Colo. Senator Michael Bennet’s ‘Exotic’ Financial Deal Cost Denver Public Schools Millions In Interest, Wall Street Fees; Leaves Schools Deeper In Debt

The New York Times just published a lengthy and analytical front page article about Colorado appointed Senator Michael Benet’s failed  scheme to shore up $400 million in unfunded pension liabilities when he was  Superintendent of the Denver Public Schools.   The disclosure of the disastrous deal has the potential to derail Bennet’s Senate campaign.   The article confirms Dem rival Andrew Romanoff’s  Wall Street manipulator image of Bennet, and will  benefit  the winner of the Ken BuckJane Norton Republican primary duel should Bennet win the Democrat primary on August 10.

The deal was similar to a variable rate loan, and went bust with the financial crisis.  But built in contractual fees made the deal sweet for Bennet’s former colleagues in the investment banking business.

The bankers [JPMorgan Chase] said that the school system could raise $750 million in an exotic transaction that would eliminate the pension gap and save tens of millions of dollars annually in debt costs — money that could be plowed back into Denver’s classrooms, starved in recent years for funds.

To members of the Denver Board of Education, it sounded ideal. It was complex, involving several different financial institutions and transactions. But Michael F. Bennet, now a United States senator from Colorado who was superintendent of the school system at the time, and Thomas Boasberg, then the system’s chief operating officer, persuaded the seven-person board of the deal’s advantages, according to interviews with its members.

Rather than issue a plain-vanilla bond with a fixed interest rate, Denver followed its bankers’ suggestions and issued so-called pension certificates with a derivative attached; the debt carried a lower rate but it could also fluctuate if economic conditions changed.

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, instead of a conventional, fixed-rate mortgage that offered larger, but unchanging, monthly payments. …

Bennet claims in the article that they didn’t have any idea the financial crisis was looming, but the NYT’s Gretchen Morgenson  points out that Bear Stearns had just gone under a few weeks before the deal was inked by the school board.   The deal quickly headed south.

In short order, the transaction went awry because of stress in the credit markets, problems with the bond insurer and plummeting interest rates.

Since it struck the deal, the school system has paid $115 million in interest and other fees, at least $25 million more than it originally anticipated.

To avoid mounting expenses, the Denver schools are looking to renegotiate the deal. But to unwind it all, the schools would have to pay the banks $81 million in termination fees, or about 19 percent of its $420 million payroll.

John MacPherson, a former interim executive director of the Denver Public Schools Retirement System, predicts that the 2008 deal will generate big costs to the school system down the road. “There is no happy ending to this,” Mr. MacPherson said. “Hindsight being 20-20, the pension certificates issuance is something that should never have happened.”

A spokesman at JPMorgan, which led the Denver deal, declined to comment. Royal Bank of Canada, which acted as the school system’s independent adviser even though it participated in the debt transaction, declined to comment. Denver school officials said that they had agreed to sign a conflict waiver with Royal Bank of Canada.

How cozy.   And it was the supposed Wall Street expertise of Bennet that got him the job as schools Superintendent and praise for his education system expertise from Barack Obama.

Unlike many school district officials, both men were financially sophisticated and had worked together in the private sector. Mr. Bennet handled investments and structured financial deals for the Anschutz Investment Company, a private concern owned by the billionaire Philip Anschutz that has stakes in telecommunications and oil. Mr. Boasberg, meanwhile, was a deal maker in mergers and acquisitions at Level 3 Communications, a telecommunications concern.

Exotic Deal Had a Spicy Recipe

But the deal was too clever by half.

Joseph S. Fichera, chief executive of Saber Partners, a financial advisory firm that specializes in structured finance, said that the type of transaction pursued by the Denver schools was a false solution for what the issuers want to achieve — lower long-term costs — because the banks selling the deals rarely quantified all of the potential risks involved.

“The issuer [DPS] made a simple financing highly complex and took on substantial risk without knowing how large its downside could be,” he said, referring to the Denver deal. “The advisers and bankers may have disclosed that there were risks, but apparently did not help the issuer truly understand them. They typically present economic outcomes to the issuer only on projected savings and assume away any chance of the risks happening.”

The Times takes Bennet to task for claims that the JPMorgan Chase scheme is actually saving the DPS money.  And school board members contend that the downside risks of the deal were not adequately spelled out by the investment bankers who met with them or by Bennet.

But the savings cited …do not take into account termination fees associated with the complex deal. And had the school district issued fixed-rate debt, Wall Street would not have received the cornucopia of fees embedded in the more complex deal.  (Emphasis added). …

So far, Denver has paid about $9.7 million more in fees for its deal than it would have had it chosen a simpler transaction. …

Agreeing to be locked into a 30-year contract, as public entities have done, is especially costly because getting out of it requires paying penalties to the banks for every remaining year of the transaction.

Debt structuring expert Andrew Kalotay asks a rhetorical question about Bennet’s DPS deal:

“Why would the school district want to do this transaction with all the attendant risks of mispricing and the possibility of unfavorable unwind costs when they could have done a conventional, taxable fixed-rate deal?” he asked.

The Times appears to provide the answer in the next sentence:

Bankers, however, love these deals. In addition to the enormous termination fees they can snare, bankers also get remarketing fees and swap advisory fees.

Termination fees, however, top them all. Like the punishing prepayment penalties some homeowners have to come up with when paying off a mortgage early, termination fees on deals like Denver’s are essentially charges levied to rewrite the terms of a contract.

Though not explicitly saying Bennet engaged in any self-dealing, DPS board member Jeannie Kaplan felt the board was not well served by Bennet and Boasberg:

“Bennet and Boasberg had been presented as financial saviors of the Denver school system, and I sat there wanting to believe what they were saying,” she said. “The board probably should have had their own financial consultant.”

Despite the debt financing, Denver Public Schools barely made a debt in its pension fund liability.  With the plunge in the stock market, DPS still has a hole in its pension fund of about $386 million.  Nothing like having Wall Street financiers in the school system.  Just think what Bennet could do with another six years in the Senate.

One response to “Colo. Senator Michael Bennet’s ‘Exotic’ Financial Deal Cost Denver Public Schools Millions In Interest, Wall Street Fees; Leaves Schools Deeper In Debt

  1. Swimming with Sharks( Wall Street fee milkers)
    reallly fleeced the pensions of 1,000 of teachers. Exotic deals seems to exist in an
    tandem relationship to Wall Street money dumped into Bennet’s campaign coffers.
    There was a wavier of conflict of interest associated with the deal.
    Bennet is no financial guru, it is sad how he put shark’s interests over the school districts and their teachers.
    This is scadalous.

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