Editor’s note: This story has been corrected to reflect the fact that neither of the financial consultants advising board members have formally recommended one pension restructuring option over another. Instead, they are advising board members about the risks involved in the complex transaction.
During a recent discussion with Denver Public Schools board members about tonight’s vote on the proposed restructuring of $750 million in debt, a financial adviser cast a complex topic in the simplest of terms.
“This is sort of like Goldilocks where (the question is), is it ‘just right’ for you?” said adviser Timothy Schaefer. “And I can’t answer that. That’s for the seven of you.”
But unlike the classic children’s fairy tale, the financial puzzle facing the Denver board is all too real, with no promise of a happy resolution.
School board member Jeannie Kaplan pushed the March 7 meeting at which Schaefer invoked Goldilocks well past its scheduled ending time, peppering financial advisers with question after question.
To appropriate the Goldilocks analogy, she was clearly still in an uncomfortable limbo somewhere between too hot and too cold, with “just right” eluding her.
“I feel like our backs are against the wall,” Kaplan said that night about the pending decision.
She’s not entirely wrong. Because a pivotal financial partner in the controversial 2008 pension transaction is bowing out of the arrangement April 14, the board must take corrective action by that date. And the paperwork pipeline created in such a complex deal is so substantial that board action must come no later than March 22.
Board members tackled the topic again earlier this week, at their Monday work session. They are expected to vote on the issue at tonight’s regular monthly meeting – but they’ve got another meeting penciled in for Tuesday, just in case.
“This transaction has more moving parts to it than any financing ever undertaken by any other local government in the country,” said financial adviser David Paul, who, like Schaefer, was hired to advise board members and district leaders of their options in refinancing the massive debt.
Weighing the restructuring options
The 2008 pension transaction was conceived and approved when U.S. Sen. Michael Bennet, D-Colorado, was the district superintendent and current Superintendent Tom Boasberg was its chief operating officer.
Its purpose was to meet a $400 million shortfall in the DPS pension fund and facilitate a merger with the statewide Public Employees Retirement Association or PERA. Approval of the deal, however, coincided with the crash in financial markets and the beginning of the Great Recession.
Now board members are facing four options in restructuring the debt – and they’re grappling with how much risk they’re comfortable in assuming as they do so.
The option recommended by Boasberg and DPS staff is to “fix” $250 million, or one-third of the debt, at current market rates and put the remaining $500 million in variable-rate short-term investments. They would have the option of moving more of that $500 million into fixed-rate investments at a later date, in response to the changing market.
Fixed-rate investments are more secure, but also more expensive. Variable-rate investments are less secure and subject to market forces – they carry more risk but also the possibility of greater reward.
The other three options presented are variations of the “fixed” versus “variable” ratio – putting all $750 million into fixed-rate investments that would be locked in for the remaining life of the debt; splitting the $750 million equally between fixed-rate and variable-rate investments; or the reverse of what’s recommended, putting two-thirds into fixed-rate notes, with only one-third left in variable-rate investments.
Each option carries a different price tag. The recommended option would cost the district an average of $67 million per year through 2038.
At the other end of the spectrum, putting all $750 million into fixed-rate investments now, likely at an interest rate of about 7.25 percent – which would grow to about 8.4 percent when all expenses of the transaction are factored in – would cost the district an average of $77 million a year for the next 27 years.
The difference between those two options is about $10 million a year in district operating dollars.
A $10 million difference
Boasberg is urging board members not to invest more than one-third of the $750 million in fixed rates. To do so, he said, would tie the district’s hands should market rates subsequently improve. And he doesn’t want to see the district forced to cut up to $10 million a year from its operating budget.
- Board members are wrestling with how much of the $750 million pension debt to lock in “fixed-rate” investments versus “variable-rate” investments.
- Essentially, fixed-rate investments are more secure but more expensive while variable-rate investments are less expensive but subject to market forces – they carry more risk but also the potential for greater reward.
- District staff are recommending board members put no more than one-third of the debt in fixed-rate investments.
- Some board members want more of the debt in more secure fixed-rate investments; a compromise of half in fixed and half in variable was discussed Monday.
- The difference in costs to the district between the recommendation and the compromise is $2.4 million more annually.
“Ninety-five percent of your money is in schools, and for you to cut $10 million, a very large amount of that is going to come out of your schools,” he said. “The impact of that is going to be very, very significant in your classrooms.”
Put another way, Boasberg said being forced into such cuts could mean “the loss of one to two teachers at every school in your district.”
Kaplan and board member Andrea Merida, both outspoken critics of the 2008 pension transaction, which they say was too risky, want more of the $750 million in fixed-rate investments. They argue the classroom is not where DPS should look to make any necessary cuts – instead, they believe the budget axe should swing first at DPS administration.
“I think the concept that the only place we’re going to save money is by cutting teachers, I mean…wow!” Merida said during Monday’s work session. “Some blinders!”
