrad. I agree with John MacPherson's comment on her blog: Conrad likely didn't know much about the 2008 pension financing deal at the time she voted for it. (MacPherson is a former executive director of the DPS retirement system, and he opposed the deal's structure from the outset.) Now, however, Conrad holds herself out as an expert, giving 18 reasons the Times story was wrong.
The blog is useful, however, in that it neatly lays out Denver Public Schools' claims about the transaction. The letter and blog were undoubtedly co-written by DPS leadership and covers the District's stance on the 2008 transaction. So I will use Conrad's blog to examine many of the claims made about the DPS pension financing deal after the New York Times article was published.
Conrad's piece hinges on two elements: (1) the DPS pension needed to be fully funded for a merger with PERA to occur and (2) DPS is saving money as a result of the transaction. The both claims are promoted by Tom Boasberg and Michael Bennet. However, the claims are completely misleading.
- Nowhere does Senate Bill 09-282 say the DPS' pension system shall be fully funded prior to a merger. In fact, by the time the merger occurred in 2010, DPS' pension was again $386 million underfunded.
(For readers who want to revisit how the transaction came about, please see Chris Romer and the $1 Billion Retirement Question. I stand by every fact in this piece. The entire article is based on direct testimony from members of the PERA board or from John MacPherson, except where noted.)
- Ms. Conrad and DPS are correct: the District did pay off its $400 million pension debt, which was ever increasing because of the interest associated with this debt. However, according to the last DPS retirement system actuarial valuation, DPS' retirement system is again underfunded by at least $386 million, which is accruing interest at 8% per year, the new interest rate established by PERA for 2010. Thus, while DPS' debt could be larger, it is still paying $31 million per year on the pension's $386 million unfunded liability.
Look at it this way, if you pay off $10 grand on your Visa, but then the next month you put $10 grand back on it, have you saved money? Well, true, if you hadn't paid off the first $10 grand, you would now owe $20 grand. But essentially, you are still sending Visa a check each month to cover the interest on the $10 grand debt. Your cash flow hasn't improved. This is true for DPS as well, although it doesn't make monthly payments on the debt.
- DPS claims part of its $20 million per year savings result from refinancing its 1997 and 2005 PCOPs. This claim, however, must have been calculated by one of the District's non-proficient 10th grade math students. Essentially, DPS' claim would be like a home owner saying that, after refinancing his house, he can now claim the amount that would have had to be paid against the old mortgage as savings. The owner continues to pay his new mortgage. Worse yet, on the "mortgage" DPS refinanced using the 2008 PCOPs, the District would have paid approximately $30 million per year toward the debt's principal, thereby reducing its debt load. Instead, DPS is now paying, on average, $54 million in interest and fees per year, none of which is going toward the debt's principal. The interest on its old mortgage would have been approximately $33 million per year between 2008 and June 2010.
This last item is especially disturbing. By almost any standard, the decisions DPS made around the 2008 pension financing transaction do not constitute sound fiscal management of public money, but especially after the bond markets froze in January 2008.
It should also be noted that DPS did not actually fully refund the 1997 PCOPs, so it continues to pay a relatively small amount of interest on that debt as well. Moreover, as I state above, after 2017, the 1997 and 2005 debts would have been paid off. Now the vast majority of that debt will be carried by our schools until 2038.
The Michael Bennet/Tom Boasberg myth of "savings" resulting from the 2008 transaction being debunked, the rest of Jill Conrad's points easily fall apart. Let's look at some of the key issues.
- Conrad refutes the Times' assertion that, since it struck the deal, DPS has paid $115 million in interest and other fees, at least $25 million more than it originally anticipated. These numbers are easily verifiable. The first, $115 million in interest and fees, was provided to the school board in May by DPS Chief Operating Officer David Suppes. As for the statement DPS has paid $25 million more than expected, that number comes from page II.49 of the DPS Comprehensive Annual Financial Report for 2009.
(If you are curious about seeing this annual report, it can be found here. The 2010 DPS CAFR is expected to be released in mid November.)
