CHICAGO — Moody’s Investors Service placed on negative watch five Wisconsin school districts involved in a risky investment to help fund their other post-employment benefits. The move follows Depfa Bank Plc’s decision last month to demand repayment of notes issued to fund the investment.

Depfa last month called on the districts to make good on their moral obligation pledge to repay the notes. The bank also seized the meager $5.3 million that remained in the trusts established by the schools.

The actions marked the latest development in the ongoing saga of the districts’ $200 million gamble in a complex investment scheme in three synthetic collateralized debt obligations.

Moody’s attributed its action Tuesday to “uncertainty about the district’s willingness and ability to meet the obligations” of their trusts.

The watch-list status threatens ­Kimberly School District’s A1 rating on $55.2 million of outstanding general obligation debt, West Allis-West Milwaukee School District’s A1 rating on $19.5 million of debt, Waukesha School District’s A2 rating on $12.3 million of bonds, Kenosha School District’s A1 rating on $145.7 million of debt, and Whitefish Bay School District’s Aa2 rating on $1.4 million of debt.

Kimberly’s trust issued $4.3 million in asset-backed notes, while West Allis issued $72.4 million, Waukesha $50 million, Kenosha $28.4 million, and Whitefish Bay $9.7 million.

The five districts established trusts in 2006 that in turn issued the notes.

The proceeds were combined with $35 million in collective cash to invest in the three CDOs. The school systems put their moral obligation pledge behind the note issues.

“Among other concerns, Moody’s is looking to clarify how the district plans to respond to Depfa’s request and any potential impact on the district’s credit quality,” analysts wrote in each of their five reports. “Moody’s believes that involvement in the synthetic CDO investment is limited to five Wisconsin school districts and therefore has negligible potential impact for other municipal entities in Wisconsin.”

The districts expected to benefit financially by capturing the spread between the low rate they paid on the notes and the higher rate of return they expected on its investments to help pay down their collective $432 million in OPEB liabilities.

The districts put up their moral obligation pledge to cure any deficiency in value of the trusts should the worth of its assets fall below 101% of the principal amount of the notes.

The schools thought the investments were safe in 2006 when they entered into the transactions.

The districts believed the investments were made in highly rated corporate securities that were not exposed to subprime or other market risks.

When the subprime real estate market collapsed and the value of other structured securities fell, the value of the trusts dwindled.

The trusts went into default in December 2007 and the districts were required to cure the defaults. The districts never moved to cure the default and Depfa said it took its action last month seeking repayment of the notes because of frustration over the schools’ resistance to restructuring efforts. 

Each school board must now decide whether to stand behind its moral obligation pledge and appropriate the funds in the next budget. Depfa has said the door remains open to renegotiating the note agreements.

The districts have sued the firms that proposed and structured the trusts — Stifel, Nicolaus & Co., James Zemlyak, an executive vice president at the firm, and the Royal Bank of Canada Europe Ltd. — alleging they fraudulently misrepresented the safety of the investments. The firms counter that the districts were aware of the risks.

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