September 12, 2013
Peralta Community College District Other Post Employment Benefits Bond Program Swap Update
Keygent LLC 338 Spear Street, 23D San Francisco, CA 94105 (415) 746-9168
Table of Contents Section
Page
I.
Swap Basics
3
II.
District’s Other Post Employment Benefit Bond Review
14
Section I Swap Basics
What is a Swap? There are many types of swaps but the most common is the interest rate swap An interest rate swap is an agreement between two parties to exchange one stream of interest rates for another over a specific period of time ◆ A derivative’s contract ◆ Trades over-the-counter ◆ Independent Swap Dealers are market makers
Generally a swap involves 2 parties, is an exchange of 2 different interest rates, usually fixed rate payments for floating rate payments ◆ Payments based on taxable LIBOR (London Interbank-Offered Rate) or tax-exempt SIFMA (Securities Industry and Financial Markets Association) index ◆ Party that pay fixed rates and receives floating rate is the receiver ◆ Party that pays floating rate and receives fixed is the payer
CFTC and SEC have regulatory authority over swaps Dodd Frank forced over 20 changes in regulation and reporting of swaps
3
Why Use a Swap? Major borrowers evaluate the swap market and the bond market Alternative way to access capital ◆ ◆ ◆ ◆
Lock in fixed rate and receive floating rate to match rate being paid on bonds Asset liability match - pay floating and receive fixed Limit or manage variable rate interest rates Obtain marginally lower interest rate
4
A Swap Transaction A municipal issuer issues variable rate interest bonds ◆ Bonds interest rate changes weekly or monthly ◆ Variable rate is tied to an index like LIBOR or SIFMA
Issuer wants to reduce the variable rate interest rate risk ◆ ◆ ◆ ◆
Exchange fixed rate interest payment for variable rate interest payments Variable rate is tied to LIBOR or SIFMA index Variable rates offset each other Convert variable rate bonds to “synthetic” fixed rate bonds
5
Example Interest Rate Swap Maturity: 1 year Notional: $1, 000,000 ABC:
Pays 5% fixed rate to XYC
XYZ:
Pays Libor + 1%
LIBOR will be 4% at end of year ABC pays $50,000 or 5% x $1,000,000 XYZ pays $57,500 or 5.75% x $1,000,000 XYZ pays $7,500 to ABC with no principal exchanged
Company ABC
5% fixed rate
LIBOR + 1%
6
Company XYZ
Example Interest Rate Swap ABC Company and XYZ Company enter into one-year interest rate swap with a nominal value of $1 million. ABC offers XYZ a fixed annual rate of 5% in exchange for a rate of LIBOR plus 1%, since both parties believe that LIBOR will be roughly 4%. At year end ABC will pay XYZ $50,000 (5% of $1 million). If the LIBOR rate is trading at 4.75%, XYZ then will have to pay ABC Company $57,500 (5.75% of $1 million, because of the agreement to pay LIBOR plus 1%). The value of the swap to ABC and XYZ is the difference between what they receive and spend. Since LIBOR ended up higher than both companies thought, ABC won out with a gain of $7,500, while XYZ realizes a loss of $7,500. The net payment will be made of $7,500 will be made from XYZ to ABC avoiding the additional cost of including principal.
7
Swaps Simplified
8
Synthetic Fixed Rate Swap Synthetic Fixed Rate
Dealer Floating Floating
Issuer pays Swap Fixed Rate minus the Difference between the two Floating Rates
9
How to Exit a Swap To get out of a swap is to “terminate” a swap ◆ An issuer can terminate a swap at any time ◆ A swap provider (Morgan Stanley) generally cannot
There is no prepayment penalty to terminate a swap early – there is a gain or loss called a termination payment Termination payment is based on ◆ Interest rates at the time ◆ Remaining years to final maturity ◆ Notional principal amount
Termination payment is calculated on original market rate versus current rate, the dollar size and the time to maturity.