An attorney I recently talked to about the 2008 transaction said, "Those numbers [provided by DPS] had better be correct, or DPS is in violation of Colorado's Blue Sky laws."
- The Times article states, "While it is possible that the annual costs of the Denver deal will come down in the future, they are now roughly in line with what the school system would have paid in a fixed-rate transaction." Conrad reports that DPS could have obtained financing at a 7.25% interest rate, and that DPS is now paying 6.1% on its transaction.
I have no idea what DPS' potential fixed rate might have been, but Conrad's 6.1% number is misleading. DPS' interest rate for the 2009/2010 school year was 6.1%. In 2008/2009, the interest rate was 8.6%. Over the life of the transaction, DPS has incurred a 7.12% rate based on variables associated with the transaction. This rate is likely to increase, rather than fall, as DPS has budgeted $64 million to serve costs associated with the 2008 PCOPs for the 2010/2011 school year. If this amount is spent, DPS' overall interest rate will be approximately 7.75%.
All of this taken together, the District is in direct violation of the Board of Education's resolution for entering into the 2008 transaction. This resolution states that if, at any time, DPS' interest rate exceeds 7%, the District's management is to return to the Board to reexamine the deal.
This has not happened to date, all though Jeannie Kaplan has been requesting information about the transaction since July 2008 (see Bennet - Boasberg email trail on the Banking Derivative Swap). It is unclear what the legal ramifications are for this apparent breach of fiduciary duty, but I would bet there will be none given DPS' current lackluster form of governance. No one appears to be driving the DPS school bus, with the exception of a couple of vilified school board members who keep asking questions.
- Conrad takes exception to the Times' statement, "The Denver schools essentially made the same choice some homeowners make: opting for a variable-rate mortgage that offered lower monthly payments, with the risk that they could rise." She claims that DPS' rate was fixed via the interest rate swap, stating "The transaction structure is the opposite of a variable rate mortgage where the homeowner is subject to rises and falls in interest rates."
Actually, Conrad clearly does not understand the 2008 transaction as a whole. DPS attempted to enter into what is called a "synthetic fixed-rate swap," that, when structured correctly, fixes the borrower's interest rate. However, DPS' swap is not structured correctly.
Under the swap, DPS sends $36.4 million per year to its swap counterparties, or 4.859% of $750 million. DPS receives back an amount based on a London financial index called the LIBOR. Last month, DPS received a rate of 0.33% on $750 million. For the month of July, DPS sent $1.17 million to J.P. Morgan and its other swap counterparties. It received $210,000 back. The difference is the swap counterparties' profit for the month of July, which is the reason Wall Street loves swaps
While this sounds terrible for DPS, it actually is just the nature of the business. No matter what happens to interest rates, DPS will pay $1.17 million in a 31-day month, slightly less in months with 30 days. The rate is a fixed cost of the transaction. J.P. Morgan and the other swap counterparties are a risk if interest rates rise, not DPS.
However, in the type of swap DPS entered into, the amount received from the swap counterparties should equal the amount DPS has to pay its bond holders for holding its debt, say the LIBOR plus 0.5%. The 2008 DPS swap does not include this, however. As a result, DPS' interest rate varies based on the rate it has to pay its bond holders. DPS' costs are, therefore, not fixed.
This is where DPS got into trouble: when the bond markets went haywire in 2008 and 2009, DPS had to sell its bonds at interest rates way above the LIBOR. In one week in September 2008, DPS received a swap interest rate of 3.42% from J.P. Morgan but had to pay its bond holders 14%. Weeks like this are what cost DPS $25 million above what it expected to pay in 2008/2009.
- The Times article states, "...had the school district issued fixed-rate debt, it would not have paid Wall Street the cornucopia of fees embedded in the more complex deal." This statement could not be truer. For example, DPS has paid $3.8 and $5.9 million during the first 2 years of the 2008 transaction. These fees are reoccurring each year and depend on market conditions to set their amounts. So, Conrad's claim that, "...the fees would have been the same whether the debt was fixed or variable" is not accurate.
