Pennsylvania Enacts SWAP Legislation
By Rick L. Frimmer, Greenberg
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Swap Legislation Passed
Pennsylvania has officially joined the few states that have enacted legislation
specifically designed to provide the conditions under which municipalities
and school districts can legally enter into agreements hedging interest
rates. On September 24, 2003, Pennsylvania Governor Edward G. Rendell signed
H.B. 1148 into law.
|"Entering into interest rate
swaps has become a favorite tool of tax-exempt bond issuers."
H.B. 1148 represented the work originally done by lawyers at Greenberg
Traurig, LLP, particularly Rick L. Frimmer in GT’s Philadelphia office,
in concert with State Representative Stephen Nickol. The legislation received
support on both sides of the aisle and received special attention from the
Pennsylvania Department of Community and Economic Development.
Entering into interest rate swaps has become a favorite tool of tax-exempt
bond issuers and their advisors in order to keep a prudent portion of their
debt portfolio linked to the interest rate market. Historically, floating
interest rates tied to indices, such as the Bond Market Association (BMA)
rate, have been lower than fixed rates for investments of the same maturity.
Municipalities previously had to resort to issuing multi-modal debt in order
to have the ability to switch from fixed interest rates to floating interest
rates and vice versa.
Qualified Interest Rate Management Agreements
For the first time, Pennsylvania municipalities which are not distressed
may enter into "qualified interest rate management agreements." Thus, cities
(other than the City of Philadelphia), school districts, townships and boroughs
of all classes may now legally manage interest rate risk through swaps and
other forms of hedging devices, including caps, collars, corridors, ceilings,
forward agreements and float agreements.
Agreement Adopted by Resolution
There are a few basic procedural matters that must be observed by the
- The governmental unit must authorize and award the agreement (or confirmation
thereof) by resolution and at a meeting duly and specifically advertised
for this purpose at least three (3) days prior to the meeting;
- The resolution must include, either in its text or by appendix, all
of the following:
- A copy of the interest rate management agreement or the confirmation
proposed to be executed;
- A copy of an "interest rate management plan" adopted by the governmental
unit or by the municipal authority whose debt is being guaranteed by
the governmental unit; and
- A statement of how the interest rate agreement was awarded.
Provisions Required in Interest Rate Agreement
A "qualified interest rate management agreement" must contain certain
- It must specify which of the government unit’s existing notes or bonds
"relate" to the notional amount of the interest rate agreement (thus preventing
- A term, which cannot be longer than the latest maturity date of the
bonds or notes which the governmental unit states are "related to" the
- It must terminated when the "related" bonds or notes are no longer
- It must specify a maximum interest rate for the payments to be made
by the governmental unit;
- It must provide that the maximum net payments to be made by the governmental
unit during a fiscal year cannot be greater than the sum of the variable
rate scheduled payments (computed at the maximum rate) and the interest
payments actually made by the governmental unit on the "related" bonds
- It must specify whether the source of the payments by the governmental
unit are general revenues or specific revenues;
- A provision addressing what actions will be taken if the counterparty’s
credit rating changes; and
- A provision acknowledging that all payments to be made by the governmental
unit on its "related" bonds or notes (or those of a subordinate authority)
as well as the periodic payments due under the interest rate agreement
are all senior in right and priority to any termination payments which
may have to be made under the interest rate agreement.
- Covenants to:
- Make the payments (including termination payments) required under
- Include the periodic payments in every annual budget for each fiscal
year that the agreement is in effect;
- Appropriate annually the periodic amounts due from general or specific
A "qualified interest rate management agreement" may contain additional
provisions at the option of the governmental unit, including a covenant
to include any termination payments in a current or future budget; a provision
that the periodic payments due are equally and ratably secured with the
debt service on the "related" bonds or notes; and a provision that the agreement
may be terminated by the counterparty only with cause.
If specific revenues of the governmental unit are pledged for the repayment
of amounts due under the "qualified interest rate management agreement,"
the governmental unit may grant the counterparty a security interest in
those specific revenues. If a security interest is granted in the agreement,
it is automatically deemed perfected.
