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Banks kept CPS in shaky bond market

2017-06-08 04:33 [MARKETS] Source:Netword
Guide:Banks kNew the auction-rate bond market was unstable yet still inked a deal with Chicago Public Schools. When the market collapsed, CPS costs soared.

As investors across the country grew disenchanted with the risky auction-rate bond market in summer 2007, Bank of America officials became concerned that more trouble might lie ahead.

Auction-rate securities had been richly rewarding for BofA and other investment banks. But the market was shaky, and by that summer the banks were spending billions to keep it afloat. Records show that during an internal discussion in August, a senior BofA official warned of a potential market "meltdown."

Chicago's public school system was about to find out what such a meltdown would mean.

That same summer, BofA was preparing to underwrite a massive auction-rate bond issue for the school district. But district officials say the bank told them nothing about looming problems in the market — despite a federal law that requires banks to deal fairly with government borrowers.

The $263 million deal went forward as planned in September 2007, nearly three weeks after the BofA official's internal warning.

Within six months of the closing, banks stopped supporting the auction-rate market and it collapsed, sending the school district's interest payments soaring.

Chicago Public Schools had ventured into the market in the hope that it would save money over traditional fixed-rate debt. Instead, a Tribune analysis found that the 2007 auction-rate deal is likely to cost CPS an estimated $50 million more than the district would have paid on an equivalent fixed-rate bond.

How the Tribune analyzed CPS' bond deals

Heather Gillers and Jason Grotto

When Chicago Public Schools officials embraced auction-rate borrowing over traditional fixed-rate bonds, their goal was to save money for the Financially strapped district.

From 2003 through 2007, the district issued auction-rate bonds four times, racking up a total of $1 billion in auction-rate...

When Chicago Public Schools officials embraced auction-rate borrowing over traditional fixed-rate bonds, their goal was to save money for the Financially strapped district.

From 2003 through 2007, the district issued auction-rate bonds four times, racking up a total of $1 billion in auction-rate...

(Heather Gillers and Jason Grotto)

In its unprecedented examination of the district's $1 billion in auction-rate debt, the Tribune found that CPS stands to pay a high price for gambling on a risky and exotic borrowing strategy.

Banks catering to officials' thirst for cheap money had sold CPS on auction-rate debt and derivative products beginning in 2003. Today, as students endure school closings and other cuts, the district continues to make steep payments on the deals, the Tribune found.

The 2007 deal was the last of CPS' four auction-rate bond issues — and, according to the Tribune's analysis, by far the most costly.

The transaction worked out well, however, for Banc of America Securities — then the investment banking arm of Bank of America — and for the No. 2 underwriter, the Royal Bank of Canada's RBC Capital Markets. Thanks to the terms of the contract they negotiated, both banks pocketed fat interest payments on CPS bonds they were holding as the market collapsed.

Bank of America declined to respond to a question about why it went forward with the transaction.

CPS resisted sharing Financial data with public

Heather Gillers and Jason Grotto

Chicago Public Schools' spending is financed by taxpayer dollars, but it took months of effort by Tribune reporters and attorneys to obtain details about the district's borrowing history and how much it spends in interest on its massive debts.

The public approval process for CPS' bond transactions,...

Chicago Public Schools' spending is financed by taxpayer dollars, but it took months of effort by Tribune reporters and attorneys to obtain details about the district's borrowing history and how much it spends in interest on its massive debts.

The public approval process for CPS' bond transactions,...

(Heather Gillers and Jason Grotto)

CPS officials disputed the Tribune's findings and provided an analysis that concluded the district has saved money on the deal to date. Unlike the Tribune, the district didn't attempt to estimate future costs. The CPS analysis took credit for a massive upfront payment the district received as part of the deal while leaving out the higher interest payments it faces over the long term.

District Treasurer Jennie Huang Bennett said in an interview that it was inappropriate to estimate how much CPS will pay over the life of the deal. "I don't know what's going to happen with those bonds," she said. "Things could change."

Adela Cepeda of A.C. Advisory, the school district's lead adviser on the deal, also disputed the Tribune's analysis. "CPS did very well," she said.

The origins of the deal date to 2005 and 2006, when the district began experimenting with a derivative product with a gimmicky-sounding name: swaptions.

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