- Conrad takes issue with the Times' claim that getting out of the swaps will be extremely costly. According to Conrad, the fees are actually a make-whole payment should DPS want to get out of the swap agreement.
Technically, Conrad is correct about this. If the LIBOR were greater than DPS' 4.859% interest rate and one of the swap parties wished to exit the swap, the banks would have to make a payment to DPS. The fact remains, however, if DPS wants to get out of the swap based on current market conditions, it will cost taxpayers $81 million, all of which will go to JP Morgan, Bank of America, and the Royal Bank of Canada. Call it a make-whole payment or a fee, the $81 million is what the fact is, no matter how Conrad wants to spin it.
- Conrad also disagrees with the Times' statement that, "While the pension's merger with the state system allows Denver's school system to avoid paying interest on shortfalls, that benefit is temporary. If a shortfall still exists in 2015, the merger requires that it be closed." Conrad simply states, "False." She then goes on to correctly state that, "DPS must continue to pay interest on the shortfall, which is known as a UAAL payment." She then adds:
[The] Article fails to note that Cavanaugh and Macdonald, the independent auditor to PERA, the state pension fund, have projected the DPS pension fund will be 140% funded at the end of the current 30-year project period. The auditor also found that the district's pension fund was significantly better funded than the statewide division and all of the other school districts, and would be fully funded years before the rest of the school division would be.
This is the subject for a whole blog in itself, but simply put, the Cavanaugh Macdonald study is based on some very optimistic assumptions that, given our economic climate, seem pretty unlikely. These assumptions include (1) teachers getting a 4.5% salary increase per year for the next 30 years, (2) DPS doubling its number of hourly employees beginning this year, (3) PERA investments returning at least 6.5% per year, and (4) Cavanaugh Macdonald's liberal actuarial practices associated with reporting unfunded liabilities not impacting the pension system in the long run.
I hope Conrad is correct, but, these issues taken together, I wouldn't count on it.
For example, due to economic conditions this year, (1) DPS teachers received no raise, (2) DPS has budgeted hourly employees at about half the salary used in the Cavanaugh Macdonald evaluation, and (3) the DPS retirement system had a return on investment of 4.8% in 2009, and I wouldn't expect much better this year.So, you can choose to take Jill's word for the fabulous state of DPS' pension system, but I wouldn't bet my retirement on it.
In summary, Conrad states --
The fact remains that this transaction has positioned DPS, its employees, and most of all its students to be better off in the long run than they would have been if we had not taken action. I was proud to be a part of the [2008 PCOPs] decision then, stand by it now, and am grateful for the leadership and vision of Michael Bennet, Tom Boasberg, and my fellow board colleagues....
Based on the information provided by DPS' management to date, we can conclusively say the 2008 PCOPs have cost $115 million as of April 2010, at least $25 million more than expected, as established by DPS' most recent audited financial records.
Further, the majority of Conrad's claims are grossly misleading. Likely these claims were regurgitations of information supplied by DPS when unfavorable information was printed about District management and the school board. Moreover, I argue that many of these claims are outright lies based on the information uncovered to date by the New York Times, Jeannie Kaplan, Guerin Green, Wade Norris, and myself.
(If you are still skeptical about our findings, check out this article in the trade publication Bond Buyer, Denver Schools Defends Derivatives. Don't know the Bond Buyer? Well, it is a century-old daily national trade newspaper focused on covering the municipal bond industry and the go-to source for information on municipal financing transactions.)
In the end, there can be no doubt that DPS management team and the majority of school board members have not complied with requirements set forth by the Board's own resolution authorizing the 2008 transaction. Why? These requirements were established in part by Jill Conrad herself. They were also unenforced while Conrad was secretary of the Board of Education. Of course, during that same time frame, Theresa Pena was president of the board. She is now Michael Bennet's campaign treasurer.
If you wonder why your education tax dollars seem to go nowhere in Denver, welcome back to school, DPS style.
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