UC lost millions on interest-rate bets

University accountants estimate the 10-campus system will lose as much as $136 million over the next 34 years on complex contracts.

UC investment performance worst among nation’s richest colleges

BY MELODY PETERSEN

The University of California has lost tens of millions of dollars, and is set to lose far more, after making risky bets on interest rates on the advice of Wall Street bankers.

University officials agreed to the financial deals – complex contracts known as interest-rate swaps – because they believed they could save money in the midst of an aggressive building spree.

But the deals are now costing the university an estimated $6 million a year, according to its financial statements.

And university accountants estimate the 10-campus system will lose as much as $136 million over the next 34 years that it is locked into the deals. Those potential losses would be reduced only if interest rates start to rise.

Already officials have been forced to unwind a contract at UC Davis, requiring the university to pay $9 million in termination fees and other costs to several banks. That sum would have covered the tuition and fees of 682 undergraduates for a year.

The university is facing the losses at a time when it is under tremendous financial stress. Administrators have tripled the cost of tuition and fees in the past 10 years, but still can’t cover escalating expenses. Class sizes have increased. Families have been angered by the rising price of attending the university, which has left students in deeper debt.

The interest-rate bets have the same outlines as those made by Robert Citron, the former Orange County treasurer. Twenty years ago, the county went bankrupt when Citron’s investments in arcane securities tied to interest rates went sour. There was one difference: Citron bet interest rates would fall. The university gambled that rates would rise.

Timothy Schaefer, a municipal finance adviser in Newport Beach, said he warns clients about the dangers of interest-rate swaps.

“I don’t think they are suitable for most public agencies,” Schaefer said. “You have to have a tolerance for risk.”

In interviews, Peter Taylor, the university’s chief financial officer, defended the decisions. He said he was confident that interest rates will rise in coming years, reversing what the deals have lost.

“We have a long-term view,” he said.

Taylor was a top banker in Lehman Bros.’ municipal finance business in 2007 when the bank sold the university a swap related to debt at UCLA that has now become the source of its biggest losses on the deals.

The university hired Taylor for the $400,000-a-year position in 2009. He has continued to sign contracts for interest-rate swaps in cases where he and his staff estimate they will save money over the cost of traditional debt.

He pointed to the university’s new guidelines, which require an analysis of the expected costs and risks of each proposed swap deal before it is approved.

“They are part of our toolbox,” he said of the swaps. “If they don’t save us money, we won’t do them.”

Read the full article here: OC Register