Token Funder: Interest Rate Swaps.

[chilliaa]

Token funder, i was hoping you could help me with better understanding interest rate swaps. I think i understand the basic mechanics of them, but not the more intricate details.

First of all a generic picture:
It seems that many companies are using the swaps to hedge their interest rate exposure. These swaps seem to be entered into to match the repayment schedule of interest repayments on the underlying debt.

So question is:
If this is the case then how do central bank drops in interest rates help these companies. Effectively the floating rate of the debt instrument would drop, but the company would incur a swap hedging expense in the P&L which would offset the benefit.

 

[chilliaa]

would they effectively have to wait until the debt instruments come up for renewal to re-negotiate the new synthetic rate. I say this because in the notes to the accounts, the company (in this case brambles) mention that they utilise swap agreements to match the repayment term of interest payments, which implies the swaps are engineered for the duration of the loan.

 

[chilliaa]

Token funder another question:
What is the cost of the government guarantee on the AA lenders, was it 60basis points or 70 basis points?

Interesting note today in relation to CBA bond issues:
The offer consisted of A$2.5 billion in five-year notes
backed by the Australian government at 70 basis points over
swap and BBSW, of which A$2 billion is in a fixed rate format. There was also a tranche of A$250 million in three-year
non-guaranteed notes at 130 basis points over BBSW.

If the government guarantee cost is 60 basis points then we might have reached cost parity, if its 70 basis points then its now 10 basis points cheaper not to use the government guarantee.
In either case i think it represents an improvement on just a few months ago where not using the government guarantee would not be an option.

 

[Token Funder]

Howdy,

Questions 1 and 2 are outside of my world. We'll have to do some reserach

For AAA down to AA- it's 70bp.

Hadn't caught up with CBA's latest foray (lots of time on planes) but to get a real indication of comparability you want to see issues of the same duration. I'll chat with the boys on the treasury desk monday to get the finer details and get back to you.

 

[asdf]

We are in a brave new world now. Even if RBA goes to 0%, it will still cost us 2-3% to borrow over the counter. Gone are the days when they raise an single digits over.

With BXB's swap hedging, they would be suffering massive mark to market losses now on the books. But if executed correctly, it should be neutral to their cash flow and profitability because the accountants and CFO would've already factored it in, hence the hedging in place. If they didn't do so, they would essentially be running massive interest rate risk which is not their business as opposed to selling CHEP pallets.

Whatever the RBA does means squat diddly to them but great for us IP investors who stuck with variable rates.

 

[chilliaa]

We are in a brave new world now. Even if RBA goes to 0%, it will still cost us 2-3% to borrow over the counter. Gone are the days when they raise an single digits over.

With BXB's swap hedging, they would be suffering massive mark to market losses now on the books. But if executed correctly, it should be neutral to their cash flow and profitability because the accountants and CFO would've already factored it in, hence the hedging in place. If they didn't do so, they would essentially be running massive interest rate risk which is not their business as opposed to selling CHEP pallets.

Whatever the RBA does means squat diddly to them but great for us IP investors who stuck with variable rates.

How would they be suffering market to market losses on the books (im not criticising here, im trying to work it through). If market interest rates rates dropped, the unapplied portion of the swaps would be a liability, but because they are not recognised (ie they havent fallen due), they wouldnt be recognised as a loss (or if they did, then there would have to be a future asset class called future interest rate exposure savings or something)

The current applied portion utilised would be a loss in the P&L but with a corresponding interest rate expense improvement which would cancel each other out.


There was another comment in one of the notes to the accounts that Brambles doesnt use swaps as an investment mechanisim (ie means of speculation) only as a pure interest rate hedge, so im not worried about unhedged swap rate exposure.