Insights

    Inverted Yield Curve Presents Opportunity to Reduce Swap Costs


    Clifford R. Eisler


    Many companies in recent years have begun hedging their nonqualified deferred compensation plans with Total Return Swaps. The strategy can provide substantial economic value, reduce costs, and yield favorable tax and accounting treatment. Due to the current flat / inverted yield curve (as of September 19th 2019), these companies may now be able to lock in the cost of their Total Return Swap hedge for 5, 7 or 10 years at a cost lower than they are currently paying.


    Long fixed swap rates are now less than LIBOR. The 10-year interest rate swap rate is half of what it was just one year ago. Specifically, the 10-year swap rate is ~1.6% vs. a 1-month LIBOR rate of a little more than 2%.


    One Atlas client executed an interest rate swap on top of its Total Return Swap hedge this past summer. They receive LIBOR + the spread which directly offsets their current Total Return Swap hedge financing leg. This company locked in a fixed rate for 10 years of 1.45% + the same spread they are paying on the Total Return Swap hedge.


    As an example, let's assume a company currently has a notional Total Return Swap hedge of $150 million and is paying 2.70% to the bank counterparty (LIBOR of 2.05% + 65 bps). If this company entered into an interest rate swap similar to the one above, the company would receive LIBOR (currently 2.05%) + 65 bps, or 2.70%, and pay 2.10% (1.45% + 65 bps). And the cost of the hedge is now locked in for 10 years at 2.10%, versus the current price of 2.70%. This reduces the company’s cost of the hedge by 60 bps based upon the current LIBOR rate, or $900,000 per annum.


    These rates change over time and companies may wish to view this in the context of their hedging strategies more broadly, but Atlas would be happy to assist companies with exploring this opportunity, obtaining indicative pricing from bank counterparties, and executing the strategy.

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