BRADENTON, Fla. - Alabama on Tuesday filed a complaint in federal court asking a judge to void a swaption the Alabama Public School and College Authority entered into in 2002 and 2003 with JPMorgan.

In addition to questioning the validity of the original transaction under Alabama law, the state's complaint also said that published reports indicate investigations are under way by the Securities and Exchange Commission and Justice Department into JPMorgan's participation in transactions such as the one Alabama is contesting.

Alabama finance director Jim Main received a federal subpoena concerning the state's swaption, the complaint said.

The subpoena contained 13 pages of requests for documents pertaining to the swaption, Main said in an interview yesterday. He also said that receiving the subpoena "was the last nail in the coffin," referring to the last in a number of reasons why the state decided to legally challenge the swaption's validity.

JPMorgan declined to comment.

The Public School and College Authority, which is overseen by the governor, the state finance director, and the superintendent of schools, entered the swaption in 2002 for notional amount of $710.2 million. The swaption agreement covered $300 million of revenue bonds, Series 1998, $18.4 million of bonds, Series 1999A, $250 million of bonds, Series 1999C, and $172.7 million of bonds, Series 1999D.

In return for total payments of $12.58 million, the authority gave JPMorgan future options to enter swap transactions on the bonds where the authority would make a fixed-rate payment to JPMorgan, and the firm would make variable-rate payments to the county based on 70% of the London Interbank Offered Rate. In January 2003, the agreement was amended to change the variable-rate payments to 67% of Libor.

The authority has the right to terminate the entire swaption, a decision that Main estimates would cost it about $70 million.

Earlier this year, JPMorgan exercised its option on the 1998 bonds, which would have required the authority to issue variable-rate refunding bonds by Nov. 1.

"The lawyers started analyzing it and basically came to the conclusion that this was not a normal swap," Main said.

According to the complaint filed in the U.S. District Court for the Middle District of Alabama, the authority's payments from JPMorgan represented less than 1% of the outstanding amount of the Series 1998 bonds.

"Taking into account the costs of issuing refunding bonds, [the authority] could realize virtually no savings in connection with the supposed hedge offered by the swaption," the complaint said. "Indeed, the effect of the swaption was that [the authority] sold JPMorgan its right to potential future benefits that would result from a decline in long-term interest rates in exchange for avoiding the risk of an extraordinary and historically unprecedented increase in long-term rates. That supposed risk was so remote as to have been no risk at all, and the swaption consequently was not a legitimate hedging transaction within the meaning of Alabama law."

The complaint also contends that the fixed-rate payment schedule in the swaption also "departed materially" from legitimate swap transactions, which typically are structured so that payments match the declining balances of an existing fixed-rate bond issue.

The authority's payment schedule is front-loaded, enabling JPMorgan to receive more than 50% of the fixed-rate payments, or $35 million, within a year after exercising the swaption and more than 95% of the payments, over $66 million, within two years, the complaint said. It called the structure a $66 million loan from the authority with effectively no rate of return or implied interest rate.

The complaint also alleges that the swaption was not documented in accordance with Alabama law.

According to the swap documents, the law firm Maynard, Cooper & Gale PC and Swap Financial Group LLC were hired to advise the authority. Swap Financial could not be reached for comment yesterday.

Main would not comment on whether he believed the authority received bad advice when the swap was structured, but he pointed out that the chairman of the authority at the time was former Gov. Don Siegelman, who in 2006 was sentenced to seven years in prison for bribery, conspiracy, and mail fraud during his term in office. He is appealing his conviction.

According to Main, the amended swaption changing the Libor percentage to 67% from 70% occurred on the "last business day of the Siegelman administration in favor of JPMorgan."

Main said the dispute has nothing to do with sewer debt-related problems the state now is overseeing in Jefferson County, whose main creditor is also JPMorgan.

"If a judge orders us to pay $70 million to terminate all four of these, we'll pay the $70 million," Main said. "If the judge says the fees are void, my guess is at a minimum the judge will say we should pay back the [up-front] money plus interest."

To assist with the case, the state hired the law firms of Balch & Bingham LLP and Bradley Arant Rose & White LLP, as well as Kensington Capital Advisors as swap adviser, and Public FA Inc. as financial adviser.

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