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.

Playing the pension game

Two national stories yesterday shed light on the foolishness that’s taking place on the fringes of the public pension world. The first story, from the Los Angeles Times, is about pension obligation bonds – a classic tale of fancy, Wall Street-devised products that promised more than they could deliver. The second story, from the New York Times, is about a scheme, dreamed up in an ivory tower, of having state government pension plans take over responsibility for the pensions of corporate retirees. The mind reels at the complexity and difficulty of this idea.

Nathaniel Popper of the LA Times does an excellent job of describing the speculative risks that state and local governments take by borrowing in the bond markets to fund their contributions to their pension plans. Pension obligation bonds are a form of interest-rate arbitrage: a municipal issuer borrows at, say, 4 percent and invests these funds in its actively managed pension plan. The hope is that the funds will earn higher rates of return, usually from investments in the stock markets. It’s basically a way of borrowing to speculate, but since Congress won’t allow municipalities to do that using tax-exempt bonds, a new approach was developed. The LA Times says:

Congress made it illegal in 1986 to issue normal tax-exempt municipal bonds for this type of speculation, but municipalities and their outside advisors realized they could get around this by issuing taxable bonds, like corporations. These bonds come with higher interest rates, but many local government officials have believed they could earn enough from investments to come out on top.

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