June 2019 Capitalizing on a Flat Yield Curve: Floating Rate Guaranteed Investment Contracts
Updated: Sep 4, 2019
By Georgina Walleshauser
The shape of the yield curve in the current market continues to remain relatively flat, with minimal differences between short-term rates and long-term rates compared to historical levels. Additionally, interest rates have been declining to significantly low levels. At the end of June, the 10-year swap rate was the lowest it’s been since November 2016, and the 5-year swap rate was the lowest it’s been since September 2017.
Due to these lower long-term interest rates, it is not the most advantageous time for the reinvestment of bond proceeds for longer dated funds such as debt service reserve funds. Of the commonly used structured investment agreements, a guaranteed investment contract (of “GIC”) typically offers the highest guaranteed interest rate on a debt service reserve fund. Currently, the indicative rate for an unsecured GIC on a debt service reserve fund is ~2.375%, as compared to a rate of roughly ~3.25% as of July 2018.
Alternatively, issuers could enter into a floating rate GIC. Rather than a traditional floating rate investment that is pegged to a short-term index such as three-month LIBOR, issuers might want to consider an investment, the interest rate on which, floats with a longer dated index such as the five or ten year swap rate. For those issuers who believe that rates will rise and/or the yield curve will steepen back to historical levels, this approach would position them to increase their earnings rate if this were to occur. We estimate that a 10-year GIC for a debt service reserve fund could offer the following all in rates, if entered into in the current market:
While these floating rate GICs are unfavorable to a fixed rate GIC currently, they offer a potential benefit if interest rates were to rise significantly over the course of the 10-year contract. If you are interested in exploring your options for investing a debt service reserve fund, please contact your Blue Rose representative for more information.
About the Author:
Georgina Walleshauser, Analyst
Georgina joined Blue Rose in April 2017. She is responsible for providing analytical, research, and transactional support to senior managers serving higher education, non-profit, and government clients with debt advisory, derivatives advisory, and reinvestment services. Georgina can be reached at email@example.com.