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MBTA’s hedges against rising interest rates prove costly

“We’re going to do what’s best for the T, and get the best level of interest rates,’’ said Brian Shortsleeve. the chief administrator at the MBTA. Keith Bedford/Globe Staff/File 2015

The MBTA’s new financial overseers will soon decide whether to stop betting on the direction of interest rates to protect some of its debt, potentially taking a step away from an expensive hedging strategy that proved unnecessary after the financial crisis.

In December, the Massachusetts Bay Transportation Authority hired a new advisory firm to review these hedges, called interest rate swaps, replacing a longtime adviser, Swap Financial Group.

The MBTA has been paying for what is essentially insurance on a chunk of bonds with payouts that would otherwise rise along with interest rates. It seemed like a prudent move after rates climbed through the late 1990s and as the housing market surged through the mid-2000s. And the transit authority was not alone: Before the crisis in 2008, Wall Street was selling such swaps to everyone from hospitals to Harvard University.


But rates fell after the real estate bubble burst and global markets slumped. Rather than saving money, the transit authority spent $55 million extra for swaps from 2000 to 2005, the state auditor said in a 2008 report. Today, the MBTA is spending about $26 million extra per year in interest on swaps for $623 million of debt, records show.

The MBTA’s chief administrator, Brian Shortsleeve, appointed by Governor Charlie Baker last summer to help bring its finances in order, said the authority is now considering a change on half of its eight outstanding swaps.

“We’re going to do what’s best for the T, and get the best level of interest rates,’’ Shortsleeve said, “and that puts us on the most sustaining fiscal path.”

The T has a total of $5.3 billion in outstanding debt, most of which is borrowed at fixed, long-term rates. About 10 percent is variable-rate debt, with swaps layered on them to cap interest payments.

Because interest rates have fallen, the cost to get out of all the swaps, if the T wanted to, would be about $121 million, according to a report prepared for the authority.


The swaps currently in question were originally executed with Lehman Brothers, then were moved to Deutsche Bank when Lehman failed in 2008, at the start of the global financial meltdown. Now, a drop in Deutsche bank’s own credit rating has triggered an opening for the T to reconsider swaps on $276 million of bonds.

The drop in Deutsche Bank’s credit rating is like breaking part of its agreement with the T. It matters because if rates were to rise sharply, Deutsche Bank would need to make payments to the T on the swaps.

“It never made sense in the first place for the T to get involved in these financial derivatives,’’ said Iliya Atanasov, a senior fellow in finance with the Pioneer Institute in Boston, a think tank and frequent critic of the transit authority. “It’s more money being drained from the T.”

Proponents say the swaps enabled the MBTA to lock in lower rates than it could have at the time on fixed-rate debt. But today, the Deutsche Bank swaps are costing the T about $9 million a year in extra interest.

Getting rid of the Deutsche Bank swaps also could also be politically unpopular, costing about $30 million, according to MBTA documents.

As recently as September, the MBTA’s former financial executives were recommending continuing the swaps, but moving them to Barclays, according to a document presented to the Massachusetts Department of Transportation at the time.


“The team had a preference for Barclays,’’ said Peter Shapiro, managing director for Swap Financial Group of South Orange, N.J., which had been the swap adviser to the MBTA for a decade before being dismissed. The firm still does work the state.

Shapiro said relationships often influence such recommendations. But the firm does not “play favorites,’’ he said. “Our philosophy is to encourage competition.”

Barclays is the firm that acquired Lehman after it failed, and it’s the employer of Paul Haley, a powerful former Massachusetts state legislator who worked with the MBTA on its debt after he left government in 2001.

Shortsleeve’s team has replaced Swap Financial with PFM Swap Advisors of Philadelphia. If the MBTA decides to keep the swaps, at better terms, PFM in a December presentation recommended TD Bank, US Bank, and Wells Fargo Bank as potential new bankers.

Andrew Smith, a spokesman for Barclays in New York, declined to comment on the swaps.

According to the Commonwealth’s unaudited financial statements for the year ended in June, the Department of Transportation, including the T, has the majority of the outstanding swaps among state entities. To exit all of them today would cost $478 million.

Beth Healy can be reached at beth.healy@globe.com. Follow her on Twitter @HealyBeth.