Beyond Hand to Mouth

Harvard Paid $500 Million to Exit Backfired Interest-Rate Swaps

By John Lauerman and Michael McDonald

Oct. 16 (Bloomberg) — Harvard University, the world’s richest school, paid almost $500 million to investment banks to escape interest-rate swaps that backfired, according to the school’s annual report released today.

Harvard paid $497.6 million during the fiscal year ended June 30 to get out of $1.1 billion of interest-rate swaps intended to hedge variable-rate debt for capital projects, the report said. The university in Cambridge, Massachusetts, said it also agreed to pay $425 million over 30 to 40 years to offset an additional $764 million in swaps.

The swaps began losing value last year when benchmark interest rates fell in the global credit crisis, forcing the school to post collateral to the banks that sold the swaps, said Daniel Shore, Harvard’s chief financial officer. Harvard sold $2.5 billion in bonds, in part to pay for the swap exit, even as the school’s endowment recorded its biggest loss in 40 years, the Harvard annual report said.

“When we went into the fall, we had some serious liquidity management issues we were dealing with and the collateral postings on the swaps was one,” Shore, who is also Harvard’s vice president for finance, said in an interview today. “In evaluating our liquidity position, we wanted to get some stability and some safety.”

Swaps are a type of derivative where two parties agree to exchange payments tied to a financing, typically a variable-rate for a fixed-rate payment. The terminated swaps include three tied to $431.7 million of bonds the university sold in 2005 and 2007, the annual report said.