Boasberg said any pain from solving this issue will be equally shared.
“If we had to cut $10 million, we would be cutting everywhere. And we would preserve the classroom as much as possible,” Boasberg said. “But a $10 million cut would fall very, very heavily on the classrooms.”
However, the specter of $10 million in annual cuts comes into play only if the board votes to sink all $750 million into fixed rates, which they now appear unlikely to do.
Monday night’s discussion signaled that a board without a track record of harmony may be heading toward compromise in addressing a financial dilemma it has been struggling with publicly for more than a year.
Second-guessing, in money and politics
Restructuring $750 million in debt would be challenging even for board members who enjoyed a harmonious working relationship. These seven do not.
As one DPS board member put it, working with one another on this issue has involved 10 hours of “trust” work for every hour of “substantive” labor.
And there is perhaps nothing that lends itself to second-guessing as much as the financial market, so there has been no shortage of second-guessing on this topic.
Merida, who was not on the board at the time the original deal was approved, said she would not have approved it. She insists she is not just saying so from the comfortable position of the considerable hindsight afforded by the ensuing 35 months of financial history.
“No,” she said. “Remember, Bear Stearns had collapsed in March 2008. We’re looking at a month later, when this decision was made. That should have been a clear indicator that there was something wrong.”
Yet all seven board members approved the transaction in April 2008, including Kaplan and Arturo Jimenez, who both began publicly questioning it in March 2010. They, and Merida, complained the district was not being transparent with financial data.
Second-guessing of a different kind began when it was revealed Merida was on the payroll of Andrew Romanoff, who was running against Bennet in the Democratic primary for U.S. Senator. She soon resigned.
Kaplan also was a Romanoff supporter, though unpaid. On the other side, board member Theresa Peña, who voted for and continues to support the 2008 deal, served as treasurer – an unpaid role – in the Bennet campaign.
A complicated pension transaction became even more complicated – and heated – with the addition of politics.
But the critics won an important concession, the hiring of a financial adviser specifically to consult with board members. Schaefer, who was hired in January, is filling that role. He is advising board members on the options – but, by contract, is not recommending one option over another.
Heading toward compromise?
Most of those now involved in finding a fix in March 2011 concede that reaching a resolution of the issue represents a steep learning curve.
DPS board, then and now
- DPS board members who voted 7-0 to approve the 2008 pension transaction and who will be voting tonight: Bruce Hoyt, Jeannie Kaplan, Arturo Jimenez and Theresa Peña.
- Recently-elected board members who will be voting tonight: Nate Easley, Andrea Merida and Mary Seawell.
So much so that, between the March 7 and Monday meetings, Mary Seawell, the board’s treasurer, and Kaplan arranged a March 11 conference call with financial advisers Schaefer and Paul to discuss it yet again.
As board members debated the issue for three hours Monday, it was clear that they were split even after consulting both advisers.
Jimenez and Merida wanted to see all $750 million put into fixed-rate markets. Board members Nate Easley, Bruce Hoyt and Peña were most supportive of the recommended option to sink just $250 million into fixed-rates, with $500 million left – for now – in variables.
With the deadline for a decision looming, and hearing some flexibility being voiced, by Seawell and Kaplan in particular, Merida exclaimed, “Let’s deal.”
Over the next 30 minutes, the board negotiated themselves into a position where a vote to consider a middle-ground proposal – half into fixed-rate, half into variables – appears likely.
Should that be the decision, the district would be paying an average of $69.8 million per year for the next 27 years – or $2.4 million more annually than the option backed by Boasberg.
“Given this point in time, I think it is a bad idea to fix out more than one-third,” Boasberg said. “Two and a half million a year would be lost to us.”
The cost of financial expertise
Education of the board on the deal’s nuances – both the original 2008 agreement, and the restructuring that looms now – has included monthly meetings of the board’s finance and audit committee.
That group is headed by Seawell, the board treasurer, and originally included Merida and Hoyt. Over the past six months, however, Merida has essentially ceded her seat to Kaplan.
“It made sense, because of Jeannie’s expertise on the PCOPs and all of that,” said Merida. “It was a decision we needed to make. Jeannie was more up to speed on all of that, than I was.”
She added: “Jeannie did a great job briefing me on a lot of different things.”
Seawell said the finance and audit committee’s makeup was never intended to be rigidly locked in and that all members have been urged to attend.
“I wasn’t taking attendance,” she said. “But I think everyone on the board attended at least one of the discussions.”
In addition to Schaefer, board members have been advised by Paul, who was hired after the market unraveled in 2008 to advise the district and to work directly with participating financial institutions to restructure the deal.
Both Paul and Schaefer are being paid from the district’s general fund based on a percentage of the final refinancing. For Paul’s Fiscal Strategies Group, the payday is $300,000. For Schaefer’s Magis Advisors, the total is $43,500.
