Audit Calls Out Risky Borrowing at SEPTA
Pennsylvania's Auditor General says SEPTA is "gambling with public money" in certain financing transactions.
By Melissa Daniels | PA Independent
HARRISBURG — A recent state audit criticizes the Southeastern Pennsylvania Transportation Authority for engaging in what it considers high-risk financing.
Or, as Auditor General Jack Wagner calls it, “gambling with public money.”
SEPTA spent $41. 4 million in tax dollars to terminate swap deals after the transactions failed to work in its favor, according to the performance audit examining SEPTA financials from 2006 through 2009.
Swap transactions are made between borrowers and banks on bond interest rates to hedge against rising interest rates. In Pennsylvania, Wagner’s office has turned a critical eye toward this type of borrowing.
Too uncertain, he said.
“What we strongly recommend is that public agencies issue fixed interest rate conventional bonds that are very transparent and reliable and are understood by the decision makers and the public in terms of the dollars that are being spent,” he said.
But SEPTA officials say its deal could have worked out had it not been for legislation that put new restrictions on transit-authority financing.
The deal started with $262 million in serial fixed-rate bonds issued in 1999, with the option to refund in 2009. But the historically low interest rates of 2003 triggered the agreement to take a swap option, said Tom McFadden, assistant treasurer for SEPTA.
If interest rates had gone up between then and 2009, SEPTA would have saved money in interest payments. SEPTA determined the likelihood rates would increase was higher than the likelihood that rates would go down, making the call to take a swap.
“You have to make a decision, you can’t just sit on your hands and say, ‘Whatever happens, happens,’” McFadden said. “In our view, that’s not prudent financial management. You need to make an assessment of the risk and determine whether you want to do something or not.”
Wagner said on the whole, SEPTA makes many positive financial decisions. The audit, for example, cited that the top salary earners are paid competitively, even on the lower end when compared to similar agencies around the country.
But when it comes to borrowing, his office recommended to SEPTA, and other agencies, to eliminate the use of swaps altogether.
It’s too risky for taxpayer dollars, he said.
“There is a misunderstanding in the thinking process of many executives running public authorities and superintendents and school boards with school districts, that swaps are appropriate when in fact gambling with public money is not appropriate,” Wagner said.
One 2009 special investigation determined 107 Pennsylvania school districts and 86 local governments financed $14.9 billion in debt tied to interest-rate swaps.
In SEPTA’s case, the “swaption” would have granted the ability to change interest rates back to variable in 2009. But in 2007 — when the Legislature passed Act 44, a transit overhaul bill — limits were placed on the types of refunding agencies like SEPTA could do, McFadden said. A later update to the rules would have permitted refunding as long as the total debt service on the refunding didn’t exceed that of the initial bond issue.
But in SEPTA’s case, the calculation exceeded the original $262 million bond issue. Because of that, SEPTA couldn’t issue variable rate bonds in 2010; instead, it had to issue fixed-rate bonds, which it could only do after terminating the swap.
SEPTA also disagreed with the audit’s calculation of how much the whole transaction wound up costing in the long run. The audit’s total of $41.4 million takes into account a $7.7 million interest payment with an 18-year term, not only the costs of the swap and its termination.
Eileen Norcross, a senior research fellow for the market research Mercatus Center at George Mason University, said while swaps have the potential to secure a better interest rate, the municipality or authority risks making a bet on whether rates will go higher or lower.
While swaps might be a good bet for the private sector, it’s a different situation for financing with taxpayer dollars, she said, since the new interest rates are betting on an uncertain future.
“It starts getting exotic, it starts getting complicated and opaque,” she said.
The audit further criticizes SEPTA for hosting employee safety banquets that it called “high-end affairs,” citing four with an average cost of nearly $70,000 apiece, or around $106 per attendee.
The annual banquets are part of the union workers’ contract, meant to honor those who practice safety measures. But, the audit says, “the contract does not stipulate details such as $100 total cost per person or custom chocolates.”
SEPTA’s chief financial officer, Richard Burnfield, disagreed with the audit’s assessment of banquet spending.
Additionally, he pointed out “creative” ways SEPTA has managed to incur revenue, such as with electronic billboard advertising.
“If there are things that we can do going forward to look at how we have that event, we will do that, but I believe that is a totally appropriate event and a totally appropriate way to recognize our employees for safety,” he said.
Burnfield said SEPTA has reduced costs on employee health insurance by increasing copays, and negotiated two union contracts with no wage increases.
He also pointed out it doesn’t have legacy costs for lifetime health care, a factor that contributes to the debt of Pittsburgh’s transit Port Authority across the state.
“For the last 13 years, SEPTA has ended the year with balanced budgets,” he said. “We do not operate under the premise of spending more dollars than what we have. We are very fiscally conservative.”