Help Wanted: Volunteers to help tar and feather the idiots on these
school boards who thought highly leveraged derivatives like CDOs were
a good investment strategy for school district funds. Free beer and
pizza provided to qualified individuals. The successful candidates for
this position will have the physical strength to ride said idiots out
of town on a rail.
..
..d
Five Milwaukee area school districts may need taxpayers' help to avoid
default if CDO investment schemes sour.
"Taxpayers have no need for concern," said Waukesha School Board
member Daniel Warren, chairman of the board's finance committee. "It's
a very conservative, well-thought-out investment instrument," he said.
But some experts are skeptical about governments investing in CDOs.
The Milwaukee Journal Sentinel Online
Original Story URL:
http://www.jsonline.com/story/index.aspx?id=735976
JOURNAL SENTINEL WATCHDOG RE****T
Schools in risky business?
5 districts may need taxpayers' help to avoid default if investment
schemes sour
By AMY HETZNER and AVRUM D. LANK
ahetzner@[EMAIL PROTECTED]
April 5, 2008
Five Wisconsin public school districts have made an investment gamble
that could force taxpayers to finance multimillion-dollar bailouts.
The districts - Kenosha, Kimberly Area, Waukesha, West Allis-West
Milwaukee and Whitefish Bay - have piled up debt in deals to help fund
health insurance and other non-pension benefits for retirees. But as
global financial markets have seized up, the districts have been told
the value of their investments has fallen so much that they might need
to come up with a combined $53 million to avoid default.
Specifically:
* Kenosha might need almost $8 million in additional collateral or
risk default on $28.7 million.
* Kimberly might need to put up $1.5 million more or risk default on
$4.3 million.
* Waukesha might have to come up with more than $13.3 million in
additional money or risk default on $50.5 million in bonds.
* West Allis-West Milwaukee might need to come up with $26.8 million
or risk default on $72.4 million in bonds.
* Whitefish Bay might need to come up with $3.8 million or risk
default on $9.7 million.
The investments, in controversial instruments known as collateralized
debt obligations, highlight the bind confronting many school districts
and municipalities, which face liabilities from retirement benefits
promised decades ago and are struggling to pay for them without
raising taxes.
The districts believed they were taking only a small risk by borrowing
money at rates lower than the returns they expected from the CDOs. But
if the investments don't pan out and the districts have to come up
with more money to fix them, taxpayers could be responsible for paying
for even more debt.
Taxpayers have no need for concern, said Waukesha School Board member
Daniel Warren, chairman of the board's finance committee. "It's a very
conservative, well-thought-out investment instrument," he said.
But some experts are skeptical about governments investing in CDOs.
"They require deep and skilled analysis to understand, and unless the
municipality employs its own specialist with specific analytical
capabilities, it should otherwise only hold such things if purchased
for them by a professional asset manager," Eric Jacobson, a bond
analyst for Morningstar Inc. in Chicago, said after reviewing the CDO
prospectus. "To buy an instrument of this type . . . without any
special knowledge or ability, at the recommendation of a broker, is a
very poor and arguably reckless decision."
None of the school boards that went forward with the arbitrage deals
hired an adviser before proceeding, though that action is recommended
by the Government Finance Officers Association. The association also
advises caution before government entities borrow money to help fund
their retirement liabilities. Now, most school districts pay for such
costs from their annual operating budgets.
The Journal Sentinel learned details of the deals from public
do***ents, as well as interviews with school board members and
business officials in each of the five districts.
Officials in some other Wisconsin districts who had been approached
about making similar deals said they held off because of concern about
the risk and complexity. Each transaction involved a stack of
do***ents about a foot high.
"I'm somewhat wary of it, frankly," said Michael Barry, assistant
superintendent of the Oconomowoc Area School District.
Deals started in 2006
School district business managers said that for the CDOs to ultimately
pay off at below their original value, about a half-dozen of the
companies whose bonds they contain would have to default on their
debt. So far, none has.
"We have to wait it out," said Robert F. Kitchen, chairman of the
Business Services Committee of the West Allis-West Milwaukee School
Board. "We took the investment out on a seven-year basis."
The deals started in 2006, when a European bank, DEPFA Bank Plc of
Dublin, Ireland, lent about $165 million to trusts established by the
districts. The districts also contributed money to the trusts, much of
it borrowed. The trusts then invested the money in CDOs put together
by the European branch of a Canadian bank and issued by an
organization in the Cayman Islands.
The trusts, which are controlled by the districts, were told that they
would make more interest on the CDOs than they would pay for the money
they borrowed. That has indeed happened, allowing them to build up
reserves to pay the retirement benefits.
But CDOs - which are bundles of debt that can range from cor****ate
bonds to subprime mortgages - are at the center of the global
financial turmoil that has brought down some major companies in recent
months. The value of many such investments has fallen as global
interest rates changed and credit problems spread beyond Wall Street.
As a result, the five districts have been told that they may have to
put up millions of dollars in additional collateral to cover the
approximate difference between the value of their loans and the
currently reduced value of the CDOs.
Officials from the districts said their CDOs contain no direct
investments in subprime mortgages, but rather securities from credit-
worthy companies. However, when asked if some of those companies might
have made subprime investments, Thomas E. Griggs, the Milwaukee
attorney representing the five districts, said, "I don't think that is
an unreasonable assumption."
In addition, the managers of the CDOs periodically change what they
contain.
The odds are that the districts will get their money back, said Bill
Johnston, director of finance for Kenosha Unified School District No.
1.
"But it's not guaranteed," he said. "I guess it would be guaranteed
for the companies in the CDO that are still solvent" when the deal
ends.
