Economic Downturn Hits Choate School Learns of $1 Million in Expenses in bond insurance debacle
By Andrew Ricardo ’10
News Staff Reporter
With the recent economic downturn marked most recently by the fall of Bear Stearns, businesses and organizations across the country have lost enormous sums of money and experienced great financial pain. Choate, unfortunately, has lost about one million dollars because of the current economic circumstances.
In June of 2007, Choate issued forty-two million dollars worth of bonds in order to help finance the construction of its new dorms and refinance unrelated existing debt which had a high interest rate. Because of Choate’s relative anonymity in the stock market, the school needed to get a credit enhancement in order to look more appealing in the market. To do this, Choate bought an insurance policy from a company with the highest possible credit rating to assure people who purchased Choate’s bonds that they would be reimbursed no matter what happened to the school.
While this decision should have benefited the school, the economic crisis took its toll on XL Capital Insurance, the insurance company that issued the policy. XL Capital Insurance had invested in sub-prime mortgages, mortgages given to people with low credit ratings. Over time, more and more people who owed money for sub-prime mortgages defaulted on their payments because of spiked interest rates. This left insurance companies like XL Capital Insurance without a large chunk of their income. This unfortunate incident left XL Capital Insurance with a severely diminished credit rating. Richard Saltz, Choate’s chief financial officer, explained, “We, all of a sudden, [had] a better rating than the insurance company…it’s an ironic twist; they went out of business before we did.”
Since XL’s credit rating was the reason why people had been buying Choate’s bonds, the company’s downfall ended up deterring people from buying any more. Unfortunately Choate’s own financial status and credit had absolutely nothing to do with buyers’ decisions. “Choate is stuck in the middle,” says Saltz. “We didn’t have any financial problems; we’re just caught in this market. If investors bought our bonds based on who we were, we wouldn’t have this problem.”
As a result of Choate’s bonds’ decreased rating sparking increased risk for buyers, the interest rate Choate is required to pay rose from 3.8 percent to up to 12 percent. This created a debt of around five hundred thousand dollars for Choate.
Choate’s new strategy is to get out of the “auction market,” where people actually bid weekly on bonds, and to issue new variable rate bonds in a supply-and-demand market which Saltz calls “much more conventional.” Because Choate is still an unknown presence in the economy, the school is delving into its affairs this time with a letter of credit from the bank J.P. Morgan Chase to support it. While this is undoubtedly a beneficial decision, Choate unfortunately will derive even more expenses from reissuing its bonds, bringing the total cost of the entire ordeal to approximately one million dollars.
Knowing this information, it’s difficult not to wonder how the situation will affect the Choate community. In a note from Headmaster Edward Shanahan, the faculty was told to decrease spending in any way possible, major or minor. According to Saltz, Choate does not want to issue formal budget cuts: “We have to make up the million dollars somehow, [but] we don’t want to do budget cuts… we want people to look seriously at their spending.” In order to help the process along, some empty faculty positions may not be filled until later this year and certain financially heavy projects may be delayed. However, Saltz says that he “[does] not know of any major way” in which the school will be affected. The good news for Choate is that the school is currently in a chain of seven months of record cash flow. Daniel Courcey, Choate’s director of development and alumni relations, said, “In terms of the capital campaign…we’re about a year ahead of schedule. The campaign’s in good straits.” Hopefully, the high income will continue for Choate in this particular time of need.Unfortunately, the capital campaign was meant to increase Choate’s endowment and not to help Choate pay off any debt from such an economic crisis. Consequently, Choate has quite a financial burden on its back and a difficult task ahead. To cover the funds lost in this economic circumstance, students and faculty alike will have to come together in consideration for conserving resources and trimming costs. Whether we accomplish this by conserving energy and water through another Green Cup and Hydro Cup effort or by securing donations from current students’ families, Choate must push through these tough financial times.
The stock of XL Insurance, the comopany that insured Choate’s bonds, has dropped sharply over the past six months. contributed photo
