Monday, May 25, 2009

Ice Miller Profits From Water Company Debacle

Ice Miller served as bond counsel to the Indianapolis Water Company and the Indianapolis Bond Bank in 2005 when it foolishly converted fixed rate bonds to variable rate bonds insured through interest rate swap agreements. Now that IWC is forced to pay prepayment penalties of at least $65-$70 million after interest rates on those bonds escalated from 3.5% to 9.5%, Ice Miller is being rewarded once again to provide bond counsel work for the water company on the transaction to convert the variable rate bonds to $540 million in fixed rate interest bonds.

During a recent meeting of the Board of Waterworks, only board member Jim Atterholt sought answers to the troubling problem of how this came to be that the water company finds itself in dire financial straits. Atterholt's questioning forced the bond counsel and the Bond Bank's executive director, Kevin Taylor, to place blame on the debacle on the downgrading of two credit providers who insured the 2005 bond deals, MBIA and Depfa Bank. At the time of the 2005 transaction, MBIA had received a AAA rating from credit rating agencies. When the rating agencies finally discovered that MBIA had a terrible balance sheet because of its risk exposure from the bond deals it had insured, its rating plummeted to single A. Depfa Bank fared even worse as its rating dropped to BBB-. Italian officials seized some assets of Depfa Bank last month after charging the bank with fraud for derivative bond transactions that cost European municipalities several hundred million dollars in losses.

Atterholt asked Taylor if either of the credit providers were potentially liable to the water company. Taylor answered "no" because the credit providers had met all of their contractual obligations. According to Taylor, the agreements did not require the credit providers to maintain a certain credit rating, although their credit ratings clearly impacted the interest rates the water company could achieve in the market. Taylor testified that the variable rate bonds posed three types of risks: market risks; counter-party risks; and interest rate risks. In this case, it was the downgrading of the counter-parties' credit ratings that posed the financial risk to the water company. Ice Miller's Brenda Horn, who served as bond counsel on that transaction, deflected blame, saying her firm only performed legal work on the transaction. Substantive decision-making, she maintained, rested with the water company and the Bond Bank. The key decision-makers she says are no longer employed by the City. It seems to me that Ice Miller's legal work was deficient if it did not require in the interest rate swap insurance agreements that the insurers maintain a minimum credit rating. Its failure to include that language allows the credit providers to profit at the expense of the water company from their financial downgrading.

A member of the public asked the board if it had considered whether any of the financial advisers should be held liable for the 2005 variable rate bond transactions. Chairman Sam Odle ignored the question and moved on, prompting Atterholt to ask Odle to address the citizen's question. Odle allowed Horn and Taylor to comment. Taylor said the Bond Bank obtained a new financial advisor for the latest transaction to convert the variable rate bonds to $540 million in fixed rate bonds that will not mature until 2038. Without elaborating, Taylor answered the question by indicating that discovery had begun to determine whether any entity could be liable to the water company for the financial debacle, which threatens its very solvency. Umbaugh & Associates performed the original role as financial advisor. Former City Controller Robert Clifford, a key person involved in the 2005 bond transactions, obtained employment with Umbaugh after leaving his city job. Taylor said the Bond Bank retained Lamont Financial as its financial advisor for the new bond deal and he was confident in their ability to provide financial advisor services. (Note: Lamont's website is still under construction) He also said Morgan Stanley, the same firm which employed the problem broker who caused major losses to the ISTA Fund, would serve as underwriter.

It is worth noting that Chairman Odle is a political crony of Ice Miller's Lacy Johnson. When Johnson served as President of the Indianapolis Airport Authority, he announced a deal to allow Mansur to develop a new hotel at the airport. An equity partner in the Mansur deal included Sam Odle, who runs Methodist Hospital for Clarian Health Partners. When the Ballard administration took over in January, 2007, it cancelled the hotel deal for Mansur; however, Johnson continued on in the role as Vice President of the Airport Authority and his law firm, Ice Miller, continues to provide legal advice to the authority. Self-dealing has it rewards in Indianapolis, even when it results in losses of tens of millions of dollars to the taxpayers. Odle acknowledged during the Waterworks Board meeting last week that the Board on which he served in 2005 had failed to ask questions about the risks of the variable rate bonds at the time it signed off on them. Atterholt should be applauded for asking the questions Odle wants to ignore to protect his sponsors.


artfuggins said...

Doesn't Ryan Vaughn fit into this somewhere???

Seth M. Ward said...

