MuniLand

Denver’s high interest payments are its own fault

The Denver Business Journal is reporting an astonishing story about the Denver Public Schools paying 6.17 percent interest on $396 million of floating rate bonds that were part of a larger bond offering in 2011. The bonds were issued to fund a required contribution to the school system’s pension fund:

Denver Public Schools finance officials say they aren’t ready to refinance the $396 million variable-rate portion of a controversial $792 million pension bond deal, despite historically low interest rates on municipal bonds.

The variable-rate pension certificates of participation (PCOPs) have performed “better than expected” since they were refinanced in April 2011, said David Hart, CFO of the district.

DPS has paid 6.17 percent interest on the variable-rate PCOPs since April 2011, lower than its anticipated interest cost of 6.42 percent, he said.

The bonds, due in 2037, are rated Aa3 by Moody’s and were issued to refinance an earlier variable-rate bond deal from 2008. The earlier bond offering was backstopped by Dexia, the Belgian-French firm that encountered substantial credit problems. The question for Denver taxpayers: Why is the school district paying such a high interest rate? And why doesn’t it refinance? Current interest rates for comparable bonds at the same rating level and maturity would be 3.99 percent, according to Thomson Reuters Municipal Market Data. The cost difference between 6.17 percent and 3.99 percent for the $396 million in debt would $8.6 million per year, or about $215 million over the term of the bonds. That extra $8 million per year could hire a lot of teachers.

Detroit’s derivatives slip through the net

If you were thinking of buying some of the city of Detroit’s bonds, you might want to tread lightly. Although the city was able to come to terms with the state and avoid the appointment of an emergency manager, it still faces enormous challenges. The biggest threat to Detroit’s fiscal stability is the risk that its derivatives counterparties will activate triggers in their interest rate swaps. If this happens, the counterparties will force a lump-sum payment, draining cash from an already shaky situation.

From the outside it’s difficult to know exactly what is happening in the city. A recent Moody’s report says that counterparties may have already activated these triggers, but it’s impossible to get any public information from the city. There is a big regulatory gap or loophole that shields Detroit from having to tell investors, or their citizens, the status of these derivatives contracts.

Here is how I described the situation facing Detroit on Mar. 24:

Detroit has about $3.8 billion in interest-rate swaps outstanding, according to its most recent public filing (CAFR of June 30, 2011, page 113). These Wall Street weapons of mass destruction were sold to the city in a series of transactions since 1997, allegedly to hedge interest-rate risk….

Muni CDS goes ‘bang’

The use of credit default swaps in muniland is poised to take off, a project that’s being called the “U.S. Municipal CDS Bang.” Starting Apr. 3, the terms and conditions of new muni CDS have been standardized with the stated intent of creating a useful risk-hedging product. This project is being driven not by regulators but by Markit, a private market-data vendor, and the International Swaps and Derivatives Association, a global consortium of Wall Street banks. But it’s not so clear that this is what the market needs at this time.

Although the muni CDS market is unregulated, the SEC is set to implement new rules (§§763 and 766) in the second half of 2012, according to the schedule posted at the agency. Even that may be optimistic, as a lot of the SEC’s deadlines for Dodd-Frank rule-writing have slipped. Nevertheless, it’s curious that these changes to muni CDS contracts are being introduced ahead of the SEC’s rules. In most instances, banks and dealers wait until the regulatory framework has been established before rolling out new products, which is what happened with the Volcker Rule.

Municipal CDS do not trade publicly, nor do they have publicly available pre-trade or post-trade information. All available pricing information for muni CDS comes from Markit, the privately held market-data firm in London. When I asked for details about the firm’s ownership, Markit was unable to provide them. Instead, the firm referred me to Companies House, the UK equivalent of the SEC’s Edgar filing service. From their required filings at Companies House, I discovered that the banks that provide the pricing information for muni CDS are mostly the same banks that sit on the Markit Board of Directors and the Determinations Committee of ISDA, the organization that decides if an event that occurs in the underlying reference bond should trigger a payout of the CDS.

Green shoots?

Green shoots?

Reuters reports on recent data from the U.S. Census Bureau that shows how tax revenues are improving:

State and local governments brought in record first-quarter revenues this year, according to a Census Bureau report released on Tuesday that offered a sign their budget crises may be abating.

Total state and local revenues for the first quarter reached $321 billion, a 4.7 percent rise from the first quarter of 2010 and the highest level on records going back to 1988. It marked “the sixth consecutive quarter of positive year-over-year growth,” the Census said.

Muni sweeps: Riding the Federal cash flow

It’s an important week  for the fixed income markets: Ben Bernanke, the chairman of the Federal Reserve, will hold his first press conference on Wednesday.

Bernanke joins his European Central Bank counterpart Jean Claude Trichet in the practice of fielding questions after the central bank announces its policy stance.

Pundits and bloggers are weighing in with questions and Reuters reporter Kristina Cooke (twitter handle @kristinacooke) is encouraging her followers to tweet her questions for the chairman.

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