Interest Rate Risk: Changing the Game. May 30, 2018 New York Cash Exchange Annual Conference

Transcription

1 Interest Rate Risk: Changing the Game May 30, 2018 New York Cash Exchange Annual Conference 11

2 Disclaimer TRANSACTIONS IN OVER-THE-COUNTER DERIVATIVES (OR SWAPS ) HAVE SIGNIFICANT RISKS, INCLUDING, BUT NOT LIMITED TO, SUBSTANTIAL RISK OF LOSS. YOU SHOULD CONSULT YOUR OWN BUSINESS, LEGAL, TAX AND ACCOUNTING ADVISERS WITH RESPECT TO PROPOSED SWAP TRANSACTION AND YOU SHOULD REFRAIN FROM ENTERING INTO ANY SWAP TRANSACTION UNLESS YOU HAVE FULLY UNDERSTOOD THE TERMS AND RISKS OF THE TRANSACTION, INCLUDING THE EXTENT OF YOUR POTENTIAL RISK OF LOSS. THIS MATERIAL HAS BEEN PREPARED BY A SALES OR TRADING EMPLOYEE OR AGENT OF CHATHAM HEDGING ADVISORS AND COULD BE DEEMED A SOLICITATION FOR ENTERING INTO A DERIVATIVES TRANSACTION. THIS MATERIAL IS NOT A RESEARCH REPORT PREPARED BY CHATHAM HEDGING ADVISORS. IF YOU ARE NOT AN EXPERIENCED USER OF THE DERIVATIVES MARKETS, CAPABLE OF MAKING INDEPENDENT TRADING DECISIONS, THEN YOU SHOULD NOT RELY SOLELY ON THIS COMMUNICATION IN MAKING TRADING DECISIONS. 22

3 Today s Agenda 1 Introductions 2 3 Hedging in the Current Market Enviroment Interest Rate Hedging Strategies 4 Accounting and Operational Considerations 5 Q&A 33

4 Today s Speakers Brian Hockenberry Assistant Treasurer Director, Treasury & Risk Management Booz Allen Hamilton Ryan Ross, CTP Senior Associate, Global Treasury Booz Allen Hamilton Amanda Breslin, CFA, CTP Executive Director, Corporate Treasury Advisory Chatham Financial 44

5 Chatham Financial at a Glance 2,000 clients +++ Corporates Caterpillar Comcast Dow FedEx GE GM HP Nike Private Equity Bain JPM Asset Mgt Blackstone KKR Carlyle Oaktree Financial Institutions Deutsche Mizuho Bank Morgan Stanley Discover Santander Manulife Sallie Mae Real Estate Brookfield Hilton Hotels Forest City Simon Property Group Hines Starwood Capital Expertise ~550 Employees Scale Half trillion $ of hedges executed per year 50 million Valuations per year 55

6 Chatham Financial Overview Strategic Risk Assessment Hedging Strategy & Execution Hedge Accounting Derivative & Debt Valuation Simplifies Complexity Derivative Regulatory Compliance Legal (ISDA) Defeasance & Yield Maintenance ChathamDirect SaaS Application for Risk Management Supported by Chatham s robust technology platform: 66

7 Booz Allen: A Leader with a Proud History COMPANY OVERVIEW We are a global firm of 24,757 diverse, passionate, and exceptional people driven to excel, do right, and realize positive change in everything we do. We bring bold thinking and a desire to be the best in our work in consulting, analytics, digital solutions, engineering, and cyber and with industries ranging from defense to health, energy, and international development. Over 100 years in business HQ in McLean, VA 97% of FY17 revenue was derived from government agencies, including Department of Defense, Department of Homeland Security, and the U.S. Armed Forces Key client relationships at a high level of the U.S. Government Approximately 4,800 (1) contracts and task orders; 91% of our FY17 revenue was derived from engagements on which we acted as the prime contractor UNIQUE ORGANIZATION AND CULTURE Built on collaboration One P&L and single bonus pool for partners, vice presidents, principals, and senior associates Equity incentives broadly distributed to leadership to ensure long-term success and alignment with shareholders Approximately 70% (1) of staff with security clearances (1) Data as of 3/31/17. 77

