Bloomberg News

Harrisburg Officials Ignored Incinerator Risk, Audit Says

February 01, 2012

(Updates with swaps from fifth paragraph.)

Jan. 18 (Bloomberg) -- Harrisburg officials and advisers knew there was “substantial risk” that a city incinerator wouldn’t repay its debt and proceeded with bond deals anyway, according to an audit of the financings that drove the Pennsylvania capital into insolvency.

The Harrisburg Authority, the agency that owns the trash- to-energy plant, today released the forensic report on deals that saddled the city with more than $300 million in debt, a load five times its general-fund budget. The state placed the community in receivership last year.

Harrisburg, with 49,500 residents, in 2003 overhauled the plant to remedy environmental violations. The city, surrounding Dauphin County and bond insurer Financial Security Assurance Inc., which all guaranteed deals that year and in 2007, didn’t heed “numerous red flags,” according to the audit. It refers to the incinerator as the resource recovery facility, or RRF.

“They received significant guarantee fees or insurance premiums for doing so, knowing the risks associated with default,” the audit said. “All evidence pointed to the RRF’s inability to service existing and contemplated debt.”

Excessive Fees

The report also flagged the use of derivative investments known as swaps, calling them unnecessarily complex transactions that resulted in excessive fees and higher risks.

“It appears at least some of these swaps were entered into and terminated for short-term gains, irrespective of additional risks or negative long-term effects of the transactions,” the audit said. “It appears that the decision to enter into several of the transactions may have been driven primarily by the immediate need for money, and may not have been permissible” under the law.

RBC Dain Rauscher, a subsidiary of Royal Bank of Canada that was described as the primary architect of the financing, received above market swaps payments from the authority, the audit said. The authority paid the bank $6.16 million in fees, including some which may have been handed to other underwriters, according to the report.

“While we have not had an opportunity yet to review the report, we stand by our work with the authority which was confined to the 2003 transaction and its related components,” Elisa Barsotti, an RBC spokeswoman, said by e-mail.

Reed’s Role

Former Harrisburg Mayor Stephen Reed, who pushed through the deals, didn’t immediately respond to a telephone call for comment on the audit. He served in the position from 1982 through 2009.

The auditors said that professionals who were hired by the authority, which operates independently of the city, maintained close ties with Reed. In at least one instance, in 2000, the city got about $4.2 million from the authority for insuring some bonds and used the money to help balance the municipal budget, the audit said.

“The authority’s and the county’s independent financial advisors do not appear to have seriously challenged the plan of finance, suggested alternatives to the recommended swap transactions, or expressed concerns to their clients about management of interest-rate risk or cost relating to specific transactions or long-term planning,” the audit said.

Disturbing Structure

Philadelphia-based law firm Klehr Harrison Harvey Branzburg LLC, accounting firm ParenteBeard LLC and New York-based Public Resources Advisory Group conducted the audit.

Payments the Harrisburg Authority made to firms working on these deals, excluding the county and city, came to almost $83.5 million, the report said. Most of that, about $60.5 million, went to Barlow Projects Inc., the lead contractor for the overhaul, according to the audit.

David Unkovic, Harrisburg’s state-appointed receiver, will submit a recovery plan for the city for court approval Feb. 6.

Unkovic has called the structure of the incinerator deals “disturbing” and said those who played a part in the debt should participate in its solution. He has been negotiating with Dauphin County, and bond insurer Assured Guaranty, which bought Financial Security Assurance in 2009. The county and insurer covered debt payments when the city skipped them.

Amy Richards Harinath, a spokeswoman for Dauphin County, and Ashweeta Durani, a spokeswoman for Assured Guaranty, couldn’t immediately comment on the report.

Unkovic’s recovery plan must be approved by a state court. He doesn’t need the consent of elected officials to implement his recommendations, under the law that authorized the first receivership in the state.

--Editors: Stephen Merelman, Ted Bunker, Mark Schoifet

To contact the reporter on this story: Romy Varghese in Philadelphia at rvarghese8@bloomberg.net

To contact the editor responsible for this story: Mark Tannenbaum at mtannen@bloomberg.net


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