- Mix of Fixed and Variable Rate Debt, Derivatives, and Other Hedging Products
The University may structure its overall debt portfolio, using a combination of fixed and variable rate debt, to provide an appropriate and prudent balance between interest rate risk and the cost of capital as well as to integrate asset-liability management.
Variable rate debt can be a valuable tool for the University to use in the management of its assets and liabilities. Variable rate debt allows the University greater diversification in its debt portfolio and reduces its overall interest costs. However, the use of variable rate debt increases interest rate risk that the University must consider as the interest rate is subject to market fluctuations and tax risk.
In considering the use of variable rate debt, the University will assess the amount of short-term investments and cash reserves since the earnings from these funds can serve as a natural hedge, offsetting the impact of higher variable rate debt costs. In order to allow assets and liabilities to move in tandem, the University should also consider other strategies such as entering into interest rate swaps under appropriate circumstances, and in accordance with these guidelines.
In general, and as guidance to the appropriate level of variable rate interest-rate exposure as specified within these guidelines, the University should maintain its flexibility and continuously review new products and opportunities to allow it to take advantage of changing interest rate environments and new products or approaches as they become available. In low interest-rate environments, the University should consider ways to lock in low fixed rates through conversions, fixed-rate debt issuance, and either traditional or synthetic refundings. In high interest-rate environments, the University should consider ways to increase variable rate debt exposure and evaluate other alternatives that will allow the University to reduce its overall cost of capital.
The University should consider maintaining a portion of its portfolio in variable rate debt. In doing so, the University will attempt to increase and manage its variable rate exposure in a manner that takes into consideration its investment portfolio and stays within a range of 20 percent to 30 percent variable rate debt as it relates to all of the University’s outstanding indebtedness. Any synthetic fixed-rate debt, achieved through a swap transaction whereby the University swaps underlying variable rate for fixed rate, should not be counted toward this variable rate ceiling.
- Approach and Objectives to Interest Rate Swaps
Interest rate swaps and options are appropriate interest rate management tools that can help the University meet important financial objectives. Properly used, these instruments can increase the University’s financial flexibility, provide opportunities for interest rate savings or enhanced investment yields, and help the University manage its balance sheet through better matching of assets and liabilities. Swaps should be integrated into the University’s overall debt and investment management guidelines and should not be used for speculation or leverage.
The total notional amount of interest-rate swaps and options executed by the University will not exceed an amount equal to 50 percent of the total of outstanding debt of the University as a whole. The Vice President for Business Affairs/Treasurer will report to the Finance Committee as outlined in the Ongoing Reporting Requirements (page 16) of the Additional Interest Rate Swap Guidelines in Appendix A.
- Rationales for Utilizing Interest Rate Swaps and Options
The University may use interest rate swaps and options if it is reasonably determined that the proposed transaction is expected to:
- Optimize capital structure, including schedule of debt service payments and/or fixed vs. variable rate allocations
- Achieve appropriate asset/liability match
- Reduce risk, including: Interest rate risk, Tax risk, or Liquidity renewal risk
- Provide greater financial flexibility
- Generate interest rate savings
- Enhance investment yields
- Manage exposure to changing markets in advance of anticipated bond issuances (through the use of anticipatory hedging instruments)
- Permitted Instruments
The University may utilize the following financial products on a current or forward basis, after identifying the objective(s) to be realized and assessing the attendant risks.
- Interest rate swaps, including fixed, floating and/or basis swaps
- Interest rate caps/floors/collars
- Options, including swaptions, caps, floors, collars, and/or cancellation or index-based features
The instruments outlined above are only intended to relate to various interest-rate hedging products. They are not intended to encompass other derivative products that the University may consider.