8 Booz Allen: Service Offerings 88

9 Booz Allen: Diversified Client Base WE PROVIDE SERVICES TO A BROAD CUSTOMER BASE Defense, 48.3% Com/Int'l, 2.3% FY16 Civil, 26.0% Intel, 23.4% GLOBAL COMMERCIAL (2.6%) Commercial: International: Financial Middle East, Services, Utilities, North Africa Energy, Retail, Region, and Manufacturing, Select Asian Healthcare Markets Air Force Army DEFENSE (46.6%) Joint Combatant Commands Navy/Marine Corps CIVIL (27.7%) Homeland Security Health & Human Services (1) Client listing includes significant clients based on revenue, but the lists are not all inclusive. INTEL (23.1%) U.S. Intelligence Agencies: National Security Agency, National Geospatial- Intelligence Agency, National Reconnaissance Office, Other Classified Clients Military Intelligence Veterans Affairs Treasury Justice Agencies: Defense Intelligence Agency, Service Intelligence Centers, Intelligence Surveillance Reconnaissance Units 99

10 Today s Agenda 1 Introductions 2 3 Hedging in the Current Market Enviroment Interest Rate Hedging Strategies 4 Accounting and Operational Considerations 5 Q&A 10

11 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 3.0% April 2018 Market Update- Rates and the Fed Recent Historical 1Mo. Libor Forward Curves Fed Projections and 1 Mo. LIBOR Current Sep-17 Jun-17 Mar Mo. 2LIBOR 2.5 Fed Projections Fed 4Average % 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Year 1 Year 2 Year 3 Year 4 Year 5 5 Year Swap vs. 1 Mo. LIBOR Spread 5Y swap 1Mo. Libor 2.5% 2.0% 1.5% 1.0% 0.5% US Interest Rate Environment Short term rates have increased meaningfully, and the current forward curve is now fairly aligned with Fed projections. A relatively flat back end of the forward curve results in a significant decrease of the opportunity cost of longer dated hedging. 0.0% 11

12 1M LIBOR Hairy Chart 9% 8% Actual 1m Libor vs. Historical Forward Curves 1-Month LIBOR Projected 1-Month LIBOR Fwd Curve 7% 6% 5% 4% 3% 2% 1% 0% Forward curve undershot the realized curve Forward curve undershot the realized curve 12

13 % 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 3.0% March 2017 Market Update- Rates and the Fed Recent Historical 1Mo. Libor Forward Curves Fed Projections and 1 Mo. LIBOR Mar-17 Dec-16 Sep-16 Jun % 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Year 1 Year 2 Year 3 Year 4 Year 5 5 Year Swap vs. 1 Mo. LIBOR Spread 5Y swap 1Mo. Libor 1 Mo. LIBOR Fed Projections Fed Average 2.5% 2.0% 1.5% 1.0% US Interest Rate Environment The forward curve is pricing in expectations of multiple rate increases, but still falling short of Fed projections The spread between short term and long term rates has widened as short term LIBOR has not yet met the market s expectations 0.5% 0.0% 13

14 Today s Agenda 1 Introductions 2 3 Hedging in the Current Market Enviroment Interest Rate Hedging Strategies 4 Accounting and Operational Considerations 5 Q&A 14

15 Interest Rate Hedging Strategies Balancing Strategic and Operational Needs 15

16 Product Choice Considerations Step-Up Swap Swaption Collar Annuitized Premium Cap Swap w/ Embedded Floor Swap vs. Cap Deferred Premium Cap Cancellable Swap Stepped Strike 16

17 Interest Rate Hedging Considerations What are the tradeoffs? Swap Swap w/floor Cap Economic Structure Synthetic Fixed rate Synthetic Fixed rate (increased by floor purchase) Sets an upper bound on floating rate Risk Profile Creates predictability Creates greatest predictability, inclusive of debt floor Defines a worst case outcome Additional Considerations Requires credit Potential liability Requires credit Potential liability Upfront Cash Premium Best when Rates increase above swap rate Rates increase above swap rate Rates stay below swap rate Worst when Rates remain below swap rate, worse if rates fall below loan floor Rates remain below swap rate Rates increase, but don t exceed strike 17

