State College Area School District in Pennsylvania several years ago abandoned plans to build a new high school. This month, it received a notice that it owes $10 million to Royal Bank of Canada for skipping an interest payment on money it never borrowed for a school it didn’t build.
The notice was the latest step in a legal battle over what the district calls a “naked swap” and what RBC describes as a binding legal agreement. The conflict is an example of how cities, states, schools and other public entities are second-guessing financial deals they made in recent years, pitting them against their own bankers and advisers.
Many of the regrets revolve around interest-rate swaps that became popular as a way for municipal borrowers to guard against jumps in rates. Typically under these contracts, a borrower pays a bank interest with a fixed rate and the bank pays interest with a floating rate in return. When interest rates declined, swaps proved costly to many borrowers.