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© Fifth Third Bank | All Rights Reserved | Member FDIC
Interest Rate Risk Management
Beyond 2009 - 2017
May 2, 2017
CONFIDENTIAL | 2
Swap transactions may not be suitable for all entities or persons, involve the risk of loss, and should only be undertaken by those who are
Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will
achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only
and is subject to change.
Darren Kirby
Managing Director
Interest Rate Management
Tel. 312.704.6941 222 S. Riverside Plaza
Cell 312.798.9844 30th Floor GRVR0C
[email protected] Chicago, IL 60606
Darren Kirby joined Fifth Third Bank’s Interest Rate Management
group in 2006, and in recent years has helped to develop Fifth
Third’s corporate interest rate hedging business. Darren has
worked in interest rate derivative sales, providing hedging
strategies for clients, for the last 17 years. Prior to specializing in
interest rate hedging solutions, Darren held various roles in
capital markets and risk management, including work with the
consulting arm of a Big Four firm in New York, focusing on risk
management for international financial institutions.
Darren holds an MBA from the Stern School of Business at New
York University and a Bachelor of Science in Economics from the
Wharton School of Business at the University of Pennsylvania.
Introduction
CONFIDENTIAL | 3
Swap transactions may not be suitable for all entities or persons, involve the risk of loss, and should only be undertaken by those who are
Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will
achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only
and is subject to change.
Interest Rate Market Overview
Fifth Third Bank is pleased to have the opportunity to provide a review of the current interest rate market and simple
hedging strategies to deal with rising interest rates.
Most borrowers have enjoyed a protracted period of low interest rates engineered by the Federal Reserve to help
accelerate growth, inflation and employment in the United States.
After 8+ years of multiple rounds of quantitative easing (QE) and an aggressive zero interest policy (ZIRP), the Fed has
“tapered” its bond purchasing activity, raised its Fed Funds target rate three times (Dec 2015, Dec 2016, Mar 2017), and is
openly discussing the timing for reducing the size of its balance sheet, suggesting 2017 will be the year.
Continued economic growth, further improvements in employment, or acceleration in inflation expectations, among other
factors, could trigger hastening of Fed rate hikes.
For borrowers with significant variable rate debt and therefore exposure to changes in short term index rates, rising interest
rates (both short term and long term) could have significant implications on cash flows, debt service, covenant compliance,
etc.
CONFIDENTIAL | 4
Swap transactions may not be suitable for all entities or persons, involve the risk of loss, and should only be undertaken by those who are
Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will
achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only
and is subject to change.
Post-election market movements in rates pushed term rates significantly higher in anticipation of fiscal stimulus, healthcare
reform, tax reform, job growth, etc. (time elapsed … less than six months)
Historical Rates – Post-2016 Election
LIBOR Swap Curve Changes (November 2016 – April 2017)
CONFIDENTIAL | 5
Swap transactions may not be suitable for all entities or persons, involve the risk of loss, and should only be undertaken by those who are
Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will
achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only
and is subject to change.
From the early signs of difficulties in mid-2006, the Treasury yield curve inverted, presaging not only deceleration in US
economic growth but ultimately a deep recession followed by a prolonged period of near-zero short-term rates.
Historical Rates – Great Recession
Fed Funds / 5-Year Treasury Yield / Annual GDP Growth
CONFIDENTIAL | 6
Swap transactions may not be suitable for all entities or persons, involve the risk of loss, and should only be undertaken by those who are
Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will
achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only
and is subject to change.
Dot-coms, 9/11 terrorist attacks, recovery, real estate boom …
Historical Rates – Early 2000s
Fed Funds / 5-Year Treasury Yield / Annual GDP Growth
CONFIDENTIAL | 7
Swap transactions may not be suitable for all entities or persons, involve the risk of loss, and should only be undertaken by those who are
Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will
achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only
and is subject to change.
From recession to the Clinton years, steady, strong growth, high returns …
Historical Rates – 1990s
Fed Funds / 5-Year Treasury Yield / Annual GDP Growth
CONFIDENTIAL | 8
Swap transactions may not be suitable for all entities or persons, involve the risk of loss, and should only be undertaken by those who are
Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will
achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only
and is subject to change.
Transition from Carter to Reagan, started with 18% mortgages, growth driven in large part by efficiency introduced by
desktop computers…
Historical Rates – 1980s
Fed Funds / 5-Year Treasury Yield / Annual GDP Growth
CONFIDENTIAL | 9
Swap transactions may not be suitable for all entities or persons, involve the risk of loss, and should only be undertaken by those who are
Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will
achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only
and is subject to change.
Nixon, Ford, and Carter years, volatile decade, oil shocks in 1973-74 and 1979, with the price of oil quadrupling from 1973
to 1974, from $3 to $12 / barrel …
Historical Rates – 1970s
Fed Funds / 5-Year Treasury Yield / Annual GDP Growth
CONFIDENTIAL | 10
Swap transactions may not be suitable for all entities or persons, involve the risk of loss, and should only be undertaken by those who are
Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will
achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only
and is subject to change.