18 Bright Horizons Hedging Decisions 8% Actual 1m Libor vs. Floating Rate Floor 7% 1-Month LIBOR Fwd Curve 6% 5% 4% 3% 2% Carlyle investment Swap w/embedded Floor 1% 0% IPO Debt Floor Policy/ISDA s Hedgin g 18

19 Execution Strategies Competitive Auction Right to Match Relationship Advantage Syndication / Risk Participation Direct Negotiation Banking Relationships Invite all to participate Partial advantage Full advantage Lead bank advantage Invite to participate Liquidity Considerations Tailor sizing Tailor Sizing Tailor Sizing Lead bank takes risk Client manages Pricing Efficiency Maximum efficiency Market movement / Set advantage level Likely least efficient / Need pricing visibility Transparency Full disclosure Full disclosure Full disclosure Limited / Need pricing visibility Administrative Ease / Likely outsource Requires coordination Requires coordination Single contract rate Multiple admin channels 19

20 Today s Agenda 1 Introductions 2 3 Hedging in the Current Market Enviroment Interest Rate Hedging Strategies 4 Accounting and Operational Considerations 5 Q&A 20

21 Hedge Accounting Interest Rate Swaps Revenue - Expenses = Operating Income ± Other Income/Expense - Interest Expense = Net Income ± OCI (CTA) = Comprehensive Income Mark to Market Change in derivative value will flow through earnings in other income or expense (by policy election). Additionally, interest expense line is purely variable as payments on the debt are not offset by payments on the swap through interest expense. Hedge Accounting Amounts paid or accrued relating to the swap are recognized through interest expense therefore resulting in a fixed interest expense (debt and swap together). All other changes in value go to OCI on the balance sheet. 21

22 Leaf Impact Chart of New Hedge Accounting Guidance Definition of Benchmark Any contractually specified rate for variable rate instruments Expansion of benchmark rates to include Secured Overnight Financing Rate (SOFR) in addition to SIFMA, OIS, US Treasury and LIBOR Swap Rate Partial Term Designate any sequential fixed-rate cash flows of the hedged item s contractual term, aligning economic objectives for hedge term with application of hedge accounting Measurement of Ineffectiveness Eliminates the requirement to separately measure and report hedge ineffectiveness and generally requires the entire change in the fair value of a hedging instrument to be presented in the same income statement line as the hedged item. Partial Term Hedging Measurement of Ineffectiveness Benchmark Interest Rate Hedging Qualitative Testing Qualitative Testing While quantitative effectiveness testing is still required at inception, companies can now choose to qualitatively assess the ongoing effectiveness relationship 22

23 How does LIBOR going away affect me? Potential for Higher Interest Payments: depending on the terms of your credit agreement language, if LIBOR goes away you may revert to a fallback rate above the initially agreed upon rate Economic Mismatch: If LIBOR is replaced in both the credit agreement and interest rate swap but the updated reference rate does not match, an economic mismatch will exist Re-designation Considerations: Today, a change in index in an interest rate swap would be considered a change in critical terms, requiring re-designation. If LIBOR is replaced in the swap with the updated reference rate, will re-designation be required? Ongoing Hedging: as market participants begin adopting the new reference rate, liquidity will take time to develop. Additionally, understanding a new index creates an administrative burden for all parties involved Notable Articles: Chatham s Newsletter to Clients Life after LIBOR The Alternative Reference Rate Committee s Rate Evaluation Process and Phased Transition Plan UK Financial Conduct Authority The Future of LIBOR 23

24 ISDA Documentation Negotiation & Process Important to leverage market knowledge Understand what can be achieved across dealers and entity profiles Business Term Impacts Contractual Term Impacts Evaluate and understand the contractual terms of: ISDA Master and Schedules Credit support annexes Long-form confirmations FX agreements Cleared derivative agreements Understand hedging objectives Terms that allow for best execution if/when trades are unwound early Terms that meet your hedging objectives if your underlying debt is refinanced Client Priorities Regulatory Language Understand practical impact of regulations on negotiations of counterparty documentation 24

25 Today s Agenda 1 Introductions 2 3 Hedging in the Current Market Enviroment Interest Rate Hedging Strategies 4 Accounting and Operational Considerations 5 Q&A 25

26 Questions?