Denver Public Schools: Paid High Price for the Advice of Unwitting Experts

The Denver Public Schools District (DPS District) consists of 162 schools serving about 80,000 students and had a high-cost experience with interest-rate-exchange (swap) contracts. Until 2008, DPS District was swap free. In 2008, it had $300 million of fixed-rate bonds outstanding and $400 million deficit in public schools’ pension fund. Closing that pension deficit was of concern to DPS District. In 2008, JPMorgan Chase went to the district jointly with Bank of America and Royal Bank of Canada (RBC) with a proposal to help manage this financial difficulty. The plan had two prongs:To issue corporate bonds under the name of certificates of participation (COP) at adjustable (variable) rates. These were Certificates 2008A and 2008B. The total amount of borrowing was $750 million subscribed to by the three banks: $450 million sold to JPMorgan Chase, $200 million sold to Bank of America, and $100 million sold to RBC. The designated variable rate was the worst kind of all from the perspective of the Denver Public Schools District; it was the dreaded auction rate that requires remarketing the COP certificates and resetting the interest rate once a week. All certificates were noncancelable and have 30-year terms extending to 2037. Incidentally, it is very difficult to believe that the three banks were not strategic in timing their move since signs of the Financial Crises were evident by the time they approached DPS.While DPS District could have issued variable rate bonds without adding swap contracts, the banks either requested COPs to be coupled with writing interest-rate-exchange (swap) contracts or simply took DPS Board to trips on a trail illuminated by mystical financial engineering jargon. The swap contracts required DPS District to pay to each of these three participating banks interest at a fixed rate of 4.859% or higher and receive from them interest based on London Average Interest Rate (LIBOR). At that time, LIBOR was 2.785%.