Story of a Deal Gone Sour Between a County and Its FA

WASHINGTON — Fluvanna County, Va.’s Board of Supervisors and its former financial advisor, Davenport & Co., present two different versions of the December 2008 bond financing for a new high school in documents filed in connection with the board’s lawsuit against the firm.

The board claims Davenport gave it “deceptive, false and misleading advice” and pushed it into serving as a borrower in a standalone deal at high interest rates as the financial crisis was unfolding, instead of taking the more cautious route of participating in a pool deal, which had been sold three weeks earlier.

The Virginia Public School Authority was the issuer of both the county’s standalone bonds and the pool bonds.

But Davenport contends the board pursued the standalone deal with full knowledge of the volatile market and interest rate risks, only to have second thoughts after the members and politics of the board changed and the financial crisis sent property values plummeting, making it difficult for the county to handle debt service payments.

Davenport was FA for the bonds, not an underwriter. Wachovia was the lead underwriter.

Fluvanna had been debating the need for a new high school since at least 2002 and Davenport had been involved in the debate from the beginning, according to board members and the firm.

“It was a controversial project and it continuously became an issue in the elections” every two years, said G. Cabell Lawton 4th, who served as county administrator until February 2010. Lawton, now administrator for New Kent County, Va., said the board consisted of six members with four-year staggered terms during the 2002-2008 period. “There was always a split on the board. There never was a unanimous feeling that [the new high school and bond financing] was the correct course of action,” he said.

“There was a tremendous amount of controversy,” said Shaun Kenney, the board’s current chairman. “That’s one of the reasons I’m sitting on the board today. There were a lot of us that were very much opposed to incurring that kind of debt service just as the economy was starting to nosedive and the Board of Supervisors just pushed [the bond deal] through.”

“There are a lot of folks that might come back and say it’s buyer’s remorse with regard to the Davenport issue. But that’s not the case,” said Kenney, who declined to discuss the details of the county’s lawsuit. “Those bonds went out at about 6%, the very tippy-top of the market, when we could have gone with the Commonwealth of Virginia at 4.50%. I think that’s really the sticking point.”

“It’s [a question of] why did we get pushed into that? When a financial advisor says jump, jump, jump and then we get hit with the Great Recession, it hurts,” Kenney said.

Davenport and David Rose, its senior vice president and manager of public finance, had presented the board with several options for financing the high school after helping the county secure an initial $9.4 million through two bank-qualified private placements. He told the board at an April 2, 2008, meeting that it should consider another private placement, a standalone bond issue through the Virginia Public School Authority, the VPSA pool bond issue and private pool programs. He also mentioned the “potential use of derivatives, etc.” in his written presentation.

Rose told the county that it “will be in the best position to evaluate all of the potential options if it obtains underlying credit ratings,” according to minutes of the meeting and his written presentation.

On June 25-26, Rose and county officials traveled to Wall Street to meet with Moody’s Investors Service, Standard & Poor’s and two insurers. One month later, the county was rated AA-minus by S&P and A1 by Moody’s.

At an Aug. 6 board meeting, Rose recommended another mix of financing strategies. He had given up on the private placement but suggested standalone bonds through the school authority, a VPSA pool bond issue, and lease revenue bonds with or without insurance.

But ultimately Rose “recommended the VPSA standalone strategy even though the cost was higher than the VPSA pool program because it gave the county more refunding flexibility and control versus the VPSA pool,” Davenport said in a letter sent last month to an unidentified governmental issuer in connection with a proposal of services.

Interest Rates

Fluvanna County had enrolled in the pool issue, but withdrew at Rose’s urging. The county board claims Rose misled it at the Aug. 6 meeting by showing the estimated all-in borrowing cost for a $66.9 million standalone bond issue would be 4.87%, only six basis points above 4.81% for participating in the pool. Instead, the total interest rate for the standalone bonds was 5.95% when they were issued in December — 120 basis points above the 4.75% interest rate for the pool bonds, according to the county.

“The board thought this was the difference in borrowing cost when it issued the standalone bonds on Dec. 22, 2008,” the board said in its complaint. Since Davenport was in the underwriting syndicate for the pool bonds, it was aware of the lower cost of borrowing for pool participants but failed to disclose the significant difference — a “willful and wanton omission of a material fact,” the county charged.

But Davenport said the six basis-point differential Rose cited was based on market interest rate information as of the week of July 20, 2008. “The materials provided to the board clearly indicated that fact and that Davenport made no representation as to rates in the future,” the firm said in the letter to the governmental issuer.

“The board misstates the actual difference between rates” of the standalone and pool bonds, the firm said. “The public record reflects that no borrower in the VPSA paid 4.75% ... some paid more, some paid less. It is a virtual mathematical and historical certainty that Fluvanna would have paid 5.28% — not 4.75% — had they financed through the pool. Furthermore, during the two-week period between the pool issue and the sale of Fluvanna’s bonds the market rose another 33 basis points.”

