Interest Rate Swap Policy
GENERAL
Purpose
This policy will govern the use by the University of interest rate swap transactions (“Swaps” or “Swap Transactions”) for the purpose of hedging existing or planned debt. This policy will not address the use of any derivative transactions entered into for purposes of managing the University’s investment portfolio. By utilizing Swaps in a prudent manner, the University can take advantage of market opportunities to reduce debt service cost and interest rate risk. Swap Transactions may include, but are not limited to, interest rate swaps or exchange agreements, interest rate caps, collars, corridors, ceilings, floors, and lock agreements, forward agreements, float agreements, swaptions, warrants, and other interest rate agreements which, in the University’s judgment, will assist in managing the University’s interest rate risk or interest cost. The University shall not enter into Swap Transactions for speculative purposes.
The University will use Swap Transactions chiefly:
(a) to lock-in a fixed rate on a variable rate debt;
(b) to create synthetic variable rate exposure for the purpose of
(i) producing interest rate savings;
(ii) limiting or hedging variable rate payments;
(iii) altering the pattern of debt service payments; or
(iv) modifying its variable rate exposure within prudent guidelines;
(c) to hedge risks in the context of a particular financing plan;
(d) to utilize a forward starting swap or swaption for refinancing purposes; or
(e) for asset/liability matching purposes.
Authority and Approval
The Chief Financial Officer is charged with overseeing and implementing the provisions of this policy and shall have the day-to-day responsibility and authority for structuring, implementing, and managing interest rate swaps.
Prior to entering into a Swap Transaction, the Chief Financial Officer must first receive approval from the University’s Board of Trustees and, if necessary, any legal opinions that may be required by law or by the terms of the transaction to establish that the agreement governing the terms of the Swap Transaction (“Agreement”) is a legal, valid and binding obligation of the University and that entering into the transaction complies with applicable state and federal laws.
FEATURES OF THE AGREEMENTS
Form of Agreements
The Swap Transaction will use terms and conditions as set forth in the International Swaps and Derivatives Association, Inc. (hereinafter “ISDA”) Master Agreement. Any Agreement between the University and each counterparty shall include payment, term, security, collateral, default, remedy, termination, and other terms, conditions, provisions and safeguards as deemed necessary or desirable by the Chief Financial Officer.
Terms of Agreements Relating to Swap Transactions
Subject to the provisions contained herein, the terms of any Swap Agreement shall use the following guidelines:
(a) Collateral thresholds, if any, should be set on a sliding scale reflective of credit ratings, size and directional market risk of the transaction. Collateral requirements, including safekeeping requirements, should be established and based upon the credit ratings of the counterparty or grantor.
(b) The University shall have the right to optionally terminate an Agreement at "Market" at any time over the term of the Swap Agreement.
(c) Termination value should be set by utilizing a Market Quotation Methodology, Second Method (as defined in the ISDA Master Agreement), unless the University deems an alternate method as appropriate.
(d) Amortization schedules of the debt and associated swap transaction should be closely matched to the duration of the swap.
Qualified Counterparties
The University may enter into Agreements only with qualified counterparties. A qualified counterparty must be a bank, insurance company, or other financial institution duly qualified to do business in the State of Illinois that either:
(a) has, or whose obligations are guaranteed by an entity that has, at the time of entering into a Swap Transaction and for the entire term thereof, a long-term unsecured debt rating or financial strength rating in one of the top two ratings categories, without regard to any refinement or gradation of rating category by numerical modifier or otherwise, assigned by any two of the following: Moody’s Investors Service, Inc., Standard & Poor’s Financial Services, Fitch, Inc., or such other Nationally Recognized Statistical Rating Organization ("NRSRO"); or
(b) has collateralized its obligations under a Swap Transaction agreement in a manner approved by the Chief Financial Officer of the University.
In addition to the rating criteria specified herein, the University may seek additional credit enhancement and safeguards concerning qualified counterparties in the form of:
- Contingent credit support or enhancement;
- Collateral consistent with the policies contained herein;
- Ratings downgrade triggers; or
- Guaranty of parent, if any.
Counterparty Exposure
The University shall endeavor to diversify its exposure to counterparties. To that end, before entering into a Swap Transaction, the University will consider its exposure to the relevant counterparty or counterparties and determine how the proposed transaction would affect the exposure. The exposure should be measured in terms of notional amount mark-to-market valuation. Many derivative products create for the University a continuing exposure to the creditworthiness of financial institutions that serve as the University's counterparties on derivative transactions.
Methods of Soliciting and Procuring Swaps
Agreements can be procured via competitive or on a negotiated basis as determined by the University on a case-by-case basis. The competitive process should include a minimum of three firms with counterparty ratings as set forth herein.
