Transcript Zinsswap - HUKR - Hrvatska udruga korporativnih rizničara

Interest Hedging in Times of Uncertainty
Annual Conference of the
Croatian Association of Corporate Treasurers,
September 2009
Mag. Martina Kranzl
Agenda
Initial Situation
Interest Hedging in Times of Uncertainty
Basic Instruments
Participation in Money Market Rates
Participation in Capital Market Rates
Appendix
2
Agenda
Initial Situation
Interest Hedging in Times of Uncertainty
Basic Instruments
Participation in Money Market Rates
Participation in Capital Market Rates
Appendix
3
Initial Situation

The purpose of this material is to present you with ideas to control your interest
rate risks. On this basis, further possible solutions for you can be discussed.

The following example is precisely tailored to a specific initial situation. Modified
solutions are naturally available for an altered initial situation.

I assume the following:
1. The coverage of your EUR financing needs for the next 5 years will be met by
taking out a variable loan based on the 3M Euribor.
2. The interest rate will be stipulated at the beginning of every 3-month period based
on the current 3M Euribor whereas the interest payment will take place in arrears
on the last day of the respective period.
3. You would like to secure yourself against an unlimited increase in your interest
load. For this hedging you do not want to pay a premium.
4
Agenda
Initial Situation
Interest Hedging in Times of Uncertainty
Basis Instruments
Participation in Money Market Rates
Participation in Capital Market Rates
Appendix
5
Current Market Environment
6

A historically low interest rate environment prevails in the Eurozone with low
capital market interest rates and even lower money market interest rates.

On the one hand, low capital market interest rates offer the chance of entering into
an attractive fixed-rate agreement.
Current Market Environment
7

On the other hand, a significant premium in the form of a spread will be required
for this hedging, particularly in an economically strained environment.

The 5Y swap rate is currently more than three times as high as the 3M Euribor
(0.762%). Therefore, more will be calculated for the interest hedge than for the
financing (excluding financing margin). The interest rate difference between the 5Y
swap rate and the 3M Euribor reached its 5-year high at 2.0380%. (see appendix)

In addition to the fact that it is quite unattractive to pay a substantial premium,
particularly in a period of weak economic growth, a 5Y interest rate swap does not
fulfill the requirement for flexibility.

The 5Y swap rate exceeds the 3M Euribor because the financial markets expect,
on average, an economic recovery and consequently for the ECB to react with a
series of rate hikes in key interest rates in order to control inflation.
Current Market Environment
8

However, an economic recovery and a steady increase in money market rates is
only one possible future scenario.The swap rate should be interpreted as an
average of a wide range of market expectations (equilibrium price of supply and
demand). It does not imply that this one particular possible future development will
actually occur.

In times of robust economic growth, the range of market expectations concerning
the future course of interest rates is relatively narrow. In light of present day
uncertainties, current expectations are much more diverse.

On the next slides two extreme scenarios for economic development will be
presented. I will elaborate on which form of interest rate hedging would meet the
needs of a regular pro-cyclical customer.
Interest Rate vs. Economic cycle
9

It is assumed that the demands of a business entity will be best met if the interest
payments on debt capital are sustainable i.e. if they adjust simultaneously with the
economic cycle. This is the primary condition.

Once the primary condition is met, we can turn our attention to the secondary
condition: a low rate of interest.
Recovery Scenario
10

The recovery from the recession, already presumed on the equity markets,
continues steadily. During the following year, at the latest, the Eurozone economy
will post positive growth rates.

The positive sentiment is reflected by sharply rising commodity prices and
expectations for a rapid tightening by the ECB. The 3M Euribor is expected to
exceed the level of the current 5Y swap rate by the middle of next year.

This recovery scenario makes clear that the lack of interest hedging would lead to
a higher interest load and/or higher hedging costs.
Recovery Scenario

In a recovery scenario, an entity making use of an interest rate hedge would be
better off due to two factors:
– Fully hedged and immunised to increasing interest rates.
– No upfront premium.

