California College District Sues JPM

JPMorgan Securities LLC, a wing of JPMorgan Chase & Co. ( JPM - Analyst Report ) , has been prosecuted by a California-based community college district over a financing deal inked in 2006. The deal was originally signed with Bear Stearns Cos., which was later acquired by JPMorgan in 2008.

Peralta Community College has demanded that the bond contract should be declared invalid on the grounds of an opinion voiced by the Attorney General of California in 2009. The opinion looked down upon such refinancing deals as the taxpayers’ interest was overlooked.

The college district and Bear Stearns had entered into a forward bond purchase contract, under which college district was allowed to redeem callable bonds, issue new non-callable bonds and sell the new bonds to Bear Stearns. Under the terms of the agreement, Bear Stearns paid $550,000 to the college district.

Such deals were very commonplace during early 2000’s. These deals, often termed as cash-out refunding, helped school districts to retire outstanding bonds by issuing new bonds at higher interest rates. This generated ample cash flow besides meeting the refinancing cost.

In 2009, the Attorney General opined that these refinancing deals, issued at higher rates compared with market, were depriving the taxpayers of the benefits of refinancing. Moreover, such deals jeopardize the state’s constitutional debt and tax limits. As a result, these sorts of agreements lost popularity and eventually reduced in number.

However, the recent dispute started when JPMorgan announced the plan of exercising its options and insisted Peralta College to issue new bonds at local interest rates, which are significantly higher than the market rates.

However, Peralta College refused to honor the contract citing the deal as unconstitutional. Moreover, as stated by the college, issuing new bonds at above market rates will enhance JPMorgan’s earnings but will do very little for the taxpayers.

These constitutional changes have also affected The Goldman Sachs Group, Inc. ( GS - Analyst Report ) as the whole city of Oakland is trying to wriggle out a 15-year old interest rate swap agreement. The agreement involves $4 million of annual payments to Goldman.

JPMorgan is currently facing a plethora of issues related to lawsuits and trading debacle, which are denting its position in the market.

Currently, JPMorgan retains its Zacks #3 Rank, which translates into a short-term Hold rating. Considering the fundamentals, we also maintain a long-term Neutral recommendation on the stock.