Restructured Swaps: What Can You Expect?

In recent months, a trend has emerged: More and more companies are restructuring their pay-fixed receive-floating swaps by shifting the floating leg from the three-month LIBOR rate to the one-month LIBOR rate.

This push toward one-month LIBOR in interest rate swaps is due to the current relatively large spread between the rates. And while there certainly can be advantages to restructuring interest rate swaps in this fashion, it is worth taking a closer look at the pros and cons of doing so – particularly when the swap is part of a hedging relationship.

The upside to restructuring in the current rate environment is obvious: cash savings and lower reported interest expense, especially over the long term. Lower rates save money – it’s relatively simple.

However, restructuring a swap that is part of a hedging relationship comes with a unique set of cautions – beginning with the need to check with auditors before taking any such action. Assuming the plan is cleared there, the new hypothetical fixed rate must be recast to reflect the fact that the debt is now projected to be in 1M LIBOR, with any resulting ineffectiveness booked to the P&L. Finally, due to the financing element now in play, Other Comprehensive Income (OCI) must be measured from the remaining balance each period.

All this, naturally, creates a degree of complexity and cost. Redesignation can be something of a headache, and hedge accounting around the swap becomes more difficult. Likewise, restructuring to one-month LIBOR typically causes a degree of ineffectiveness in the hedging relationship; while relatively minor (and almost always well within testing limits), some ineffectiveness will likely flow straight to P&L. This can be problematic, depending on a company’s willingness to tolerate ineffectiveness in its hedging relationships.

What does all this mean? While it’s currently popular, restructuring the floating leg of pay-fixed receive-floating swaps from three-month LIBOR to one-month LIBOR is not for every company. If the remaining length of the swap is too short, the rate-based savings might not create positive ROI when balanced with additional costs. Likewise, the ineffectiveness (potential earnings volatility) inherent to the process can turn some companies off.

Have a question? The experts at Hedge Trackers are always happy to help. Feel free to contact us today.