Auditor general discourages school interest-rate swaps

Conventional loans safer, Wagner says

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HARRISBURG -- Allegheny County school districts have entered nearly $1 billion worth of interest-rate swaps during the past 12 months. That's no way to handle public money, according to state Auditor General Jack Wagner.

Mr. Wagner yesterday urged school districts and other government agencies to end swap agreements in favor of conventional fixed-rate loans. He's also asking the Legislature to make it illegal for public agencies to use swaps.

His plea came after an audit found that the Bethlehem Area School District lost at least $10.2 million by using swaps in financing bond issues. Swaps are transactions that, basically, bet on how interest rates will move. Swaps can result in reduced interest rates or, in volatile markets, huge unforeseen costs.

"Quite simply, the use of swaps amounts to gambling with public money," Mr. Wagner said. "The fundamental guiding principle in handling public funds is that they should never be exposed to the risk of financial loss. Swaps have no place in public financing and should be banned immediately."

Getting out of swap agreements is not necessarily cheap or easy.

It cost Butler Area School District nearly $5 million to exit a swap contract in 2008, a transaction that brought it an upfront payment of only $750,000. Superintendent Edward Fink said the loss is being financed over 20 years.

Some school districts came out ahead on swap agreements because the indices used to calculate interest rates worked in their favor.

Locally, Hampton School District is about $2.1 million ahead with its swap agreement, said Jeffrey Kline, director of administrative services.

When the district entered its swap in 2004, it received an up-front payment of $2.5 million, money it otherwise would have had to borrow for middle school construction. Since then, it has lost about $400,000, much of that last fall.

"It really was a good opportunity for us," said Mr. Kline. "We're certainly well ahead on the $2.5 million."

Mr. Wagner says that can change fast.

"The risk outweighs the benefit, and it's not a minor risk; it's a significant risk," he said.

North Hills School District is involved in three agreements, including one that extends to 2024. W. David Hall, director of finance and operations, estimates that at this point it would cost more to exit the agreements than to stay in them.

The North Hills agreements were based on the idea that taxable interest rates would be higher than nontaxable interest rates. The reverse is what has happened in what Mr. Hall termed "bizarre" credit markets.

So far, North Hills has received a $12 million up-front payment, made about $200,000 on one swap agreement and lost about $250,000 on another, he said.

Tennessee already has banned local governments from using swaps and New York is considering following suit, Mr. Wagner said.

Twenty-one percent of Pennsylvania school districts entered swaps between 2003 and this year, according Mr. Wagner's audit. More of those districts are in Allegheny than in any other county.

Tracie Mauriello can be reached at or 717-787-2141. Eleanor Chute can be reached at or 412-263-1955.


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