Praise for advisers, ‘mindset of public entities’
Paul and Schaefer have attended board and committee meetings and been available by phone and email for board members’ individual queries.
Both Seawell, who’s often seen as the mediating influence between opposing board factions, and Merida, the most vocal critic, praise the advisers’ work.
“Tim has proactively reached out to some board members, and both have been available to all board members,” said Seawell. “I am very satisfied with them, and I am especially heartened that the board really relied on both, in different ways, and the district relied on them in different ways. It was the right mix of skills and roles.”
“I really like both of them,” Merida said of Paul and Schaefer. “What I think Tim Schaefer brought was, the mindset of public entities.
“I have no doubt that the numbers, at least from David Paul’s side were fine. But for me, this is my first elected position. I may not necessarily be that cognizant of what is considered too risky for the public. And, hearing from Tim, and the experience he has had from other public entities, and their mindset, validated what I was feeling – which was, we want little to no risk.”
Pushing for unity, and lingering doubt
Seawell believes it’s important the board show greater unity tonight in resolving this financial quandary than it has mustered for many issues that have come before it during Boasberg’s tenure. The superintendent enjoys consistent support from only four of the board’s seven members.
“For the district, and for moving forward, we can’t be 4-3 on this,” Seawell said. “We’re going to have to figure out a way to move forward. We, as a board, have to do this together.”
“We’re going to have to figure out a way to move forward. We, as a board, have to do this together.”
–Board member Mary SeawellMerida doesn’t rule out all hope of Seawell’s goal being realized.
“I think that we will be able to do that, if we can all come to an agreement about what our basic values are, with regard to our basic investment policy, for the district,” Merida said.
Boasberg, who likely won’t be getting what he’d hoped for, if the board approves a 50-50 split between the fixed and variable-rate markets, nevertheless said, “I think the vote will move us forward, and continues us in a position where we are fortunate enough to be, primarily as a result of this transaction, in significantly better financial position than our neighboring districts.”
But Kaplan, who said she has been “vilified” for admitting she didn’t fully understand the 2008 deal when she voted to approve it, is still conflicted as the board’s decision nears.
“I think this is a really important decision that we’re making, and I am struggling very mightily with this proposal,” Kaplan conceded in an interview late last week. “I am trying to make it feel okay for me, and the taxpayers and the kids. And I’m not there, yet.
“I’m concerned on a lot of levels,” she added. “I’m concerned about tying 2½-to-3 generations of DPS kids to this transaction.”
How DPS got here: The need to restructure its 2008 pension transaction
The board’s problem stems a controversial step taken in April 2008 to address what was then a $400 million shortfall in the DPS Retirement System, and to refinance it with more favorable interest. This came in tandem with the district’s decision to merge its pension fund with PERA, the state’s pension fund.
The cure that then-Superintendent Michael Bennet and Tom Boasberg, then DPS chief operating officer, encouraged the board to approve was an interest-rate swap, estimated to have the potential of raising $20 million per year for the district.
Due in no small part to the almost simultaneous market collapse, critics contend the deal has instead cost the district unbudgeted millions of dollars.
At Bennet and Boasberg’s urging, the DPS board voted 7-0 to issue $750 million in Pension Certificates of Participation, or PCOPs, and to put up 26 of its school buildings as collateral. The buildings would be leased, with payments going to the holders of the PCOPs.
And, rather than choose a fixed-rate debt for the agreed-upon 30-year life of the financing plan, the board elected to reduce the interest on the debt by issuing specialized notes or bonds to be auctioned weekly at current – and changeable – market rates.
So that the district could be insulated from market fluctuations, the board agreed to enter into a credit-rate swap with a bank consortium, the two sides exchanging interest-rate obligations. DPS committed to a 4.859 percent annual interest on the $750 million.
Timing in the market is everything, and unfortunately for DPS, the ensuing market crash effectively destroyed the short-term liquidity of the district’s auction-rate securities.
DPS had sought to safeguard against such an eventuality by partnering with the Belgian-French financial institution Dexia, in an arrangement through which Dexia would protect the district by buying the bonds if they weren’t being purchased on the open market. As the interest rates nose-dived in 2008, that’s exactly what happened, the bond sales failing repeatedly.
Instead of raising $20 million per year for the district, the deal yielded nothing for the district in its first year. And some say the roughly $34 million in savings accrued through the end of December are now expected to be negated by “breakage” costs or termination fees that will be owed to participating banks.
Boasberg’s recommendation is to refinance the $750 million in a one-third/two-thirds split, with $250 million of the debt being set at a fixed rate and $500 million remaining subject to variations in the market rate.
Fixing the interest on a greater portion of the debt would be more costly but carry a lower risk. Leaving a greater portion of the debt subject to rate fluctuations would be less costly in the short term – but could spell higher long-term risk potential.
Under the recommended scenario, Boasberg has told the board, there would be nothing to preclude DPS from converting more of the $500 million in certificates to a fixed rate in the future, should the market further improve.