Hedging Treasuries in an Uncertain Market
By Samuel Gruer, Managing Director
Many higher education institutions and other borrowers in the municipal market are enticed by the low interest rates that are being reported in the press. When they speak with their banks, however, they find that the overall rates that could be achievable from issuing bonds in the current market are likely to be significantly higher. The reasons for this include reduced liquidity in the municipal market, perceived credit weakness in their sector, and reluctance of banks to underwrite bonds. For those who are contemplating an issuance of taxable municipal bonds (which typically price as a spread to benchmark Treasury securities), but are awaiting more liquid markets, a Treasury Rate Lock might be worth considering. It allows a borrower the ability to “lock” in low Treasury rates but come to market later, perhaps as much as a year later, when it expects market conditions return to “normal.”
Treasury Rate Locks function similarly to forward starting interest rate swaps other than the fact that, by their terms, Treasury Rate Locks will settle in cash on a previously agreed upon expiration date in the future at their then–market value. The cash value of the Treasury Rate Lock is determined by comparing the market rate of a specified reference Treasury security (e.g., the on-the-run 10-year Treasury) on the expiration date to the “locked” rate that was determined at the time the Treasury Rate Lock was executed. The difference in these two rates is then multiplied by the dollar value of each basis point, in accordance with industry convention. If rates are higher in the future, the borrower will receive a payment that is intended to offset their higher interest rate cost. Conversely, if rates are lower, the borrower will make a payment that can be offset through the “savings” of lower borrowing costs at that time.
Treasury Rate Locks can be documented through an ISDA confirm for those entities that have ISDAs in place with one or more banks. For those borrowers that do not have ISDAs in place, the Treasury Rate Lock can often be documented through what is typically referred to as a “long form confirmation” that would incorporate basic credit and business legal terms and save the borrower the expense of negotiating a full set of ISDA documents if it is not needed. To determine whether a Treasury Rate Lock is appropriate for your needs as well as to discuss indicative pricing, please contact your Blue Rose Advisor.
About the Author:
Samuel Gruer, Managing Director
Sam Gruer, a 30-year municipal market veteran, joined Blue Rose in June 2017 as a Managing Director and leader of the firm’s reinvestment business unit. During his career, Mr. Gruer has advised on and/or executed bond and derivative transactions totaling more than $30 billion. Serving in a fiduciary role, Mr. Gruer guides his clients through the debt/swap/reinvestment transaction process by making strategic recommendations based on sound, thoughtful and sophisticated analysis. He also offers expert advice on determining the optimal structure for reinvestment of bond proceeds by evaluating risk tolerance, identifying legal restrictions and estimating cash flow needs for his clients. Mr. Gruer can be reached at email@example.com.