The University may procure Agreements on a negotiated basis when the University makes a determination that:
(a) due to the complexity of a particular financing, a negotiated transaction would result in the most favorable pricing; or
(b) that in light of the facts and circumstances, doing so will promote the University's interest by encouraging and rewarding innovation; or
(c) marketing of the swap will require complex explanations about the security for repayment or credit quality; or
(d) market timing is important, such as coordination of multiple components of the financing is required; or
(e) based on the recommendation of a financial advisor, special circumstances exist such that a negotiated transaction would result in the most favorable pricing.
Regardless of the method of procurement, the University shall obtain an independent finding that the terms and conditions of any derivative entered into reflect a fair market value of such derivative as of the date of its execution.
Term and Notional Amount
The maximum term, including any renewal periods, of any Agreement may not exceed the latest maturity date of the bonds, notes, debt, or prospective debt referenced in the Agreement.
Unless otherwise approved in writing by the University’s Board of Trustees, the notional amount of any Swap Transaction shall not exceed the outstanding principal amount of the debt to which such agreement relates, or in the case of a refunding transaction, beyond the final maturity date of the refunding bonds.
Swap Transactions can be separated into component parts. The component parts may be transacted on an individual basis or on a combined basis. By transacting for individual components, the University may gain advantages in price efficiency, credit relationship diversification and may receive more favorable accounting treatment for its financial statements. Therefore, if it is deemed advantageous for the University to transact for component parts versus a combined structure constructed from the individual components, then the notional amount of the component parts is the same notional amount as the combined structure. The component parts are not accounted for separately against the aggregate notional amount.
Pledging of Collateral
As part of any Agreement, based on credit ratings of the counterparty or as may be requested by the counterparty of the University, the University may require collateralization or other forms of credit enhancements to secure any or all payment obligations of the counterparty under the Agreement. As appropriate, the University, in consultation with its legal counsel and financial advisor, may require of the counterparty, or grant thereto, collateral or other credit enhancement to be posted by the counterparty subject to the collateral threshold amounts specified for such Agreement. Additional collateral for further decreases in credit ratings of each counterparty and/or increases in threshold mark-to-market exposure shall be posted by each counterparty in accordance with the provisions contained in the Agreement or credit support documents related thereto.
Threshold collateral amounts shall be determined by the University on a case-by-case basis. The University will determine the reasonable threshold limits for the initial deposit and for increments of collateral posting thereafter. Collateral shall be pledged to the trustee, an independent third-party, or as mutually agreed upon between the University and the counterparty. A list of acceptable securities that may be posted as collateral and the valuation of such collateral will be determined and mutually agreed upon under the Agreement. The market value of the collateral shall be determined on a not less than monthly basis, or more frequently if the University determines it is in its best interest given the specific collateral security.
Prohibited Agreements
The University will not enter into Agreements:
(a) that are speculative or create extraordinary leverage or risk;
(b) for which the University lacks adequate liquidity to terminate without incurring a significant bid/ask spread; or
(c) that provide insufficient price transparency to allow reasonable valuation.
MANAGEMENT OF SWAP TRANSACTION RISK
Certain risks are incurred when the University enters into any Swap Transaction. The following guidelines and parameters will assist the University in managing its Swap-related risk:
Interest Rate Risk:
Interest rate risk is the risk that interest costs on a bond or an Agreement will increase and cost more than the rates associated with a fixed-rate obligation. The initial financing program for a bond issue may attempt to hedge the interest rate risk exposure in a manner that results in a net interest cost that is lower than that associated with a fixed-rate obligation. An annual evaluation of interest cost will be conducted.
Basis Risk:
Basis risk is the risk of a mismatch between the actual variable interest rate on the University’s debt and the floating rate option index under the Agreement. A review of historical relationships and trading differentials between the variable rates on similar bonds and the index will be conducted when deciding whether the relationship is sufficiently close to accept such risk. Any index chosen as part of an interest rate swap agreement shall be a recognized market index including but not limited to BMA and LIBOR.
Termination Risk:
Termination risk is the risk that the University would need to terminate the Agreement in an interest rate environment that dictates a termination payment by the University to the counterparty. Risk will be assessed by an annual review of the market value for all existing and proposed Agreements.
The University shall have the right to optionally terminate a Swap Agreement at any time over the term of the Agreement (elective termination right). In general, exercising the right to optionally terminate an Agreement should produce a benefit to the University, either through receipt of a payment from a termination, or if a termination payment is made by the University, a conversion to a more beneficial debt instrument or credit relationship.
