Magazine article Government Finance Review

Planning - the Key to a Successful Interest Rate Swap Strategy

Magazine article Government Finance Review

Planning - the Key to a Successful Interest Rate Swap Strategy

Article excerpt

With careful planning and written policies, the New York Metropolitan Transportation Authority has used interest rate swaps to successfully modernize its bond indentures, regain financial flexibility, and better match its debt to financed assets.

Between 2000 and 2002, the New York Metropolitan Transportation Authority embarked on the largest municipal debt-restructuring program in American history. Interest rate swaps played a critical role in the program's success. While the successful use of swaps requires financial and legal expertise, a number of management and policy steps also must be taken before the first swap is executed. In this article we discuss the MTA's strategy in developing its swap program and the benefits it received by using swaps in its debt portfolio.

The MTA's use of swaps in its debt restructuring program is consistent with a 2003 GFOA recommended practice, "Use of Debt-Related Derivatives Products and the Development of a Derivatives Policy." Recognizing the prevalence of derivative products in state and local government debt programs, the recommended practice advises issuers to use derivatives only after they have a sufficient understanding of derivative products, the internal expertise to manage them, and a comprehensive derivatives policy. "Governmental issuers must understand the risks and potential rewards of derivative products in order to properly evaluate them as a financing tool," the practice reads. The MTA's debt-restructuring program is a good example of how to put this recommended practice into action.


The MTA developed its debt-restructuring program to streamline its credit structure, eliminate restrictive financial covenants in its bond indentures, and better match its debt structure with the assets being financed. The program entailed refunding and restructuring $18 billion of outstanding debt and consolidating 13 existing bond indentures into four new credits. This called for the issuance of $13.5 billion in bonds in 18 separate transactions over the course of seven months, including $10.3 billion in fixed rate debt and $3.2 billion in variable rate debt. The MTA used derivatives extensively to capture the lowest borrowing rates, including 10 interest rate swaps. This was all accomplished within nine months of receiving final legislative approval and resulted in $4.3 billion of funding for the MTA's capital program.

As part of the restructuring, the MTA entered into six master swap agreements with five counterparties involving four different credits. Under these agreements, the MTA has executed 14 separate confirmations, resulting in a total outstanding notional amount of $2.29 billion against total outstanding debt of $19.4 billion. All of the swaps are variable-to-fixed, and involve different index structures including BMA and varying percentages of LIBOR.

The program was awarded the Municipal Deal of the Year for 2002 by Institutional Investor and Governing magazines and the Regional Deal of the Year by The Bond Buyer newspaper.

The MTA undertook its derivatives program confident in the correctness of Alan Greenspan's conclusion that "the benefits of derivatives . . . have far exceeded their costs."1 In deciding to utilize derivative products, the MTA had four primary goals:

* Boost savings by taking advantage of lower swap rates compared to long-term bond rates

* Diversify bond issues and break up multi-billion dollar refundings

* Shape the structure of debt service to meet financial objectives

* Hedge against rising interest rates for future new money deals


Long before the MTA entered into its first swap under this debt-restructuring program, it took several critical steps that fall under the following headings: guidelines, flexibility, professional assistance, legal documentation, timing, risk management, and oversight. Each is discussed below.

Guidelines. …

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