Over the long haul, volatility, real estate crashes, geopolitical tensions … recent rates have been the lowest in American
history
Historical Rates – 1980 to 2017
Fed Funds / 5-Year Treasury Yield / Annual GDP Growth
CONFIDENTIAL | 11
Swap transactions may not be suitable for all entities or persons, involve the risk of loss, and should only be undertaken by those who are
Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will
achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only
and is subject to change.
FOMC Voting Member Fed Funds Projections, Median Rates & Market Futures
FOMC Forward Rate Guidance
Source: Bloomberg as of April 28, 2017
Fed governors maintain guidance for two more rate hikes in 2017 and three more in 2018. Market-based futures contracts,
upon which hedge pricing is based, seem to price in a significantly lower trajectory for Fed Funds rates.
CONFIDENTIAL | 12
Swap transactions may not be suitable for all entities or persons, involve the risk of loss, and should only be undertaken by those who are
Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will
achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only
and is subject to change.
Market-Based Forward Rate Expectations (1 month LIBOR)
Source: Bloomberg as of April 24, 2017
1-month LIBOR Forward Curve
Accordingly, market-based LIBOR forward contracts underlying LIBOR-based swaps imply 1.50% LIBOR in mid-2018,
2.00% LIBOR in mid-2020, and 2.50% LIBOR in mid-2024.
CONFIDENTIAL | 13
Swap transactions may not be suitable for all entities or persons, involve the risk of loss, and should only be undertaken by those who are
Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will
achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only
and is subject to change.
Labor Market
Unemployment, Nonfarm Payrolls & Average Hourly Earnings
10% unemployment in 2009 has been reduced to 4.5%, while underemployment has been reduced from 17.1% in 2009 to
8.9% today. Average hourly earnings are presently growing at 2.7% above a year ago.
CONFIDENTIAL | 14
Swap transactions may not be suitable for all entities or persons, involve the risk of loss, and should only be undertaken by those who are
Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will
achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only
and is subject to change.
US Treasury - Leverage
Source: Bloomberg as of April 24, 2017
Treasury Outstandings ($T), GDP in $Blns & Debt/GDP (%)
The aftermath of the Great Recession has been unprecedented peacetime growth in national debt, nearly doubling since
2009. Growth in debt has significantly outpaced GDP growth, shifting leverage from 0.6x to 1.05x in less than a decade.
CONFIDENTIAL | 15
Swap transactions may not be suitable for all entities or persons, involve the risk of loss, and should only be undertaken by those who are
Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will
achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only
and is subject to change.
Interest Rate Management Considerations
Market Conditions
Liquidity
Growth Strategy
Risk Tolerance
Leverage
CONFIDENTIAL | 16
Swap transactions may not be suitable for all entities or persons, involve the risk of loss, and should only be undertaken by those who are
Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will
achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only
and is subject to change.
Example Cap Structures
Interest
Rate Cap
$2.02MM upfront premium for an interest rate cap for 5 years on $100MM at 2.00% (equiv. of 42 five year swap bps).
$1.36MM upfront premium for an interest rate cap for 5 years on $100MM at 2.50% (equiv. of 28 five year swap bps).
Allows the client to float with a known maximum rate on the dollars hedged.
Example Swap Structures
Current Starting
Interest Rate Swap
1.82% for a current starting swap for 5 years.
Provides the client with a known rate from a budgeting and planning perspective.
Forward Starting
Interest Rate Swap
1.96% for a 1 year forward starting swap for 4 years.
2.06% for a 2 year forward starting swap for 3 years.
Allows the client to float at a low rate in the near term but also have a known interest expense in the later years when
LIBOR is expected to be higher.
Step Coupon
Interest Rate Swap
5-year step-coupon structure:
1.29% for the first year
1.66% for the second year
1.89% for the third year
2.08% for the fourth year
2.22% for the fifth year
Reduces the initial rate impact to the client, in comparison to a current starting interest rate swap, effectively locks in the
current forward curve and establishes known future rate increases for the company.
Cancellable
Interest Rate Swap
2.02% for a current starting swap for 5 years with the client’s monthly right to cancel the rate protection without penalty
(and still retaining the upside potential) beginning on the 3rd anniversary.
Allows the client to cancel the rate protection without penalty at certain points in the future (can be useful if the debt is
prepaid and/or if rates are lower in the future).
Current Market Structures and Pricing
Assuming core 1 month LIBOR based outstandings with no amortization, an Actual/360 day count basis and monthly interest
payments, a current market swap rate on 1 month LIBOR is…
Source: Bloomberg as of April 24, 2017
CONFIDENTIAL | 17
Swap transactions may not be suitable for all entities or persons, involve the risk of loss, and should only be undertaken by those who are
Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will
achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only
and is subject to change.
Swap Function / Flows
1M LIBOR 1M LIBOR
+ Borrowing Spread
1.82%
Client Pays Fixed Monthly and Receives One Month LIBOR Monthly for 5 Years with No Amortization
Floating-rate
Liability Client
Client Debt Obligation LIBOR + 2.00%
Floating Rate Received in Swap LIBOR
Fixed Rate Paid in Swap 1.82%
All In Rate for Client 1.82% + 2.00% = 3.82%
A floating to fixed interest rate swap is a contractual agreement between the hedge provider and the client to exchange a
series of interest payments for a stated period of time on a schedule of specified notional amounts.