Counterparty Risk:
Counterparty risk is the risk that a counterparty might fail to make required payments under the Agreement. The University will manage this risk primarily through the use of only highly rated and experienced counterparties. Standards of creditworthiness, as measured by the credit ratings, will determine eligible counterparties. Differing standards may be employed depending on the term, size and interest-rate sensitivity of a transaction, types of counterparty, and potential for impact on the University's credit ratings. In addition, eligible counterparties should have demonstrated experience in successfully executing derivative transactions.
To guard against a counterparty’s credit rating downgrade below a specified threshold, the University may require that its exposure to the counterparty be collateralized as per an ISDA Credit Support Annex.
Liquidity Risk:
Liquidity risk is the risk that the University would be unable to renew a liquidity facility on a floating-rate bond issue. In the event that a current provider has liquidity problems or will not renew its agreement, the University would request bids from other liquidity facility providers in addition to considering alternative bond structures, such as auction rate bonds.
Tax Risk:
Tax risk is created by potential changes in the tax laws that could affect payment under the Agreement. The University will evaluate the impact of potential changes in tax law on proposed Agreements and on payments under current Agreements based on taxable indices and shall take into account the reduction in the University’s fixed payer rate in return for accepting tax risk.
REPORTING REQUIREMENTS
Accounting
The accounting treatment for any Swap Transaction must be understood by the University’s Chief Financial Officer and the Controller prior to the execution of any Agreement. U.S. GAAP will be followed in establishing the appropriate accounting treatment. The objective is to ensure the appropriate accounting treatment of hedging instruments so that accounting ramifications are assessed prior to inception.
The University will require its counterparties to provide mark-to-market valuations of Swaps at least quarterly, and if applicable, the University shall periodically evaluate the effectiveness of the hedge. In addition, the University will obtain periodic mark-to-market valuations from an independent third-party advisor or valuation firm.
Reporting
An annual report prepared by the Chief Financial Officer will be presented to the Finance Committee of the University’s Board of Trustees that will discuss the status of all Swap Transactions. The report shall include the following:
- A list of all Swaps with notional value and interest rates, a list of counterparties and their respective credit ratings, and other key terms.
- Information concerning any material event involving outstanding Agreements, including a default by a counterparty, a counterparty downgrade, or termination.
- Actual collateral postings by counterparty, if any, per Agreement and in total by swap counterparty.
June 2024
GENERAL
Purpose
This policy will govern the use by the University of interest rate swap transactions (“Swaps” or “Swap Transactions”) for the purpose of hedging existing or planned debt. This policy will not address the use of any derivative transactions entered into for purposes of managing the University’s investment portfolio. By utilizing Swaps in a prudent manner, the University can take advantage of market opportunities to reduce debt service cost and interest rate risk. Swap Transactions may include, but are not limited to, interest rate swaps or exchange agreements, interest rate caps, collars, corridors, ceilings, floors, and lock agreements, forward agreements, float agreements, swaptions, warrants, and other interest rate agreements which, in the University’s judgment, will assist in managing the University’s interest rate risk or interest cost. The University shall not enter into Swap Transactions for speculative purposes.
The University will use Swap Transactions chiefly:
(a) to lock-in a fixed rate on a variable rate debt;
(b) to create synthetic variable rate exposure for the purpose of
(i) producing interest rate savings;
(ii) limiting or hedging variable rate payments;
(iii) altering the pattern of debt service payments; or
(iv) modifying its variable rate exposure within prudent guidelines;
(c) to hedge risks in the context of a particular financing plan;
(d) to utilize a forward starting swap or swaption for refinancing purposes; or
(e) for asset/liability matching purposes.
Authority and Approval
The Chief Financial Officer is charged with overseeing and implementing the provisions of this policy and shall have the day-to-day responsibility and authority for structuring, implementing, and managing interest rate swaps.
Prior to entering into a Swap Transaction, the Chief Financial Officer must first receive approval from the University’s Board of Trustees and, if necessary, any legal opinions that may be required by law or by the terms of the transaction to establish that the agreement governing the terms of the Swap Transaction (“Agreement”) is a legal, valid and binding obligation of the University and that entering into the transaction complies with applicable state and federal laws.
FEATURES OF THE AGREEMENTS
Form of Agreements
The Swap Transaction will use terms and conditions as set forth in the International Swaps and Derivatives Association, Inc. (hereinafter “ISDA”) Master Agreement. Any Agreement between the University and each counterparty shall include payment, term, security, collateral, default, remedy, termination, and other terms, conditions, provisions and safeguards as deemed necessary or desirable by the Chief Financial Officer.