10
Swap Risks Both issuer and counterparty sides are at risk in a swap transaction ◆ Counterparty Risk – Credit quality of dealer and collateral – Length of contract
◆ Termination Risk – Downgrade of swap provider, issuer or default situation
◆ Basis Risk – Floating interest rate you receive does not offset floating rate being paid on bonds
◆ Index risk – SIFMA or LIBOR – Interest rate changes
◆ Tax Risk – Tax-exemption
11
Swap Market is Big Type
Global Market (in trillions)
US Market
Swaps
$633
$430
Stock
$50
$22
Fixed Income
$84
$37
160
140
Size in Trillions of Dollars
120
100 80
60 40 Stocks
20 0
12
The Fixed Income Markets Have Changed
Source: Learn Bond, Mark Prosser
13
Section II District’s Other Post Employment Benefit Bond Review
OPEB Program The District sold $153,749,832.15 in Other Post Employment Benefit bonds in December 2005 ◆ The bonds were structured as two series of bonds – Short current interest bonds – 6 longer term tranches of zero coupon bonds that converted at a specific date to auction rate securities (variable rate bonds) – The zero coupon bonds are non-callable until the conversation date to variable rate
In 2006, the District entered into 6 swaps with Morgan Stanley as the dealer/counterparty ◆ A forward starting swap is a contract that begins in the future – No money is exchanged until the swap start date
◆ The B-1 tranche was to convert to variable rate (auction rate) in August 2010 – The District refunded and restructured that series of bonds to fixed rate bonds as the auction rate market was dead – The matching swap was not terminated in 2009
◆ The B-2 tranche converts in August 2015
15
Summary of OPEB 2005 Bonds
$20,015,000 Series A Serial Bonds Maturity August 1
Principal Amount
Interest Rate
Price
2006 2007 2008
$1,725,000,000 $3,180,000,000 $4,110,000,000
4.710% 4.82% 4.87%
100% 100% 100%
2009 2010
$5,340,000,000 $5,660,000,000
4.910% 4.94%
100% 100%
$133,734,832.55 Convertible Auction Rate Securities Series
Initial Issuance Date
Final Maturity Date
Initial Principal
Accreted Value
Accretion Date/ Initial Variable Date
Interest Rate
Price
B-1
2005
2015
$27,090,742
$33,950,000
2010
4.964%
100%
B-2
2005
2020
$23,633,292
$38,450,000
2015
5.133%
100%
B-3
2005
2025
$19,866,112
$43,175,000
2020
5.387%
100%
B-4
2005
2031
$20,025,603
$57,525,000
2025
5.456%
100%
B-5
2005
2039
$21,514,328
$86,650,000
2031
5.516%
100%
B-6
2005
2049
$21,604,753
$134,475,000
2039
5.516%
100&
16
Peralta Swaps Fixed Rate Bond
Synthetic Fixed Rate
Issuer
Issuer
Fixed
Dealer Floating
Fixed
$
$
Bond Holder Final Maturity Series Date
Floating
Bond Holder
Initial Principal
Accreted Value
Full Accretion Date/ARS Initial Interest Rate (August 5)
Swap Rate
Notional Amount
B-1
2015
$27,090,742
$33,950,000
4.964%
2015
4.90%
$33,950,000
B-2
2020
$23,633,292
$38,450,000
5.133%
2020
5.158%
$38,450,000
B-3
2025
$19,866,112
$43,175,000
5.387%
2025
5.279%
$43,175,000
B-4
2031
$20,025,603
$57,525,000
5.456%
2031
5.207%
$57,525,000
B-5
2039
$21,514,328
$86,650,000
5.516%
2039
5.055%
$86,650,000
B-6
2049
$21,604,753
$134,475,000
5.516%
2049
4.935%
$134,475,000
17
Timeline – Swaps with Morgan Stanley
B-1 B-2 Converted 2010 Converts 2015 Matures in 2015 Matures in 2020
2015
2020
Initial Series Issuance Date
B-3 B-4 Converts 2020 Converts 2025 Matures in 2025 Matures in 2031
B-5 Converts 2031 Matures in 2039
2035
2040
B-6 Converts 2039 Matures in 2049
2025
2030
2045
Initial Principal
Accreted Value
Accretion Date/ Initial Variable Date
Maturity Date
Swap Term
B-1
2005
$27,090,742
$33,950,000
2010
2015
2010-2015
B-2
2005
$23,633,292
$38,450,000
2015
2020
2015-2020
B-3
2005
$19,866,112
$43,175,000
2020
2025
2020-2025
B-4
2005
$20,025,603
$57,525,000
2025
2031
2025-2031
B-5
2005
$21,514,328
$86,650,000
2031
2039
2031-2039
B-6
2005
$21,604,753
$134,475,000
2039
2049
2039-2049
18
2050
LIBOR Yield Curve Comparison
19
19
Timeline – Swaps with Morgan Stanley 7.00%
6.00%
5.00%
4.00%
3.00%
District enters into six swap agreements with Morgan Stanley Swap MTM on 9/9/13 ($8,583,900)
2.00% Swap MTM on 6/12/07 $4,208,000
1.00%
Swap MTM on 7/24/12 ($28,693,000)
0.00% 2006
2006
2007
2007
2008
2008
2009
2009
2010
2010
20
2011
2011
2012
2012
2013
2013
Current Swap Values – September 10, 2013
21
