Thursday, August 15, 2013

Drip, drip, drip

An underappreciated headline locally is that: Charges Against 2 Traders Fault JPMorgan for Lack of Oversight. Hold that thought.

Seemingly unrelated it seems to the news coming at the beginning of next year.  With a change in administration Downtown there is going to be all sorts of public and political machinations filling local news headlines.  Some changes of great import, others not.  If you want to watch the inside game keep a close eye on all things that happen at the Pittsburgh Water and Sewer Authority (PWSA).  Why?  Simply put, because of longstanding consent decrees the PWSA entered into with the EPA, the authority along with ALCOSAN at the county level, are soon to begin one of the greatest public expenditure programs in the region's history. The spending coming soon is, quite rationally, making contractors salivate. As always, follow the money.  For more on the broader ALCOSAN consent decree checkout:

But back to JP Morgan.

I was trying to figure out what was my first post mentioning the PWSA's variable rate debt (or this post) came in July 2008. I apologize profusely for not standing on my head more over that at the time.  Eventually it became a news event that was so convoluted few understood at the time.  But the variable rate bond that somehow JP Morgan was able to convince the PWSA to issue soon became a ticking financial time bomb.  The details are in fact too much to get into here, but it was a pattern in Western Pennsylvania. Some school districts who were hit up the same way.  So bad were the deals JP Morgan got out of the municipal swaps business altogether soon thereafter. Many have sued JP Morgan over their advice and assistance during this period.  Many have received money back. The PWSA never attempted to recoup anything to the best of the public record. What befuddles me is that by 2008 the PWSA went ahead with variable rate debt even though it was known at the time similar variable rate debt was already blowing up for other public authorities.

How much are we talking about?  At the time the 2008 bond offerings were for $419 million dollars in total which should give you a clue into the scale of dollars we are talking about. The PSWA is going to have to finance a lot of this coming infrastructure replacement with new debt, even though it already has an incredibly high debt level for its size. A lot of that 2008 debt was the problematic variable rate debt that still is part of the equation.  Last I looked a tranche of it needs its letter of credit extended past this coming October. That may have happened, but the lack of news coverage compared to the past is of note. So it's unclear.

A side point, but the only reason the whole variable rate bond imbroglio has appeared to be stable (i.e. out of the news) in recent years is not that the problem has gone away, but the historic low interest rate world of late has eased the pressure on maintaining what is called a line of credit backing the deal.  If interest rates were any form of 'normal' the bad situation observed in 2008 would have long since passed a disastrous critical mass. The counterfactual is often out of sight and so, out of mind.

So what I would love is for some finance or accounting class to tackle for a semester long project is going back and looking at the 2008 Variable Rate bond deal the PWSA entered into and ascertain how much of the $$ raised ever went into the capital improvements it was intended for... vice what went into financial fees and interest along the way. It is a bill that keeps accumulating since the variable rate debt continues to need renegotiated letters of credit to back it up.  The swaps fees were big deal in other cases, and I am sure they add up here though I have never seen anyone look in depth at the numbers.  Then compare the results to what would have happened if they had done what happens I bet 95% of the time and issue some form of a fixed interest rate instrument. I am sure there is a journal article to be made of it as well.


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