Terms of Agreements Relating to Swap Transactions
Subject to the provisions contained herein, the terms of any Swap Agreement shall use the following guidelines:
(a) Collateral thresholds, if any, should be set on a sliding scale reflective of credit ratings, size and directional market risk of the transaction. Collateral requirements, including safekeeping requirements, should be established and based upon the credit ratings of the counterparty or grantor.
(b) The University shall have the right to optionally terminate an Agreement at "Market" at any time over the term of the Swap Agreement.
(c) Termination value should be set by utilizing a Market Quotation Methodology, Second Method (as defined in the ISDA Master Agreement), unless the University deems an alternate method as appropriate.
(d) Amortization schedules of the debt and associated swap transaction should be closely matched to the duration of the swap.
Qualified Counterparties
The University may enter into Agreements only with qualified counterparties. A qualified counterparty must be a bank, insurance company, or other financial institution duly qualified to do business in the State of Illinois that either:
(a) has, or whose obligations are guaranteed by an entity that has, at the time of entering into a Swap Transaction and for the entire term thereof, a long-term unsecured debt rating or financial strength rating in one of the top two ratings categories, without regard to any refinement or gradation of rating category by numerical modifier or otherwise, assigned by any two of the following: Moody’s Investors Service, Inc., Standard & Poor’s Financial Services, Fitch, Inc., or such other Nationally Recognized Statistical Rating Organization ("NRSRO"); or
(b) has collateralized its obligations under a Swap Transaction agreement in a manner approved by the Chief Financial Officer of the University.
In addition to the rating criteria specified herein, the University may seek additional credit enhancement and safeguards concerning qualified counterparties in the form of:
- Contingent credit support or enhancement;
- Collateral consistent with the policies contained herein;
- Ratings downgrade triggers; or
- Guaranty of parent, if any.
Counterparty Exposure
The University shall endeavor to diversify its exposure to counterparties. To that end, before entering into a Swap Transaction, the University will consider its exposure to the relevant counterparty or counterparties and determine how the proposed transaction would affect the exposure. The exposure should be measured in terms of notional amount mark-to-market valuation. Many derivative products create for the University a continuing exposure to the creditworthiness of financial institutions that serve as the University's counterparties on derivative transactions.
Methods of Soliciting and Procuring Swaps
Agreements can be procured via competitive or on a negotiated basis as determined by the University on a case-by-case basis. The competitive process should include a minimum of three firms with counterparty ratings as set forth herein.
The University may procure Agreements on a negotiated basis when the University makes a determination that:
(a) due to the complexity of a particular financing, a negotiated transaction would result in the most favorable pricing; or
(b) that in light of the facts and circumstances, doing so will promote the University's interest by encouraging and rewarding innovation; or
(c) marketing of the swap will require complex explanations about the security for repayment or credit quality; or
(d) market timing is important, such as coordination of multiple components of the financing is required; or
(e) based on the recommendation of a financial advisor, special circumstances exist such that a negotiated transaction would result in the most favorable pricing.
Regardless of the method of procurement, the University shall obtain an independent finding that the terms and conditions of any derivative entered into reflect a fair market value of such derivative as of the date of its execution.
Term and Notional Amount
The maximum term, including any renewal periods, of any Agreement may not exceed the latest maturity date of the bonds, notes, debt, or prospective debt referenced in the Agreement.
Unless otherwise approved in writing by the University’s Board of Trustees, the notional amount of any Swap Transaction shall not exceed the outstanding principal amount of the debt to which such agreement relates, or in the case of a refunding transaction, beyond the final maturity date of the refunding bonds.
Swap Transactions can be separated into component parts. The component parts may be transacted on an individual basis or on a combined basis. By transacting for individual components, the University may gain advantages in price efficiency, credit relationship diversification and may receive more favorable accounting treatment for its financial statements. Therefore, if it is deemed advantageous for the University to transact for component parts versus a combined structure constructed from the individual components, then the notional amount of the component parts is the same notional amount as the combined structure. The component parts are not accounted for separately against the aggregate notional amount.
Pledging of Collateral
As part of any Agreement, based on credit ratings of the counterparty or as may be requested by the counterparty of the University, the University may require collateralization or other forms of credit enhancements to secure any or all payment obligations of the counterparty under the Agreement. As appropriate, the University, in consultation with its legal counsel and financial advisor, may require of the counterparty, or grant thereto, collateral or other credit enhancement to be posted by the counterparty subject to the collateral threshold amounts specified for such Agreement. Additional collateral for further decreases in credit ratings of each counterparty and/or increases in threshold mark-to-market exposure shall be posted by each counterparty in accordance with the provisions contained in the Agreement or credit support documents related thereto.
