How tax reform allowed New Mexico to drop an expensive swap

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Termination fees for interest-rate swaps in a New Mexico transportation bond program that was tarnished by a criminal investigation came to a steep $67 million, but a fortuitous refunding brought the net cost to zero, according to state officials.

The swaps were investigated by a federal grand jury in 2009 and were arranged by swap advisor CDR Financial Products, which was found guilty in a larger bid-rigging investigation. The New Mexico Finance Authority terminated the swaps in June with proceeds from a $420 million refunding issue.


Michael Zavelle, chief financial strategist at the NMFA, said that a confluence of events, including Congressional tax reform in December and opportunities in the bond market, made the refunding necessary and successful.

“That transaction is viewed as one that couldn’t possibly have gone any better,” Zavelle said. “Not only was the net present value savings a positive NPV of several million dollars, but it allowed the state to even out the flow of payments in future years. I think in terms of the timing of the transaction, the bids and the pricing, I don’t think anyone in the state could have expected it to be better.”

The refunded bonds and notes issued in 2008 and 2011 were always refundable under terms of the original variable-to-fixed-rate transaction, but the swap termination fees were previously considered too high to make the deal feasible.

Under the 2017 tax legislation passed by Congress in late December, the existing debt became much more costly to service, Zavelle said.

“What made this transaction viable in an unfortunate way was the tax bill in December,” he said. "It added an extra margin to the fixed rate. It increased the cost by about $1 million per year.”

Zavelle said the 2004 transportation bond financing that included the swaps took place under very different market conditions than today's.

“When you issue fixed-rate bonds, the investor is taking all the risk,” he said. “If you’re willing to take on some of the investor’s risk by doing floating rate to fixed, you can reduce the cost. That’s what the swaps achieved, shifting the risk to the entity that issues them. Sometimes that’s a good idea, sometimes that’s a bad idea. In this case, it was a bad idea in light of the collapse of floating rate in 2008.”

One of the counterparties in the swaps was Lehman Brothers, whose bankruptcy shocked the global financial community and virtually froze markets in 2008. But no one saw that coming when the transaction took place.

“If you were looking at it from perspective of 2004, you might have said ‘Geez this market’s fine, it’s a risk worth taking,'” Zavelle said.

The 2009 federal grand jury indictment alleged that CDR rigged the bids for investment contracts involving a variety of issuers and got kickbacks. The indictment said the scheme started in 1998 and was ongoing until at least November 2006.

CDR and its founder, David Rubin, donated $120,000 to Richardson’s political committees between 2003 and 2005.

In 2011, CDR and Rubin pleaded guilty to criminal charges stemming from a wider bid-rigging investigation.

At the end of the investigation, no state officials were indicted, though Richardson’s cabinet appointment by President Obama was scuttled.

Richardson wanted the $1.6 billion in bonds known as GRIP (Gov. Richardson’s Investment Partnership) to boost the state’s lagging economy. The GRIP bonds were issued in 2004 and 2006.

New Mexico issued $420 million of the 2004 bonds as variable-rate interest bonds – meaning the interest rate paid by the state would be determined by various market indexes like Libor, the London Interbank Offered Rate.

Under the original floating-rate deal, the New Mexico Department of Transportation faced a debt-service “cliff” in 2025 and 2026, when revenues would have fallen far short of the $100 million per year required, Zavelle said. Under the refunding, however, debt service is extended by three years and the “cliff” is reduced to a manageable $40 million per year, Zavelle said.

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Variable-rate bonds Credit derivatives Refunding bonds New Mexico Finance Authority New Mexico
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