And what about the Tax Payers.....could this loss tried to be gained with an increase in rates somewhere down the road? Really enjoy your blog. Thanks for all the informative info. I have been behind the curve when it comes to political issues, but I am slowly changing that. Keep it up.

Gary R. Welsh said...

If you google Lamont Financial, you will find several links to older stories where the company's advisors are touting the variable bonds with interest rate swap agreements as a means of reducing borrowing costs. In other words, if Lamont had been advising the water company in 2005 instead of Umbaugh, the water company would have likely received the same financial advice.

Gary R. Welsh said...

The following is from Lamont's website:

Lamont is a leading swap advisory firm, having negotiated or bid competitively over $6 billion of interest rate swaps and swaptions on behalf of its clients, and served as a co-advisor/bidding agent for an additional $3 billion. Presently, Lamont has served as swap advisor to a number of large municipal issuers including the State of Connecticut, the State of New Jersey, the Massachusetts Turnpike Authority, MBTA, the Massachusetts Water Resources Authority, Maine State Housing Authority, and the Connecticut Housing Finance Authority. Lamont has assisted issuers in the fields of transportation and housing in execution of swaps, and works with a variety of issuers who are considering swap options and forward refunding agreements.

Our general view is that derivative products should only be used to save money, hedge interest rate risk, and to capitalize on certain inefficiencies/opportunities between the taxable and tax-exempt markets. The advisability of such products should be based upon various additional considerations, such as duration matching, asset/liability management, redistribution of risk to other parties, and the availability of sufficient management and administrative support. Because Lamont can provide its clients with the necessary independent analysis to make informed decisions on complex derivative transactions, they can consider more efficient financing structures, without relying on investment banks or swap counterparties for analysis. Lamont prepares reports for various audiences, including legislative committees and Authority boards, outlining their derivative alternatives and the associated risks.

Lamont has considerable experience in the use of interest rate swaps to convert variable rate obligations to synthetic fixed rate debt, to provide a minimum rate of return on short term investments, as well as the use of forward investment contracts for escrows, debt service funds, and reserve funds. We have also provided evaluations to our clients on the proposed use of interest rate caps and floors, various inverse floater products, and Dutch auction floating rate securities. While some of these products have proven useful to certain issuers, we generally recommend them only if their pricing delivers substantial net benefits, including offsetting the cost of documentation and administration.

Lamont has provided significant analysis of opportunities for governmental issuers of tax-exempt bonds to use forward swaps as a means of currently locking in refunding savings for bonds that are not refundable for several years into the future. Our general advisory duties in connection with such swap transactions include the preparation of the swap documents and term sheet(s) for negotiated or competitive procurement.

Swaps and swaptions can be effectively incorporated to achieve specific goals, including refunding debt in low market rate environments; lowering borrowing costs; creating synthetic fixed rate debt on existing variable rate bonds; generating additional portfolio value, and improving the overall yield on an investment portfolio. In pursuit of such goals, we advise our clients to evaluate the amount of basis risk inherent in interest rate swaps and determine the most appropriate plan to manage that risk. As part of Lamont’s analysis in connection with entering into swaps, we use existing floating rate data to construct a LIBOR-based floating rate index that will best match the expected performance of the floating rate bonds. We can further adjust the index for anticipated changes in tax rates and imbed cancellation options in the swaps.

Paul K. Ogden said...

Didn't the Ice Miller bond attorneys say their job was not to offer fiinancial advice? How could it not be their job? What is the purpose of even hiring expensive bond counsel from a law firm?

I know, I know...political patronage, pure and simpl.e

Gary R. Welsh said...

It's laughable, Paul. Anyone who follows government bond transactions in this state knows that Ice Miller leads government leaders around by the nose.

Jon said...

So why do we choose the same people everytime we need a bond issue? Why do we reward the same people who erred so badly? Why do we reward their incompentence?

Seth M. Ward said...

Maybe Jon it's not so much we rewarding them, but the ignorant. I call it the ostridge mentality. I lived by it a long time. I would stick my head in the ground and would pull it up every now and then to see all the bull crap going on and then I would put my head right back down in the ground, hoping that the next time I pulled my head up it would be better....but it wasn't.....and I doubt it ever will be.

Hansa Gruber said...

Doesn't K. Hupfer figure in with these guys now? The Governor let him pal around with the lobbyists while doing his itty bitty stint with IDNR - and now he can use all those contacts. Even probably has a bright political future ahead of him. Hurray for connecting administrative appointees with legal firms. That way the tax payer gets the biggest shaft from both.