Talks with trustees
District officials and Griggs have been talking with trustees for the
bonds held by the bank that lent them the money, but so far, no public
announcement has been made on how those talks went.
"We should not ever have to borrow the money" to pay for a drop in
value of the CDOs, said Erik Kass, executive director of business
services for Waukesha. "But, again, this is an investment, and there's
a possibility where if the economy were to go back to the '30s
depression, we'd have to borrow the money."
The Kimberly Area School District is not doing anything, said Gary
Kvasnica, director of business services for the district. "We don't
plan on selling" the CDO, he said. "The intent is to hold it until it
matures."
But Dave Wagner, senior vice president of Ehlers & Associates Inc., a
government financial adviser in Brookfield, said that if the
valuations being placed on the CDOs are correct, then it is easy to
believe "you would not be made whole" when they mature.
Complicating the situation is that, in addition to the money borrowed
by the trusts, the districts have contributed between $1 million and
$15.7 million each to the trusts. In the cases of Kenosha, Waukesha
and West Allis-West Milwaukee, much of it was borrowed on the general
obligation of the taxpayers. If the trusts were to default, that would
still have to be repaid through the property tax levy.
To shore up their collateral and avoid default, the districts could be
forced to issue even more bonds. And some have taken steps that would
allow them to do so.
Between last summer and this winter, the West Allis-West Milwaukee,
Waukesha and Kenosha school boards passed resolutions that could move
the responsibility for coming up with additional collateral to their
general obligation and put the responsibility for paying off the loans
squarely on their taxpayers, if the CDOs don't pay full value when
they mature. The school boards did so in Waukesha and Kenosha with the
understanding that the new collateral would be used for future
investments.
But within a month of the Waukesha board passing a resolution
authorizing $40 million in additional borrowing, district officials
received the call for additional collateral for the existing CDOs.
The value of the bonds allowed by those resolutions could be counted
as collateral even if they are never issued, David Noack, the broker
who sold the deals to the districts, said at separate meetings of the
Waukesha School Board's Finance & Facilities Committee in November and
January.
At that point, he was working for Robert W. Baird & Co. Inc. of
Milwaukee, though when he put the deals together, Noack worked for
Stifel, Nicolaus & Co. Inc., a St. Louis brokerage.
Waukesha School Board member Joseph Como, a finance committee member,
said the most recent update on the health of the board's investment
before the January meeting came in the fall. "The re****t that we got
at that time was the financial vehicle itself was performing as
expected," he said.
At the November finance committee meeting, Noack also told board
members that while there was volatility in the overall financial
markets, he had all good news regarding the district's investments.
Other districts said they had little communication regarding the value
of their investments until receiving letters in February and March
saying they risked triggering a default. Whitefish Bay business
manager Shawn Yde said he had to call the trustee involved in the CDO
transactions before he was notified of the problem.
In Whitefish Bay, as the value of its investments dropped, Yde said,
the district added as collateral some of the value of life insurance
policies its trust holds on district employees. The policies were
purchased with borrowed money.
Kimberly did not borrow money to start its trust and has enough in it
to meet the collateral call, Kvasnica said.
Although Noack initially answered some general questions about the
school districts' investments, Baird later would not allow him to
speak and insisted on answering questions only by e-mail. Baird
spokesman John Rumpf referred many questions to Stifel as the original
placement agent for the deals.
After some preliminary conversations, Stifel officials declined
requests for interviews.
A DEPFA bank official did not return several phone calls.
Representatives of the bank's bond trustees also declined to talk.
A spokesman for the Royal Bank of Canada, which devised the CDO, took
questions but never called back with answers.
"This part of the market is deliberately opaque," said Jacobson, the
Morningstar bond analyst.
Pitched as conservative
School officials said the pitches they received from Noack ****trayed
the deals as extremely conservative with near-guaranteed results.
They compare the risks involved favorably to other possible
investments, such as borrowing to play the stock market, a strategy
that Milwaukee County is considering to help pay its pension
obligations.
In the Elmbrook School District, officials are considering investing
in a plan that would buy life insurance policies at a discount and
profit when the insured die. They are pursuing the strategy with an
adviser from Baird.
According to Robert Borch, Elmbrook's assistant superintendent who is
looking into the situation, the returns are small for the amount of
time involved.
But school systems in Wisconsin have few other options, said Borch,
former president of the Wisconsin Association of School Business
Officials.
State-imposed revenue caps have clamped down on their ability to raise
taxes unless they appeal to constituents for extra money. They also
are not able to control the growth in non-pension retirement costs -
known as OPEBs, for other post-employment benefits - as they might
salaries and benefits of existing employees.
Outstanding OPEB liabilities pose a serious issue for school
districts, some more than others, said Todd Berry, president of the
Wisconsin Taxpayers Alliance in Madison. But borrowing money to solve
the problem should be approached carefully by school boards, he said.
Districts should remember when they hear pitches from financial
institutions that the businesses stand to gain substantially from fees
they charge on the transactions, he said. The Waukesha School District
paid nearly $540,000 in fees to Stifel and others for its retiree-
related investments, including about three times as much for attorneys
hired by the other parties involved than it paid for its own counsel.
"There are various financial institutions that are happy to loan them
money to cover their liabilities, and they are recommending borrowing
to cover the liability because it's a good business proposition for
the financial institutions," Berry said. "It may or may not be for the
school districts and the taxpayers."
From the April 6, 2008 editions of the Milwaukee Journal Sentinel
http://www.jsonline.com/story/index.aspx?id=735976
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