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Sunday, January 25, 2009
State Bond Deal Loses Its Luster
By Colleen Heild And Mike Gallagher
Copyright © 2009 Albuquerque Journal
Journal Investigative Reporters
They were touted as a state-of-the-art financing tool that would help New Mexico stretch its highway improvement dollars.
Nearly five years later, state officials are trying to keep the $420 million in fancy financing from turning sour.
In the last six months, one of the banks involved in the so-called interest rate swaps has gone bankrupt and the state has had to post about $16 million in collateral because the value of the investments dropped.
That's in addition to major political fallout. The swaps and how a California company was selected to handle them are at the center of a federal grand jury investigation that derailed Gov. Bill Richardson's nomination as commerce secretary.
State finance officials said last week that, given the current economic climate, they may try to renegotiate the complex contracts. There has also been talk of bailing out of them all together.
"They were originally envisioned to (last 20 years), but it's very possible they will be terminated before that time," said John Duff, chief financial officer for the New Mexico Finance Authority. "We certainly are exploring the alternatives."
For the time being, the state is trying to maintain the status quo because the price of getting out of the investments is high — $60 to $100 million at the outset, with long-term increased interest rates.
Meanwhile, questions have arisen as to why the state's interests weren't better protected in the swap transactions.
CDR Financial Products of Beverly Hills, Calif., was hired in March 2004 to be the state's adviser on the swaps at a time the company and its president were contributing to Gov. Bill Richardson's political committees.
Both CDR and Richardson contend the process was competitive and no wrongdoing occurred.
The financing, which also included $1.1 billion in fixed rate bonds, provided $1.6 billion for Governor Richardson's Investment Partnership. The money has helped pay for a wide range of road projects and the Belen to Santa Fe Rail Runner commuter train.
CDR was paid more than $950,000 out of bond proceeds, but Finance Authority boss Bill Sisneros, who took over after the initial deal with CDR was done, says the company's role in the bond transaction isn't clear.
He said, "CDR was paid by the counter-parties in the swaps, so there is a question of who they were advising." The swaps have saved the state about $8 million in lower interest costs since they were approved in 2004, Duff said.
However, the financial crisis that began in November 2007 and continues today makes the swap agreements riskier for the state.
The state Transportation Commission held an emergency meeting last month to approve a $30 million line of credit because the state unexpectedly had to post about $16 million in collateral on the swaps.
The collateral payment will be returned if market conditions improve, but in a best-case scenario the state must still pay interest on the line of credit. That tab so far is $17,000 with the money coming from state road funds, Duff said.
Though market conditions have been more favorable in recent weeks, Duff said, "that may not continue."
One NMFA document obtained by the Journal said the state could end up paying more than $200,000 annually in interest.
Why collateral?
The state is being required to post collateral under terms of the original swap contracts it agreed to, but Duff said his agency has since been advised the state should not have been required to post collateral at all.
"We've been told that in 2004 (when the swaps were made) and as recently as 2008, a party with the credit rating of the state Department of Transportation wouldn't have been expected to have to post collateral," said Duff, who joined the agency in 2006.
Generally, collateral is required in case of default.
Who was responsible for the collateral provision?
"We have no idea," said Duff, adding that no one currently working at the NMFA can say and those who might know have long since left the agency.
NMFA officials have found few records on file relating to swap negotiations, he added.
Officials are seeking short-term solutions to keep the swaps intact while investigating the specific risks they pose.
The NMFA doesn't enter into swaps anymore.
"Certainly in the last year, market conditions have made them uneconomic," Duff said.
But in 2003 and 2004, officials at the NMFA were sold on the idea.
NMFA records show that among those lobbying for the swaps was a lead banker for JP Morgan, Chris Romer. His company ended up among the five banks that entered into swap agreements with the state.
JP Morgan was also the lead underwriter for the bond portion of the GRIP financing.
Mike Stratton, a high-powered Denver consultant and political adviser to Richardson, was also working on behalf of JP Morgan.
Records show state finance officials at the time were attracted to the swaps because the state DOT couldn't afford to pay any more than $162 million a year in debt service. The swaps allowed the state to sell more bonds by using a variable interest rate.
"So to (keep the $162 million cap) they kind of came up with these fancy damn things that make me crazy," said Sisneros, who was hired by the finance authority in June 2004 after the swap deals were completed.
The interest New Mexico had to pay was much lower than fixed rates offered at the time, Sisneros said.
But swaps posed more risk than fixed-rate bonds.
That's why the state Board of Finance, which had approved use of the swaps, wouldn't authorize the NMFA to put any more than 20 percent to 30 percent of the $1.6 million GRIP financing into swaps, Sisneros said.
By contrast, Sisneros said Jefferson County in Alabama is on the brink of bankruptcy after sinking 100 percent of its $5 million sewer system financing into swaps. JP Morgan and CDR were also involved there.
Last September, the NMFA was left scrambling after the huge Wall Street bank Lehman Bros. went under. Lehman, which has since filed for bankruptcy, had one of the state's swaps.
At that point, the Lehman default could have cost the state $4 million under the swap terms.
But NMFA officials say they were fortunate to get Deutsche Bank to pick up the deal and continue the arrangement.
But what about the future viability of the four other original swap banks, which include JP Morgan, UBS, Goldman Sachs and RBC?
"Keeping these agreements going is dependent on these counter-parties keeping solvent," Duff said.
Deal and donation
CDR got the initial swap deal several months after its president, David Rubin, donated $25,000 to a Richardson political committee called Moving America Forward.
In June 2004, the finance authority entered into a sole source, no-bid contract with CDR to handle millions of dollars held in escrow from the sale of the GRIP bond refunding.
The money was originally invested in U.S. treasury bills rather than state and local government securities, until CDR proposed actively managing the escrow accounts.
A week before the finance authority's then-chief financial officer Keith Mellor recommended a sole-source, no-bid contract be given to CDR to manage the escrow, CDR's owner contributed $75,000 to another of Richardson's political committees.
The main justification for moving ahead with the sole source contract was that federal regulations were going to change and there wouldn't be time to go through a full procurement process before that happened.
Sisneros told the Legislative Finance Committee last October that CDR was the source of information that the federal regulations were going to change.
Sisneros last week recalled receiving numerous calls from Stratton's (aide) trying to set up a meeting with CDR to discuss the escrow work.
"They really wanted to meet," Sisneros said.
In the end, Sisneros said, there was no reason to hurry. The federal regulations didn't change until after CDR finished its work on the escrow account.
"The Treasury Department ended up moving very slowly," Sisneros said.
CDR was involved in three transactions in New Mexico, according to a study conducted for the Legislative Finance Committee.
All three involved the sale of variable rate bonds. State agencies and colleges historically have sold fixed rate bonds.
The difference between the two is that the variable rate bonds carry more risk to the state because if interest rates increase, the state has to pay more.
Federal and state law enforcement agencies have been asking questions about all three bond issues.
Besides the finance authority GRIP bond issue, authorities have expressed interest in the fact that:
• CDR was the financial adviser to the Region III Housing Authority, which is under a state grand jury investigation. That investigation involves misspending money from another bond issue. But how Region III came to hire CDR as a financial adviser has been a matter of interest to federal authorities.
• CDR was involved with JP Morgan in a University of New Mexico bond issue. Federal investigators are curious about the relationship between JP Morgan and CDR. That curiosity extends past New Mexico's borders and includes the states of New Jersey, Alabama and others.
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