Under a floating to fixed swap:
The client pays fixed rate on notional amount of swap. Notional predicated on debt principal amount to be hedged.
The hedge provider pays floating rate index (LIBOR) on notional amount of swap.
When combined with client’s floating rate payment under the debt obligation, client achieves a known synthetic fixed
rate on exactly the notional amount specified in the swap contract.
Floating to Fixed Interest Rate Swap
Hedge Provider
Source: Bloomberg as of April 24, 2017
CONFIDENTIAL | 18
Swap transactions may not be suitable for all entities or persons, involve the risk of loss, and should only be undertaken by those who are
Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will
achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only
and is subject to change.
Floating to Fixed Interest Rate Swap (continued)
A floating to fixed interest rate swap allows a borrower to effectively convert floating rate debt to fixed rate debt, thus
minimizing exposure to changes in interest rates.
The combination of a floating rate loan and an interest rate swap can provide a borrower with substantial benefits when
compared to a traditional fixed rate loan…
Two-Way Early Breakage - The Borrower receives a gain on the interest rate swap if canceling the rate contract when
market fixed rates are higher than the original swap rate. If replacement rates are lower, there is a cost to cancel the
rate protection early.
Transferable Hedge - The Borrower may apply a swap to any of its loans since the hedge contract is separate from the
debt contract.
Flexible Risk Management - The Borrower has flexibility as to when they enter into rate protection, for what term and on
what amount of their variable rate debt.
CONFIDENTIAL | 19
Swap transactions may not be suitable for all entities or persons, involve the risk of loss, and should only be undertaken by those who are
Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will
achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only
and is subject to change.
Description Assumptions
Potential Market Value of an Example $100MM 5 Year Non-Amortizing Swap at 1.82%
The analysis below calculates indicative market values of the illustrated spot start swap under various scenarios.
The base case assumes the LIBOR forward curve remains constant and has a shift at the listed valuation dates.
The alternate scenarios shift the LIBOR curve by a given amount, thus shifting the replacement rate, and the market
value of the swap is calculated under those assumptions.
This analysis depicts a few of many possible scenarios. Alternative scenarios available upon request.
Scenario Analysis
CONFIDENTIAL | 20
Swap transactions may not be suitable for all entities or persons, involve the risk of loss, and should only be undertaken by those who are
Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will
achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only
and is subject to change.
Discussion, Q&A
CONFIDENTIAL | 21
Swap transactions may not be suitable for all entities or persons, involve the risk of loss, and should only be undertaken by those who are
Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will
achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only
and is subject to change.
Important notice
Fifth Third Financial Risk Solutions (“FTFRS”) is subject to Commodity Futures Trading Commission (“CFTC”) rules which require FTFRS to
communicate with clients in a fair and balanced manner based on principles of fair dealings and good faith.
The specific risks presented by a particular Swap necessarily depend upon the terms of the Swap and your present and future circumstances. In
general, however, all Swaps involve one or more of the following risks — credit risk, market risk, liquidity risk, funding risk, operational risk, legal and
documentation risk, regulatory risk and/or tax risk. To provide FTFRS clients with a sound basis for evaluating the facts with respect to the Swaps
discussed herein, prior to execution clients are encouraged to review material information disclosed to them during the:
• Onboarding process – ISDA Protocols, Master Agreement & Credit Support Documentation, or the FTFRS Bilateral Dodd Frank Agreement
• Pre-trade negotiations – Contact FTFRS or visit https://www.53.com/resource-center/swap-dealer-disclosures.html
If after review of this presentation and the disclosures referenced herein, you have any questions pertaining to the discussed transaction, please contact
FTFRS.
This document has been prepared by Fifth Third Bank (“Fifth Third”) or one of its subsidiaries for the sole purpose of providing a proposal to the parties
to whom it is addressed in order that they may evaluate the capabilities of Fifth Third to supply the proposed services. It is not intended to provide
specific investment advice and does not constitute either a commitment to enter into a specific transaction or an offer or solicitation, with respect to the
purchase or sale of any swap transaction.
The information contained in this document has been compiled by Fifth Third and includes material which may have been obtained from information
provided by various sources and discussions with management but has not been verified or audited. This document also contains confidential material
proprietary to Fifth Third. Except in the general context of evaluating our capabilities, no reliance may be placed for any purposes whatsoever on the
contents of this document or on its completeness. No representation or warranty, express or implied, is given and no responsibility or liability is or will
be accepted by or on behalf of Fifth Third or by any of its subsidiaries, members, employees, agents or any other person as to the accuracy,
completeness or correctness of the information contained in this document or any other oral information made available and any such liability is
expressly disclaimed.
This document and its contents are confidential and may not be reproduced, redistributed or passed on, directly or indirectly, to any other person in
whole or in part without our prior written consent.
This document is not an offer and is not intended to be contractually binding. Should this proposal be acceptable to you, and following the conclusion of
our internal acceptance procedures, we would be pleased to discuss terms and conditions with you prior to our appointment.