Threshold collateral amounts shall be determined by the University on a case-by-case basis. The University will determine the reasonable threshold limits for the initial deposit and for increments of collateral posting thereafter. Collateral shall be pledged to the trustee, an independent third-party, or as mutually agreed upon between the University and the counterparty. A list of acceptable securities that may be posted as collateral and the valuation of such collateral will be determined and mutually agreed upon under the Agreement. The market value of the collateral shall be determined on a not less than monthly basis, or more frequently if the University determines it is in its best interest given the specific collateral security.
Prohibited Agreements
The University will not enter into Agreements:
(a) that are speculative or create extraordinary leverage or risk;
(b) for which the University lacks adequate liquidity to terminate without incurring a significant bid/ask spread; or
(c) that provide insufficient price transparency to allow reasonable valuation.
MANAGEMENT OF SWAP TRANSACTION RISK
Certain risks are incurred when the University enters into any Swap Transaction. The following guidelines and parameters will assist the University in managing its Swap-related risk:
Interest Rate Risk:
Interest rate risk is the risk that interest costs on a bond or an Agreement will increase and cost more than the rates associated with a fixed-rate obligation. The initial financing program for a bond issue may attempt to hedge the interest rate risk exposure in a manner that results in a net interest cost that is lower than that associated with a fixed-rate obligation. An annual evaluation of interest cost will be conducted.
Basis Risk:
Basis risk is the risk of a mismatch between the actual variable interest rate on the University’s debt and the floating rate option index under the Agreement. A review of historical relationships and trading differentials between the variable rates on similar bonds and the index will be conducted when deciding whether the relationship is sufficiently close to accept such risk. Any index chosen as part of an interest rate swap agreement shall be a recognized market index including but not limited to BMA and LIBOR.
Termination Risk:
Termination risk is the risk that the University would need to terminate the Agreement in an interest rate environment that dictates a termination payment by the University to the counterparty. Risk will be assessed by an annual review of the market value for all existing and proposed Agreements.
The University shall have the right to optionally terminate a Swap Agreement at any time over the term of the Agreement (elective termination right). In general, exercising the right to optionally terminate an Agreement should produce a benefit to the University, either through receipt of a payment from a termination, or if a termination payment is made by the University, a conversion to a more beneficial debt instrument or credit relationship.
Counterparty Risk:
Counterparty risk is the risk that a counterparty might fail to make required payments under the Agreement. The University will manage this risk primarily through the use of only highly rated and experienced counterparties. Standards of creditworthiness, as measured by the credit ratings, will determine eligible counterparties. Differing standards may be employed depending on the term, size and interest-rate sensitivity of a transaction, types of counterparty, and potential for impact on the University's credit ratings. In addition, eligible counterparties should have demonstrated experience in successfully executing derivative transactions.
To guard against a counterparty’s credit rating downgrade below a specified threshold, the University may require that its exposure to the counterparty be collateralized as per an ISDA Credit Support Annex.
Liquidity Risk:
Liquidity risk is the risk that the University would be unable to renew a liquidity facility on a floating-rate bond issue. In the event that a current provider has liquidity problems or will not renew its agreement, the University would request bids from other liquidity facility providers in addition to considering alternative bond structures, such as auction rate bonds.
Tax Risk:
Tax risk is created by potential changes in the tax laws that could affect payment under the Agreement. The University will evaluate the impact of potential changes in tax law on proposed Agreements and on payments under current Agreements based on taxable indices and shall take into account the reduction in the University’s fixed payer rate in return for accepting tax risk.
REPORTING REQUIREMENTS
Accounting
The accounting treatment for any Swap Transaction must be understood by the University’s Chief Financial Officer and the Controller prior to the execution of any Agreement. U.S. GAAP will be followed in establishing the appropriate accounting treatment. The objective is to ensure the appropriate accounting treatment of hedging instruments so that accounting ramifications are assessed prior to inception.
The University will require its counterparties to provide mark-to-market valuations of Swaps at least quarterly, and if applicable, the University shall periodically evaluate the effectiveness of the hedge. In addition, the University will obtain periodic mark-to-market valuations from an independent third-party advisor or valuation firm.
Reporting
An annual report prepared by the Chief Financial Officer will be presented to the Finance Committee of the University’s Board of Trustees that will discuss the status of all Swap Transactions. The report shall include the following:
- A list of all Swaps with notional value and interest rates, a list of counterparties and their respective credit ratings, and other key terms.
- Information concerning any material event involving outstanding Agreements, including a default by a counterparty, a counterparty downgrade, or termination.
- Actual collateral postings by counterparty, if any, per Agreement and in total by swap counterparty.
June 2024