The 5.95% of interest rate for the standalone bonds was below the 6% maximum rate the board had set in its September 2008 resolution authorizing the bond issue, Davenport added.

The VPSA had higher credit ratings than Fluvanna County: a AA-plus from S&P, two notches down from the county’s AA-minus, and an Aa1 from Moody’s, compared to the county’s A1.

The interest rates for the pool bonds ranged from 4% to 5.25% for bonds maturing between 2009 and 2033, according to information provided by VPSA officials. VPSA added five basis points, 0.05%, to those rates to cover the pool’s costs, said Richard Davis, public finance manager for Virginia’s Treasury Department. The pool rates compare to interest rates between 4% and 6.5% for the standalone bonds maturing from 2011 through 2035, according to data on EMMA and the official statement.

But most of the county’s bonds were in maturities of 2026-2035, with interest rates ranging from 6.0% to 6.5%, compared to pool bond interest rates of 5.0% to 5.25% for maturities of 2026-2033, according to EMMA data and the official statements.

“In retrospect, it looks like people who stayed in the pool did fairly well, but they didn’t know that at the time,” said Davis. “The fall of 2008 was not a good time,” he said, referring to the financial crisis.

The board of supervisors claims Rose advised them to go with a standalone deal because they would not be able to refund the bonds if they went with the pool deal —- a statement that was “knowingly material and false.”

Davenport says Rose advised the board it would have less flexibility and control over refunding pool bonds. Davis said the VPSA refunds pool bonds, but issuers of standalone bonds have more flexibility.

The agency might refund all or part of a pool issue, but not necessarily at the request of a participant. “We’ll do whatever works to meet the threshold we have of 3% present value savings,” he said.

Lawton recalls some confusion. Board members thought Davis was telling them that with standalone bonds they would be able to refund the bonds any time, he said. They did not understand the bonds could not be called for years and that governmental bonds can only be advance refunded once under federal tax laws.

The Board of Supervisors voted 4-2 to authorize the standalone bond issue at a Sept. 17 meeting, two days after Lehman Brothers Holdings Inc. filed for bankruptcy and four citizens at the meeting urged the board to delay the transaction. Then-board members Marvin Moss, Charles Allbaugh, Mozell Booker and John Gooch voted for the resolution. Donald Weaver and Gene Ott voted against it.

Delay Urged

On Nov. 24, the board convened a special meeting at the request of Weaver and Ott to determine whether the bond issue should be delayed because of volatility in the market. Weaver, Ott and 13 of 16 citizens urged the board to hire an independent consultant or someone who would give a second opinion on the bond issue and its timing.

But the proposal was rejected by a 4-2 vote, with Weaver and Ott in the minority. The bonds were priced on Dec. 9 and the deal closed on Dec. 22.

The county’s suit claims that Rose was pushing for a refunding of the bonds even before the bonds were issued and immediately afterward so he “could reap substantial fees on both the front end and the back end of the transaction.” Rose discussed the idea of a refunding at a Jan. 7, 2009 board meeting, the first one after the bonds were issued.

Davenport was paid $168,812.50 in financial advisory fees when the bonds were issued in December 2008, said William Allcott, counsel at McGuireWoods LLP, which is representing Davenport. The firm also was paid $17,397 in expenses from 2003 through 2008 in connection with its FA work on the deal. Davenport was paid an additional $12,000 for helping the board explore the idea of a refunding.

The county re-hired Davenport as its FA in 2009 after issuing a request for proposals and considering it and two other firms. Davenport’s term was for three years plus two one-year extensions, according to Allcott. But in January 2010 Davenport’s contract was terminated, after Ott was elected board chairman. The lawsuit was not filed until September 2011 in the Fluvanna County Circuit Court.

With all the sparring between the county and Davenport about the bonds’ interest rates and Rose’s advice, the lawsuit could be determined on procedural issues.

Davenport told the court: “In deciding to fund a new public school by issuing bonds, and in passing a resolution specifically selecting a type of financing, the board exercised a delegated legislative power of the General Assembly ...

“The separation of powers principles prevent courts from deciding whether the terms of the legislation are good or bad policy, and from taking action on that account .... Virginia courts have repeatedly refused to inject themselves into legislative decisions made by county boards of supervisors.”

Davenport also claims virtually all of the charges are time-barred and should have been filed within two years after the bonds were sold.

An attorney for the board, Douglas Palais at Eckert Seamans Cherin & Mellott LLC in Richmond, did not respond to requests for comment. Most of the board members and county attorney Fred Payne declined to comment on the lawsuit.


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