11
It should also be noted that a pro-cyclical business entity could presumably
sustain these higher interest costs. The improvement of the business outlook
justifies a higher interest load. After all, new projects would have to be financed at
a higher level.
Weakness Scenario
12

Although many market participants anticipate an early recovery, some predict a
much slower recovery and even long-term economic weakness cannot be
excluded.

In this scenario, the financial market continues to be overwhelmed by everincreasing uncertainty and consumer confidence decreases further, even in stable
economies like Germany.

Improvements in sentiment prove to have been too optimistic. Many companies
are put under severe pressure as their production capacities which were
increased in recent years can no longer be exploited or sustained.

At the same time, governments are obliged to reform social aid and increase tax
income to satisfy lenders and avoid a rise in financing costs putting the private
sector under additional pressure.
Weakness Scenario
13

This scenario clearly points out how essential it is for a company to choose a
variable loan that adjusts to the economic cycle at least for a portion of the
financing requirement.

In a weakness scenario, an entity making use of variable financing would better off
due to two factors:
–
In comparison to the swap, no “premium“ in the form of a spread has to be
paid to the 3M Euribor.
–
The entity can fully participate in a further declining 3M Euribor.

Therefore, at least some of the demand-side shocks can be buffered by lower
financing costs.

Moreover, interest management contributes to flexibility under the constraints of a
tight financial situation in times of an economic crisis.
Smoothing Results via Variable Financing
Presented below is the smoothing effect of matching the interest costs with the
development of the sales revenues by means of variable financing.
Sales Revenues
- Cost of Production
_________________
Gross Profit
Bear Market:
Declining sales revenues absorbed by
decreasing interest costs.
- Distribution Cost
- Administration Cost
_____________________
Operating profit (EBITDA)
Bull Market
Rising interest costs
compensated by higher sales
revenues.
-
Interest Costs
- Write-offs
- Taxes
+/- Extraordinary
Earnings/Expenditure
Net Income of the Year
The gross profit and operating profit (EBITDA) will remain unaffected by the smoothing
effect of variable financing but the fluctuation in annual profit can be minimised by
adjustable interest costs.
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Interim Conclusion

If the recovery scenario occurs, a fixed rate swap may well have been a
reasonable solution in hindsight. This will not be the case with the weakness
scenario. The possibility of retaining at least some sort of participation in lower
interest rates and keeping financing costs flexible remains unutilized.

This leads to two recommendations regarding interest hedging:

15
–
Don`t miss the chance to secure a maximum interest rate level to take
advantage of current low interest levels. (Hedging)
–
Maintain participation in low 3M Euribor interest rates for as long as the
economic recovery is delayed. (Participation)
Below are various adjustable interest hedging solutions calculated with the
expressed recommendations “Hedging and Participation“. All structures are free of
premium. The following conditions are reference points on which a dialogue
should be built.
Agenda
Initial Situation
Interest Hedging in Times of Uncertainty
Basic Instruments
Participation in Money Market Rates
Participation in Capital Market Rates
Appendix
16
Interest Rate Swap





You enter into an interest rate swap which allows for the exchange of 3 month
Euribor (3M Euribor) of your funding against the payment of the fixed interest
rate of 2.8000% p.a. for the period of 5 years.
The 3M Euribor will be used to service the underlying funding; this interest rate
provision is not dependent on your funding. The fixed rate of 2.8000% p.a.
plus your individual funding margin will be your total interest load of the swap.
For the remainder of the document this will be your comparison rate.
Alternative indications: 2.2000% p.a. for 3 years; 3.5500% p.a. for 10 years
Rewards: fixed calculation rate, no upfront costs
Risk: no participation in low Euriborrates
Loan
3M-Euribor
3M-Euribor
Client
17
2.8000% p.a.
Interest rate Cap





