Presenting a live 90-minute webinar with interactive Q&A Swaps in Loan Transactions: Coordinating Loan Document Terms with the ISDA Master Agreement Documenting Covenants, Security, Required Consents, Voting and Control, Reporting, and Regulatory Issues THURSDAY, JANUARY 26, 2017 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific Today’s faculty features: Alexander P . Fraser, Partner, Michael Best & Friedrich , Milwaukee Harris I. Antoniades, CFA, FRM, Managing Director, Stout Risius Ross , Los Angeles Felix Shipkevich, Principal, Shipkevich , New York The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10 .
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Swap Documentation in Loan Transactions: Coordinating Loan Document Terms with the ISDA Master Agreement Alexander P. Fraser, Esq., Michael Best & Friedrich LLP Felix Shipkevich, Esq., Shipkevich PLLC Harris I. Antoniades, CFA, FRM, Stout Risius Ross January 26, 2017
Agenda 1. Financial Overview – Use of Derivatives to Obtain Fixed Rate Loan 2. ISDA Document and Regulatory Overview 3. Coordinating Loan Documents with the ISDA Master Agreement 6
Use of Interest Rate Swaps (IRS) to Hedge Interest Rate Risk • Interest Rate Swaps are derivatives that can be used to hedge against exposure to fluctuations in interest rates • An agreement between two parties (the counterparties) where future interest payments are exchanged based on a specific principal (notional) amount • Typically, companies enter into credit agreements with banks based on a benchmark interest rate such as LIBOR or prime, plus a “spread” for a total interest rate • Companies usually get loans with floating interest payments and then enter into swap agreements as the Fixed Payer in order to transform the loan to a fixed rate loan by hedging the interest rate risk (cash flow hedge) • Eliminates or reduces the exposure that arises from changes in interest rate payments due to changes in the benchmark interest rate on a floating rate debt instrument 7
Example: • On July 1, 2016, the Company entered into $200 million Loan (hedged item) with interest rate payments of 3M USD-LIBOR (with 1% floor) plus 3.50% spread • The loan matures in 5 years when all principal will be repaid, and provides for quarterly interest payments due on March 31, June 30, September 30 and December 31 until maturity • On the same day, July 1, 2016, the Company entered into an interest rate swap (hedging instrument), which matures in 5 years as well • Fixed rate: Company Pays 3M USD-LIBOR - Floating rate: Company receives 1.001% • At inception, the terms of the swap agreement (outlined in a term sheet) are typically established such that the net present value of the anticipated payments from the Floating Payer and the Fixed Payer is equal to zero • I.e., the swap is entered into at-market (i.e., at a fair value of zero) and as a result there is no exchange of a premium at the inception date • However, changes in interest rates and counterparty credit risk can result in an advantageous or disadvantageous financial position for counterparties in subsequent reporting periods 8
Terms of the Interest Rate Swap • Fixed Payer: Company A • Floating payer: Bank B • Notional Amount: $100 million • Fixed Interest Rate: 1.001% • Floating Interest Rate: 3M USD-LIBOR • Day-Count Convention Actual/360 • Original Settlement Date: 07/01/2016 • First Exchange: 09/30/2016 • Maturity Date: 06/30/2021 9
Determination of Cash-Flows To determine the net pay position of the counterparties, it is first necessary to determine the future payments for the Fixed Payer as well as for the Floating Payer. • Fixed Payments : The projected fixed payments are based on the fixed interest rate established upon consummation of the initial swap contract. This interest rate is typically set such that the net present value of the anticipated payments from the Floating Payer and Fixed Payer is zero at the contract’s initiation. • Floating Payments: The projected variable payments are based on the estimated LIBOR forward (i.e., future) yield curve as of the measurement date, which is derived by bootstrapping the LIBOR spot yield curve. 10
Determination of Present Value Cash Flow Analysis LIBOR Floating Fixed Floating Net Cash Discount PV Cash Date Reset Rate Interest Rate Tenor Payment Payment Flows Factor Flows 1 9/30/2016 0.4724% 1.0000% 0.2556 $ -255,226 $ 252,778 $ -2,449 0.9934 $ -2,432 2 12/31/2016 0.5023% 1.0000% 0.5111 -258,031 255,556 -2,475 0.9908 -2,453 3/31/2017 0.5239% 1.0000% 0.7611 -252,422 250,000 -2,422 0.9892 -2,395 3 4 6/30/2017 0.5576% 1.0000% 1.0139 -255,226 252,778 -2,449 0.9877 -2,419 5 9/30/2017 0.5993% 1.0000% 1.2694 -258,031 255,556 -2,475 0.9857 -2,440 6 12/31/2017 0.6329% 1.0000% 1.5250 -258,031 255,556 -2,475 0.9844 -2,437 7 3/31/2018 0.6531% 1.0000% 1.7750 -252,422 250,000 -2,422 0.9847 -2,385 8 6/30/2018 0.6495% 1.0000% 2.0278 -255,226 252,778 -2,449 0.9852 -2,412 9/30/2018 0.6794% 1.0000% 2.2833 -258,031 255,556 -2,475 0.9842 -2,436 9 10 12/31/2018 0.7010% 1.0000% 2.5389 -258,031 255,556 -2,475 0.9818 -2,430 11 3/31/2019 0.7347% 1.0000% 2.7889 -252,422 250,000 -2,422 0.9785 -2,370 12 6/30/2019 0.7764% 1.0000% 3.0417 -255,226 252,778 -2,449 0.9749 -2,387 13 9/30/2019 0.8100% 1.0000% 3.2972 -258,031 255,556 -2,475 0.9718 -2,406 14 12/31/2019 0.8089% 1.0000% 3.5528 -258,031 255,556 -2,475 0.9689 -2,399 3/31/2020 0.8931% 1.0000% 3.8056 -255,226 252,778 -2,449 0.9664 -2,366 15 16 6/30/2020 0.9294% 1.0000% 4.0583 -255,226 252,778 -2,449 0.9637 -2,360 17 9/30/2020 0.9650% 1.0000% 4.3139 -258,031 255,556 -2,475 0.9608 -2,378 18 12/31/2020 1.0048% 1.0048% 4.5694 -258,031 256,777 -1,254 0.9574 -1,201 19 3/31/2021 1.0769% 1.0769% 4.8194 -252,422 269,235 16,813 0.9539 16,038 20 6/30/2021 1.1182% 1.1182% 5.0722 -255,226 282,659 27,432 0.9502 26,067 21 Risk-Free Swap Value $ 0 Source: Bloomberg, L.P. 11
Counterparty Risk • The fair value of the swap should also reflect the Counterparty Credit Risk (CCR), which is the exposure to loss as a result of a counterparty failing to meets its contractual obligations due to default • Prior to the financial crisis OTC derivatives were valued without incorporating CCR due to the assumption that large derivative counterparties will never default • Derivatives can be classified as unilateral, which have only one sided CCR (options) and bilateral derivatives (swaps, forwards, etc.) • Bilateral derivatives are more complex, with two way counterparty risk, since both the company and the counterparty are exposed to each other • CCR may be mitigated through netting and offsetting positions in case of default through ISDA master agreements • There may also be an ISDA Credit Support Annex (CSA) that provides for posting of collateral to cover all or a portion of the net market value of the positions to limit the exposure 12
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