Jackson Free Press

Hinds County Audits for Fiscal Years 2006 (PDF, 15.6MB),
2007 (PDF, 1.2MB), 2008 (PDF, 1.1MB), 2009 (PDF, 1.2MB)

Hinds County may have earned almost $4.5 million from a complex financial deal, but few in the county appear able to explain where the money went. At a June 7 Board of Supervisors meeting, Supervisor Phil Fisher seized on a report by county financial adviser Porter Bingham on the transaction, called an interest-rate swap. Fisher demanded to know how the county has spent its proceeds from the swap. No one could provide an answer.

Fisher is not alone in his concern over the deal. An independent audit of the county's finances for the 2006 fiscal year warned that county officials did not adequately understand the transaction enough to verify that the county was receiving the payments it was due.

"County officials could not explain how the swap was supposed to benefit the county; nor did management demonstrate an understanding of the extent, multitude and nature of the various risks inherent in a swap," Madison-based auditor Ruth Wylie wrote in her report, released in 2009.

Hinds County's interest-rate swap is a financial derivative designed to lower the cost of its bond debt. In the transaction's most basic form, sometimes called a "plain vanilla" swap, a government or other entity exchanges fixed-rate interest payments for payments based on a floating rate that fluctuates according to market trends. Counterparties in these swaps are usually investment banks. When the floating rate rises, the government--or whoever pays the fixed rate--benefits; when it falls, the investment bank wins.

Hinds County's swap is a more exotic breed, however, less plain vanilla and more Rocky Road. The deal, which Bingham said could also be described as a "synthetic refunding," involves variable-rate payments on both sides. The county makes one set of variable-rate payments on $46.945 million in bonds in exchange for other variable-rate payments from Rice Financial Products, a New York-based investment firm.

Records provided by the Hinds County Chancery Clerk's office show that the county has received $4.36 million in payments from the swap since 2006 and an additional $81,000 in interest on those proceeds. The county has spent $3.21 million of those earnings as part of its general fund budgets since 2008. Another $469,686 has gone to pay fees associated with the transaction, leaving the county with a balance of $757,227 from the swap as of May 31.

"The timing of the transaction ... was at a point in time when the market for 
this product was trading at an extreme, which helped to create this positive return for the county," Bingham told the Jackson Free Press.

The transaction has benefitted Bingham, chief executive officer of the Atlanta-based Malachi Group, which helped negotiate the swap. Malachi received $100,000 of a $875,000 upfront payment to the county for signing the transaction in 2006, and another $80,291 went to bond attorneys with the Jackson-based Priester Law Firm. When Rice made a second, $500,000 payment in 2007, the county gave another portion to Malachi and other attorneys.

County oversight of the swap was inadequate, though, in Wylie's opinion. "County officials could not explain how the semi-annual amounts paid by the counterparty of the swap agreement were determined," she wrote in her audit. "Accordingly, the county has not verified that the amounts were computed accurately and in accordance with the agreement."

Subsequent auditors agreed. "(T)he County has entered into ... interest-rate swap agreements which could subject the County to significant gains and losses due to factors outside the County's control," the accounting firm BKD LLP wrote in its 2009 audit. "(I)t does not appear that anyone in County management understands whether these agreements represent an effective internal rate hedge."

The total value of the swap represented a liability of $6,548,276, which the county could be forced to pay if it terminated the deal early, Wylie wrote. That figure can fluctuate wildly, though: the county's 2008 independent audit estimated the transaction's value at $11.766 million, while the 2009 audit--the most recent currently available--put it at $6.22 million.

Wylie's warning could have been informed by the experiences of other county and municipal governments, which have risked far greater sums in interest-rate swaps and have suffered huge losses as interest rates have fallen over the past two years. Jefferson County, Al., which includes Birmingham, invested $5 billion in the derivatives and nearly went bankrupt when its payments ballooned. Jefferson County would have had to pay $647 million just to end its swap contract, if not for the Securities and Exchange Commission. The SEC intervened, and in November 2009, forced JP Morgan Chase, the investment bank that served as a counter-party to the county's swap, to forfeit its termination fee and pay the county $50 million in penalties, for what it called "an unlawful payment scheme" to win the county's business.

At the June 7 meeting, Bingham told supervisors that a swap "collar" shielded the county from the plummeting interest rates that burned Jefferson County and other local governments.

"When the county engaged to do this transaction in 2006, one of the requirements of the board was that we take the most conservative posture," Bingham said. "We recommended a structure that would protect the county for three years from any potential downside risk. The collar basically covered the transaction for that time. Without the collar, the county is exposed to normal swap market risk."

The "collar," essentially a hedge on the bet that the county made by engaging in the swap, limited the county's annual exposure. Bingham urged supervisors to renew the collar. He also suggested that the board hire Malachi to monitor the swap transaction, at a cost of $5,000 per quarter. Bingham told supervisors that his firm could check the swap markets periodically for opportunities to end the swap and generate even more money for the county.

"The market has swung so far in one direction, we expect that the market will correct itself, and it will normalize," Bingham said. "We have an opportunity at that point, to terminate the swap at a net positive to the county."

Fisher asked county officials how the county would pay the additional monitoring fee. The county could take the expense out of its regular swap earnings, Budget Director Lillie Woods said. The board voted 3-1 to renew the collar and hire Malachi to monitor the transaction, with Fisher casting the lone vote in opposition. Fisher maintained that the county's other bond attorneys and consultants may already be providing a similar service.

"I think we've got some confusion here over how many times we're paying people to look at the same thing," Fisher said. "I'd like to get this definitively drawn out."

Previous Comments

ID

158466

Comment

Hey Ward, don't look now but Kingfish is singing your prasises. Don't know if you guys are allowed on JJ, so here is: "Ward Schaeffer at yes, the Jackson Free Press, pens a very good article on the interest rate swaps Hinds County used back in 2006. This story is worth reading and the reporter gets the details of a very complex subject down pat. None of the Clarion-Ledger' s business reporters could have written this story..." and: "Nice reporting. Kingfish, how did you miss this one? I didn't. Spoke to Mr. Fisher a few weeks ago about the swap. Requested said information. Got an email from him two days ago it was ready so I'll be looking at this one on my own but I don't think I'll be adding much of anything to what Mr. Schaefer has already written. "

Author

annyimiss

Date

2010-07-01T14:21:50-06:00

ID

158478

Comment

Nice, but I won't rest until I've won the hottest reporter poll.

Author

Ward Schaefer

Date

2010-07-01T16:24:00-06:00