Risky Morgan Keegan Derivative Bond Deals Leave Small Towns Reeling
Lewisburg, Tennessee, is a quaint, affable town known for rich farmland and friendly neighbors. Now, thanks to investment bank Morgan Keegan & Company, Lewisburg is becoming known for something else: municipal bond derivative deals gone bad.
The small city’s introduction to Morgan Keegan and the derivative instruments occurred five years ago, when Lewisburg was trying to lower the interest on a bond for a new sewer system. Bob Phillips, Lewisburg’s part-time mayor, approached Morgan Keegan for advice and quickly became immersed in the complex world of derivatives.
As reported April 7 by the New York Times, that world soon soured for Lewisburg an hundreds of small cities just like it. Municipalities that bought derivatives were much like homeowners, securing fixed-rate mortgages and then refinancing with lower interest, variable rate mortgages, says the New York Times article.
In the case of the municipalities, however, many officials now say they were never told or didn’t understand that interest rates on derivatives can go much higher if economic conditions turn sour.
When the inevitable happened and the economy, in fact, worsened, Lewisburg paid the price. The cost of interest paid on its sewer bonds has quadrupled to an astounding $1 million. As for Lewisburg residents, they face a 33% increase in water and sewer rates.
And the added costs couldn’t come at a worst time. Unemployment in Lewisburg currently stands at more than 10%, as a slew of established businesses close their doors. Even longtime employer Sanford Pencil, the Sharpie pen maker, is preparing to relocate to Mexico.
At the time Lewisburg officials entered into their municipal derivative contract with Morgan Keegan, the Memphis based investment firm dominated nearly the municipal bond derivative business in Tennessee, both in terms of acting as an adviser and as an underwriter. According to the New York Times article, data compiled by Tennessee’s comptroller’s office show Morgan Keegan sold some $2 billion worth of municipal bond derivatives to 38 cities and counties since 2001.
Many of the deals orchestrated by Morgan Keegan have resulted in similar predicaments like happening in Lewisburg. In nearby Claiborne County, Tennessee, for instance, officials there are desperately trying to get out of a municipal bond derivative contract with Morgan Keegan. Doing so, however, will cost the county $3 million, money the county can ill afford.
The same is true in Mount Juliet. Located about 17 miles from downtown Nashville, city leaders recently learned that payments on their bonds had increased by 500% to $478,000, according to the New York Times story.
Meanwhile, as Lewisburg, Mount Juliet and many other Tennessee municipalities struggle to find a way out of their derivative messes, Morgan Keegan is counting the millions and millions of dollars in fees it’s collected by serving in the dual, and questionable, role of underwriter and adviser.
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