Texas General Land Office and Texas Veterans' Land Board Annual Financial Report: 2014 Page: 64
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TEXAS GENERAL LAND OFFICE
AND VETERANS' LAND BOARDUNAUDITED
PAY-VARIABLE, RECEIVE-VARIABLE INTEREST
RATE SWAPS
Objective of the swaps. The board is currently a party
to two pay-variable, receive-variable interest rate swaps that
are associated with one taxable variable-rate bond issue and
one tax-exempt fixed-rate bond issue. The swap associated
with the taxable bonds is LIBOR-to-SIFMA basis swap, and
effectively converts the variable rate on the associated
taxable variable-rate bond issues from a LIBOR (taxable)
based rate to a SIFMA (tax-exempt based rate). The swap
associated with the tax-exempt bonds is a SIFMA-to-LIBOR
basis swap. These swaps are expected to generate an
effective lower borrowing cost to the board over the life of
the swaps.
Terms, fair values, and credit ratings. The terms, fair
values, and counterparty credit ratings related to the
outstanding variable-to-variable swaps as of August 31,
2014, were as shown in Table 20 on page 68. The notional
amounts and amortization schedules of the swaps match
those of the associated funds.
SWAP TRANSACTIONS
Fair Value. The fair values of the swaps were
determined using the zero-coupon method. Using observable
market information for Treasury bonds and LIBOR spreads,
a smoothed LIBOR curve is constructed. From this swap
yield curve, the path of future expected floating LIBOR
interest rates, is determined for a specific swap transaction.
The path of the floating payments is then averaged together
to produce a single fixed swap rate for the same time horizon
as the swap being valued. The difference between this
calculated fixed swap rate and the actual fixed swap rate on
the transaction is then multiplied by the applicable
outstanding notional amount at each future payment date to
generate a series of payments. These payments are then
discounted back to the valuation date using hypothetical
zero-coupon bond rates derived from the LIBOR swap yield
curve. The sum of these discounted payments produces the
fair value of the swap.
An additional calculation similar to that described
above is conducted to determine the value of the knock-out
provision. Using the approach described above, a swap rate
is derived for each potential exercise date of each knock-out
provision. Market-derived data for interest rate volatility is
then used to determine a probabilistic range of potential swap
rates. For each potential swap rate, a value is determined for
the knock-out provision. These values arethen weighted by their probabilities and discounted back to
the valuation date using hypothetical zero-coupon bond rates
as described above. The sum of the present value of the
values for each exercise date produces the fair value of the
knock-out provision.
Credit risk. The board mitigated the credit risk
associated with its swaps by entering into transactions with
highly-rated counterparties. As shown in Table 19 on
pages 66 and 67, and in Table 20 on page 68, the credit
ratings of the board's counterparties range from AAA to A-
by Standard & Poor's and Aal to Baa2 by Moody's
Investors Service.
The board also mitigates its concentration of credit
risk by diversifying its swap portfolio across several
different counterparties. The board's currently outstanding
swaps are spread among 10 different counterparties, with no
more than approximately 39 percent of the total notional
amount of swaps outstanding being associated with any
single counterparty.
The board's swap agreements also contain collateralization
provisions that require-counterparties to post collateral in the
full amount of the fair value of the swap if the counterparty's
credit rating is at or below various levels, ranging from
A+/A1 to BBB+/Baal, as rated by Standard & Poor's or
Moody's Investors Service, respectively. Only U.S.
government obligations are acceptable forms of collateral.
Posted collateral may be held either by the board itself or by
a third party custodian that is rated at least BBB+ by
Standard & Poor's or Baal by Moody's Investors Service.
Basis risk. The board is exposed to basis risk to the
extent that the interest payments on its variable-rate bonds
do not match the variable-rate payments received on the
associated swaps. The board mitigates this risk by: (1)
matching the notional amount and amortization schedule of
each swap to the principal amount and amortization
schedule of each associated variable-rate bond issue, and (2)
selecting an index for the variable-rate leg of each swap that
is reasonably expected to closely match the interest rate
resets on the associated variable-rate bonds over the life of
each bond issue.64
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Texas. General Land Office. Texas General Land Office and Texas Veterans' Land Board Annual Financial Report: 2014, report, Autumn 2014; Austin, Texas. (https://texashistory.unt.edu/ark:/67531/metapth639012/m1/68/: accessed July 18, 2024), University of North Texas Libraries, The Portal to Texas History, https://texashistory.unt.edu.; crediting UNT Libraries Government Documents Department.