18
Your interest load is based on the 3M Euribor and you want to maintain your
interest load on a floating basis.
You pay a premium of 2.5000% p.a. to guarantee a maximum interest rate on
the 3M Euribor at 3.5000% p.a. for the period of 5 years.
Alternative indications:
 Maximum interest rate at 2.7500% p.a. for 3 years; upfront premium:
1.5000% of the notional amount
 Maximum interest rate at 5.0000% p.a. for 10 years; upfront premium:
3.9000% of the notional amount
Rewards: full participation in low Euriborrates, hedge against rising interest
rates
Risk: upfront costs
3M-Euribor
3M-Euribor
Loan
Client 3M-Euribor,
maximum rate 3.5000% p.a.
Premium: 2.5000%
Agenda
Initial Situation
Interest Hedging in Times of Uncertainty
Basic Instruments
Participation in Money Market Rates
Participation in Capital Market Rates
Appendix
19
Libor Factor with Cap
Market Expectations:
Slightly rising or falling 3M-Euribor.
Alt. Fixed Rate: 2.8000% p.a.
Term:
Interest Mode:
5 Years, bullet
quarterly, act/360, mod. foll.
Customer Receives:
3M-Euribor
Customer Pays:
Liborfactor rate: 1.25 x 3M-Euribor
i.a.*, max. 4.0000% p.a.
3M-Euribor:
0.762% p.a.
Stand Still:
Savings:
0.9525% p.a.
1.8475% p.a.
Worst Case:
Best Case:
4.0000% p.a.
0.000% p.a.
* Interest rate determination at the end of a period (in arrears)
Loan
3M-Euribor
3M-Euribor
Client
20
Liborfactor rate: 1.25 * 3M-Euribor,
max. 4.0000% p.a.
Libor Factor with Cap
 You enter into an interest rate swap which allows for the exchange of 3 month Euribor
(3M Euribor) of your funding against the payment Liborfactorrate.
 The 3M Euribor will be used to service the underlying funding; This interest rate
provision is not dependent on your funding. The liborfactor rate plus your individual
funding margin will be your total interest load of the swap.
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Libor Factor with Cap
RISKS
 The factor of 1.25 leads to commensurately higher interest load.
 The maximum rate is 1.2000% p.a. higher than the alternative rate.
 In case of increasing Euriborrates the fixing in arrears leads to a higher interest rate
load.
REWARDS
 You can participate in low Euribor rates.
 You have secured a maximum rate at no upfront premium.
 In case of falling Euriborrates the fixing in arrears leads to a lower interest rate load.
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Interest Swap with Contingent Fixed Rate
Market Expectations:
Slightly rising or falling 3M-Euribor
Term:
Interest Mode:
5 Years, bullet
quarterly, act/360, mod. foll.
Customer Receives:
3M-Euribor
Customer Pays:
Alt. Fixed Rate: 2.8000% p.a.
3M-Euribor:
0.762% p.a.
Stand Still:
Savings:
0.762% p.a.
2.0380% p.a.
Worst Case:
Best Case:
4.7000% p.a.
0.0000% p.a.
3M-Euribor i.a.*
as long as 3M-Euribor i.a.* < 2.6000% p.a.,
otherwise 4.7000% p.a. until the end of the Term
* Interest rate determination at the end of a period (in arrears)
Loan
3M-Euribor
3M-Euribor
Client
23
3M-Euribor i.a. or
4.7000% p.a.
Interest Swap with Contingent Fixed Rate
 You enter into an interest rate swap which allows for the exchange of the 3-month
Euribor against the payment of the participation interest rate for the period of 5 years.
This interest rate provision is not dependent on your funding. The participation interest
rate plus your funding margin will be your total interest load of the swap.
 The participation interest rate will be the 3M Euribor fixed at the end of every quarter
(in arrears), as long as the 3M Euribor in arrears is fixed below the level of 2.6000%
p.a. If the 3M Euribor is fixed above the level of 2.6000% p.a. you have to pay the
Maximum rate of 4.7000% p.a. for this period and the rest of the tenor.
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Interest Swap with Contingent Fixed Rate