The Interest Rate Management Plan
The adopting resolution must contain, in its body or in an appendix,
an "interest rate management plan." This is a written plan prepared or reviewed
by an independent financial advisor which contains at least the following:
- A schedule showing all debt service on all outstanding debt of the
governmental unit. In the case of variable rate debt, the debt service
must be listed both by computing interest at expected rates and by computing
interest as well at the maximum rate specified in the debt instrument;
- A schedule listing the notional amounts of all previous and active
qualified interest rate management agreements (although probably all outstanding
swap agreements were meant to be included here);
- A schedule of all fees of every kind to be paid both by the governmental
unit and the counterparty;
- A schedule of the estimated and maximum payments both to be made and
received by the governmental unit under the agreement;
- An analysis of the interest rate risk, basis risk, termination risk,
credit risk, market access risk and other risks involved in the transaction
to the governmental unit; and
- The governmental unit’s plan to monitor the risks of the current agreement,
including obtaining valuations of the periodic market and termination
values of all active qualified interest rate management agreements.
Awarding a Qualified Interest Rate Management Agreement
The government unit must establish a process for selecting the potential
counterparties to the "qualified interest rate management agreement." No
entity is eligible to be a counterparty unless it is then rated in the top
three rating categories by at least one nationally recognized rating agency
(e.g., Moody’s, Standard & Poors, Fitch). The award can be made either by
private negotiation or in a public bid.
The form of the agreement to be entered into and adopted in the resolution
must contain financial terms and conditions which, in the opinion of an
independent financial advisor, are fair and reasonable.
An "independent financial advisor" must be experienced in interest rate
risks and in interest rate management agreements, and must not be the counterparty
or affiliated with the counterparty.
Default by the Governmental Unit
If the governmental unit fails to include the amount of periodic payments
in its annual budget, the counterparty may bring an action for mandamus
in the court of common pleas, whereupon the court may order the governmental
unit to pay the periodic payments out of the first revenues received thereafter
by the governmental unit which are not required to be placed in a sinking
fund for certain tax anticipation notes.
If the governmental unit fails to pay any amount due under a "qualified
interest rate management agreement" for thirty days or more, the counterparty,
subject to any contrary provisions in the agreement, may sue the governmental
unit in common pleas court. Any judgment rendered in favor of the counterparty
will, subject to a few exceptions, be payable of the first revenues received
thereafter by the governmental unit.
If the governmental unit is a school district and fails to make periodic
payments under a "qualified interest rate management agreement," the Pennsylvania
Secretary of Education must be notified (by either party). The Secretary
of Education will then notify the school board and the Pennsylvania Department
of Economic and Community Development. Additionally, until paid, any amounts
due to the school district from the state will thereafter be paid to the
Also, any judgment rendered against a governmental unit for failure to
pay and an unpaid termination payment is now eligible to be the subject
of new bonds issued for "unfunded debt."
Further, termination payments can now be included in refunding issues.
A certified copy of the resolution adopted for a "qualified interest
rate management agreement" must be filed within fifteen (15) days with the
Pennsylvania Department of Community and Economic Development.
If the maximum amount of net payments that could be made under a "qualified
interest rate management agreement" are greater than the debt service that
would be payable on the "related" bonds and notes, computed at their maximum
rates, the governmental unit must adopt a resolution increasing the maximum
interest rate on the "related" bonds and notes. No other approvals are required.
The governmental unit must account for all "qualified interest rate management
agreements" in its financial statements under applicable principles adopted
by the Government Accounting Standards Board of the American Institute of
Certified Public Accountants.
In H.B. 1148, Pennsylvania municipalities have been given a broad authority,
subject to appropriate checks and balances, to enter into sophisticated
transactions and can manage their borrowing needs on a more streamlined
and efficient basis.
Greenberg Traurig’s public finance lawyers in Philadelphia and elsewhere
are experienced in these sophisticated transactions and proud to have assisted
the Commonwealth of Pennsylvania in being among the few states recognizing
the need to have formal guidance in this area.
© 2003 Greenberg Traurig
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