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U.S. Probe Urged for Harrisburg

A forensic audit focusing on the incinerator bond deals largely responsible for driving Harrisburg into insolvency has prompted another request for federal investigations into the transactions.

The latest call came Thursday from City Council member Brad Koplinski, one day after the Harrisburg Authority, the agency that owns the incinerator, released a report that scattered blame in many directions for the fiasco that has left Pennsylvania’s capital $310 million in debt and under state receivership.

Koplinski called for the U.S. Department of Justice to investigate bond financings in 2003 and 2007, as well as the $25 million loan from CIT Group Inc. to finish the incinerator retrofit project.

The authority and Dauphin County are contesting the validity of the latter in federal court, saying the loan did not receive proper local approvals.

“No one got paid unless these deals went through. They said and did whatever it took to close the deal and get their paychecks,” Koplinski said at a press conference in the City Hall atrium. “In the end, they left the people of the city holding the bag.”

Two weeks earlier, the attorney representing the City Council in its attempted bankruptcy filing said “questionable practices” surrounded the financings. Mark Schwartz has asked the Internal Revenue Service and the Securities and Exchange Commission to examine the bond deals.

“There is an odor to the financings,” Schwartz said.

Wednesday’s 133-page report by the Harrisburg Authority pointed fingers at multiple parties, including the original contractor, bankrupt Barlow Projects Inc. of Fort Collins, Colo., for its failure on the project; city, regional and state agencies for sloppy due diligence, including failure to question Barlow over whether the project was self-liquidating; and financial advisors for fees it considered excessive, and for conflicts of interest.

“The report speaks for itself,” said Harrisburg Authority board member William Cluck, who declined further comment.

The 2003 and 2007 bond deals, intended to modernize the trash burner to comply with federal clean-air requirements, account for about two-thirds of the incinerator debt, the authority said in its report, which law firm Klehr Harrison Harvey Branzburg LLP and accounting firm ParenteBeard LLC prepared.

“Sometimes you have to get to the federal level so you don’t have conflicts of interest,” said Koplinski, an attorney who has worked at the Justice Department and the IRS in Washington, D.C. “And they would have the resources to put together a solid investigation which honestly would potentially take months and years.”

City Controller Dan Miller welcomed the calls for federal scrutiny.

“I would hope that someone with authority would come down and punish the people who did this,” he said.

The authority’s report said government and financial officials who guaranteed the bond issues in 2003 and 2007 ignored many warning signs about the deals.

“The professionals, consultants and advisors who were paid significant fees to assist the authority, the city and the county in the decision-making process do not appear to have adequately identified or responded to numerous red flags that, if heeded, could have led to a different outcome,” the audit report said.

The audit also said the financings were sold based upon city and — even more so — county guarantees, and not the financial merits of the project.

“A good bond deal should be sufficient to stand alone. Don’t try to sweeten the frosting by adding layers of credit enhancement,” Bill Brandt, president and chief executive of consulting firm Development Specialists Inc. and chairman of the Illinois Finance Authority, said during a recent visit to The Bond Buyer’s New York offices.

“AGM was not asked to evaluate project revenues. Instead, AGM evaluated the GO security pledge provided by the city and also by Dauphin County,” Assured Guaranty Municipal Corp., the incinerator bond insurer, said in a statement. “The forensic investigation report confirms that AGM acted at all times only as bond insurer and that AGM relied on the general obligation guarantees of the city and Dauphin County in issuing the bond insurance policies for the RRF project.”

The report also said the deals involved widespread use of complex derivative transactions known as swaps. “The structure of the financial transactions related to the debt issued to fund the retrofit projects, including multiple swaps, was unnecessarily complex, and resulted in the payment of excessive fees, increased risks and the potential for greater financial burden on the authority,” the report said.

According to the report, Royal Bank of Canada — under the RBC Dain Rauscher name and led by point man James Losty — engaged in numerous swaps that were “unnecessarily complex” and resulted in excessive fees and greater risks. RBC and co-swap advisor Investment Management Advisory Group, or Image, incorporated multiple swaps into the finance plan.

RBC’s interests “were not aligned with those of the authority, the city or the county in many respects,” the report said. “These swaps were entered into and terminated for short-term gains, irrespective of additional risks or negative long-term effects of the transactions.”

RBC responded in a statement: “The swaps are not the reason for the authority’s financial difficulties, nor does the report state that the derivatives the authority entered into were the cause of the default. The swaps have worked as expected and have reduced the interest expense of the authority’s debt. We stand by our work on behalf of the authority.”

“The report appears incomplete and contains inaccuracies,” RBC said. “For example, it incorrectly states that we were financial advisor; we were not. There were several independent advisors involved. In addition, many parties, including RBC, were not interviewed for the report regarding their role in the project or the financing.”

“The problems with the project were due to the contractor’s (Barlow Projects Inc.) failure and we had no role in the hiring of Barlow as the contractor, who was on board since before 2000, which long predated RBC’s involvement,” the firm said.

Additionally, the report said Reynolds Construction Inc. of Harrisburg “played numerous and conflicting roles on the retrofit project, including simultaneously working as a contractor for both the authority and Barlow.”

Reynolds did not respond to a message seeking comment.

Bond issuers such as a city government or school district often take out swaps to switch a variable rate to a fixed interest rate to protect against interest-rate increases.

But after the recession hit, “interest rates plummeted and the payments became nearly one-sided, with the counterparties receiving far larger payments than the bond issuers,” the Pennsylvania Budget and Policy Center wrote in a report last week that said Philadelphia and its school district lost $331 million in net interest payments and cancellation fees relating to swaps, and could lose a further $240 million in net interest payments if interest rates stay low.

Harrisburg’s Miller said municipalities should generally avoid swaps. “Two years ago, we made a little money on swaps, but it’s really a ridiculous kind of financing for a city. We should lock in certain rates and know the marketplace. It’s just a great windfall for the financial professionals,” he said. “You have people on city councils who are not financial experts. If they can’t understand or explain these kinds of transactions, it seems to me, and forgive the cliché, but it’s a recipe for disaster.”

The calls for federal investigations come as David Unkovic, the city’s state-appointed receiver, prepares his financial plan for an expected Feb. 6 release. Unkovic will probably will recommend a sale of the incinerator and other city assets, including parking garages.

Unkovic has called the bond deals “troubling,” though speaking at a town meeting last week, he said it was not his job to start legal proceedings against parties mentioned in the Harrisburg Authority report. He has said he would probably insist on more concessions from creditors than recommended in the original plan under the state’s Act 47 program for distressed communities.

Koplinski hopes Unkovic, former chief counsel for the state Department of Community and Economic Development, will bring the full weight of the state down on the incinerator creditors. “He’s got to tell them that if they still want state contracts, they’ve got to do right by Harrisburg. Pay up and contribute to the solution,” he said. He also criticized Dauphin County for not providing some documents to the authority’s forensic team.

“We’re currently reviewing the 133-page report that was released Wednesday. No further comment until the report has been carefully evaluated,” Amy Richards Harinath, a spokeswoman for the county commissioners, said in an email response Friday.

Schwartz, a Bryn Mawr, Pa., solo practitioner, agreed on the assessment of poor oversight. Additionally, he blamed the DCED, which also approved the deals. “Send a corpse to them and they’ll rubber-stamp it,” he said.

“The whole problem with municipal bonds is that it’s largely self-regulating,” Schwartz added. “It’s an absurd milieu to be in because it’s largely self-regulating and it doesn’t deserve to be self-­regulating.”

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