RISKS
 The maximum rate of 4.7000% p.a. is 1.9000% p.a. above the comparison rate.
 Once the 3M Euribor is fixed above the level of 2.6000% p.a. you will pay the
maximum rate of 4.7000% p.a. for this period and the rest of the tenor.
 The fixing in arrears can lead to a higher Interest load and a sooner change into the
fixed rate of 4.7000% p.a.
REWARDS
 You have secured a maximum rate and therefore a fixed calculation basis.
 As long as the 3M Euribor is fixed below the interest rate level of 2.6000% p.a., you
can fully participate in low Euriborrates.
 You do not have to pay a premium for this hedging instrument.
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Smooth-In Swap
Market Expectations:
Term :
Interest Mode:
Customer Receives:
Customer Pays:
Euribor Share:
Falling or constant 3M-Euribor in the beginning and
increasing later on
Alt. Fixed Rate: 2.8000% p.a.
5 Years, bullet
quarterly, act/360, mod. foll.
3M-Euribor
Euribor Share + fixed portion
3M-Euribor:
0.762% p.a.
Stand Still
in Period 1:
0.762% p.a.
Stand Still
in Period 20:
4.2000% p.a.
Worst Case:
Best Case:
4.2000% p.a.
0.0000% p.a.
3M-Euribor i.a.*, max. 4.2000% p.a.
initially 100%, decreasing by 5.26% points per period
(finally reaching 0%)
Fixed portion:
4.2000% p.a.
initially 0%, increasing by 5.26% points per period (finally
reaching 100%)
* Interest rate determination at the end of a period (in arrears)
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Smooth-In Swap
You enter into an interest rate swap which allows for the exchange of the 3-month
Euribor against the payment of the Smooth-in rate for the period of 5 years. This
interest rate provision is not dependent on your funding. The Smooth-in rate plus your
funding margin will be your total interest load of the swap.
The Smooth-in Interest Rate will be calculated from the sum of the fixed rate portion
which will increase during the strategys maturity and the 3-month Euribor, multiplied
by a simultaneously decreasing factor. For the first period the smooth-in rate consists
of 100% of the 3M Euribor, maximum 4.2000% p.a.; for the last period the smooth-in
rate consists 100% of the fixed rate of 4.2000% p.a.
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Smooth-In Swap
28
Smooth-In Swap
29
Smooth-In Swap
RISKS
 The maximum rate of 4.2000% p.a. is 1.4000% p.a. higher than your comparison
rate of 2.8000% p.a.
 The participation in low 3-month Euribor rates decreases over time.
REWARDS
 Based on the current 3-month Euribor, you would pay an interest rate of 0.7620%
p.a. for the first period, which corresponds to an interest reduction of 2.0380% p.a.
in relation to the comparison rate.
 You will have the opportunity to participate in low 3-month Euribor rates.
 The floating interest portion will reduce during the maturity of the strategy. Thus
your fixed rate portion will become more important and your interest load more
calculable.
 No premium payment
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Combi-Swap
Market Expectations:
Slightly rising or falling 3M-Euribor
Alt. Fixed Rate: 2.8000% p.a.
3M-Euribor:
0.7620% p.a.
Term :
Interest Mode:
5 Years, bullet
quarterly, act/360, mod. foll.
Customer Receives:
3M-Euribor
Customer Pays:
0.5* 3M-Euribor + 1.9000% p.a.,
max. 3.8000% p.a.
Loan
2.2810% p.a.
Worst Case:
Best Case:
3.8000% p.a.
1.9000% p.a.
3 month Euribor
3 month Euribor
Client
31
Stand Still:
Combi-Swaprate, max.
3.8000% p.a.
Combi-Swap
 You enter into an interest rate swap which allows for the exchange of the 3-month
Euribor against the payment of the Combi-Swaprate for the period of 5 years. This
interest rate provision is not dependent on your funding. The Combi-Swaprate plus
