Yesterday the Philadelphia Inquirer had a headline that read “Wall Street wins as Pennsylvania public schools bet against interest rates.” One of the school districts that bet against interest rates was the Colonial School District.
From the article:
Worried about rising interest rates last year, at least three school districts — the Upper Merion and Colonial districts in Montgomery County, and Avon Grove in Chester County — took the advice of advisers at Philadelphia-based Public Financial Management Inc. (PFM) to buy so-called interest-rate swaps. Those financial tools were touted as insurance against rising finance costs for the next few years, when their boards plan to borrow tens of millions of dollars to build new schools.
PFM matched the districts, which bet rates would rise, against an investment bank, RBC Capital Markets (owned by Royal Bank of Canada), which bet that rates would fall.
The school districts promised the banks a percentage of the money they hoped to borrow in exchange for payments that rise (or fall) with interest rates. Whoever owes more starting in June 2020 will pay the other the difference.
Since interest rates have not gone up, the article states that the Colonial School District may need to pay RBC $3 million next August. (Upper Merion could be on the hook for $5 million+).
The Colonial School Board considered the “Interest-rate swap” in two phases. During the Finance & Audit Committee meeting on September 4, 2018, and then a full meeting on September 20, 2018. The committee consisted of Chair Adam Schupack, Eunice Franklin-Becker, and Susan Moore. During the September 4th meeting, there was a presentation made by PFM Financial Advisors and the bank. Note that the entire school board was in attendance for the presentation.
From the committee meeting minutes:
Mr. Szablowski (David Szablowski, Business Administrator at Colonial School District) introduced Scott Shearer and John Frey from PFM Financial Advisors and Lauren Stadel from RBC Capital Markets. Mr. Shearer reviewed the financing plan for the proposed construction of a new Colonial Middle School and informed the Committee that the Borrowing Parameters Resolution is proposed to be considered by the School Board at the September 20 Board meeting. The parameters resolution would authorize the borrowing of a maximum $84 million in the form of General Obligation Bonds (GOBs). The first bond issue is to be completed by the end of 2018 in the approximate amount of $10 million. An additional amount of bonds with the approximate value of $30 million would be issued in 2019 and the final bonds issued in 2020 in the approximate value of $34 million. The committee discussed the maximum issue amount of $84 million as the budget for the project has not yet been established. The committee was informed that the $84 million was a not to exceed amount and that depending on the accepted bids for the project, the District would only issue the required amount. The committee was informed that the purpose of the bonds would include the Colonial Middle School but additionally language to allow for other capital projects to allow the School Board flexibility in the future to address other buildings’ needs. The committee recommended the Borrowing Parameters Resolution for Board consideration on September 20.
John Frey reviewed the Cash Settled Forward Swap, which will be utilized to hedge against possible increases in the bond market interest rates prior to the issuance of the 2020 bonds. The swap locks in the current interest rates for the approximately $34 million bond issue. The counterparty for this agreement will be Royal Bank of Canada (RBC) and PFM Swap Advisors LLC will act as Swap Advisor. The swap will have a mandatory termination in August 2020 and if interest rates increase, the District will receive a cash settlement to reduce the size of the bond issue, therefore reducing the level of debt service required. Conversely, if interest rates would be lower in August 2020 than today’s market, the District would issue bonds at a lower interest rate but would be required to pay RBC at the termination of the agreement. Either scenario would produce similar levels of borrowing costs for the District over the life of the bonds issued. Mr. Frey reviewed the various risk factors with the committee, including project risk of not proceeding with the project. The cost of the swap agreement with a notional amount of $33.855 million was presented and estimated at .096%. This estimate means that at the effective date of 8/15/20, if the interest rates did not increase by 0.10%, the District would owe a termination payment. The committee reviewed a presentation regarding the swap, illustrating the hedge and possible scenarios of interest rate changes with and without the swap.
Administration supported the Cash Settled Forward Swap agreement be entered into to fix the interest rate exposure of the 2020 bond issue. The committee had their questions regarding the swap agreement addressed and recommended the action appear on the September 20 agenda for Board consideration.
Then the full board voted on the plan on September 20, 2018. From the minutes:
Action: G. CMS Financing – Forward Swap Agreement Adoption
Motion to approve and adopt the Interest Rate Swap Resolution also referred to as the Forward Settled Swap Agreement as proposed and presented by Bond Counsel, Rhonda Lord from Kegel, Kelin, Almy, & Lord
Motion by Adam Schupack, second by Mel Brodsky.
Final Resolution: Motion Carried
Yea: Adam Schupack, Cathy Peduzzi, Felix Raimondo, Eunice Franklin-Becker, Jennifer Dow, Leslie Finegold, Mel Brodsky, Susan Moore, Rosemary Northcutt
You should really read the entire article from Philly.com, which you can here. It goes into how this type of transaction became legal (Ed Rendell) and offers an explanation from Szablowski on the Colonial School District’s reasoning for going forward with the swap plan.