your funding margin will be your total interest load of the swap.
 The Combi-Swaprate consists of the 3-month Euribor multiplied by the factor of
0.5000 plus a fixed rate of 1.9000% p.a. You will pay a maximum rate of 3.8000%
p.a.
32
Combi-Swap
RISKS
 The maximum rate of 3.8000% p.a. is 1.0000% p.a. higher than your comparison
rate of 2.8000% p.a.
 Participation in low 3-months Euriborrates only with 50% of your interest load.
REWARDS
 You may participate in low 3-month Euriborrates with 50% of your interest load.
 Based on the current 3-month Euribor you would pay an interest rate of 2.2810%
p.a. for the first period, which is an interest reduction of 0.5190% p.a. in relation to
the comparison rate.
 You have hedged a maximum interest rate.
 You do not have to pay a premium for this hedging instrument.
 Your best case of 1.9000% p.a. in case the 3-months Euribor fixes at 0.000% p.a.
is 0.9000% p.a. below your comparison rate.
33
Agenda
Initial Situation
Interest Hedging in Times of Uncertainty
Basic Instruments
Participation in Money Market Rates
Participation in Capital Market Rates
Appendix
34
CMS-Libor Factor with Cap
Market Expectations:
Slightly rising or falling 2Y-EUR CMS rate. (see appendix)
Alt. Fixed Rate: 2.8000% p.a.
3M-Euribor:
0.762% p.a.
2Y-EUR CMS: 1.686% p.a.
Term:
Interest Mode:
5 Years, bullet
quarterly, act/360, mod. foll.
Stand Still:
Savings:
2.0232% p.a.
0.7768% p.a.
Customer Receives:
3M-Euribor
Worst Case:
Best Case:
4.000% p.a.
0.000% p.a.
Customer Pays:
CMS Factor rate: 1.20 x 2Y-EUR CMS i.a.*
max. 4.00% p.a.
* Interest rate determination at the end of a period (in arrears)
3M-Euribor
Loan
3M-Euribor
Client
35
CMS Factor rate: 1.20 * 2Y
EUR CMS i.a., max. 4.00% p.a.
CMS-Libor Factor with Cap
 You enter into an interest rate swap which allows for the exchange of 3 month Euribor
(3M Euribor) of your funding against the payment CMS Factor rate.
 The 3M-Euribor will be used to carry forward to the underlying funding; This interest
rate provision is not dependent on your funding. The CMS Factor rate plus your
individual funding margin will be your total interest load of the swap.
36
CMS-Libor Factor with Cap
RISKS
 The factor of 1.2 leads to commensurately higher interest load.
 The maximum rate is 1.2000% higher than the alternative rate.
 In case of increasing CMS-rates the fixing in arrears leads to a higher interest rate
load.
 Your minimum interest load is at 0.0000%
REWARDS
 You can participate in low CMS-rates.
 You have secured a maximum rate at no upfront premium.
 In case of falling CMS-rates the fixing in arrears leads to a lower interest rate load.
37
Agenda
Initial Situation
Interest Hedging in Times of Uncertainty
Basic Instruments
Participation in Money Market Rates
Participation in Capital Market Rates
Appendix
38
39
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Appendix
Spread between 5Y Swap rate and
3M Euribor
2,50%
2,00%
1,50%
1,00%
0,50%
0,00%
-0,50%
-1,00%
-1,50%
-2,00%
Frequently Asked Questions

What does CMS stand for?
CMS is the abbreviation for “Constant Maturity Swap“. With a CMS Swap, a long-term
swap rate will be used as the reference rate instead of a short-term rate (e.g. EURIBOR).

How is the fixing of the Capital Market Rate determined?
The fixing is carried out by the independent organization ISDA (International Swaps and
Derivatives Association). Quoted swap rates from a panel of various reference banks are
used to establish an average. The fixing for the EUR swap rate is published on the Reuters
page ISDAFIX.
40
Contact
Maja Crnec
Erste&Steiermärkische Bank d.d.
Financial Markets and Investment Banking
Mag. Martina Kranzl
LPA GmbH
Zagreb I.Lučića 2
Tel.: +385 (0)62 37 1548
Frankfurt am Main
Email: [email protected]
Email: [email protected]