Floating Rate Borrowers Are Missing The Swap Spread Party
Many corporate treasurers kicking back on summer vacation are missing out on the chance to snap up cheap floating rate financing due to widening swap spreads. As mortgage companies have found themselves with huge amounts of surplus cash due to the record mortgage refinancing volume in May they have dashed en masse to the interest rate swap market to put the cash to use, causing swap spreads to gap out, said Robert Gay, head of fixed income strategy at Commerzbank Securities. In the U.S. there is approximately USD6.2 trillion of mortgages outstanding, compared to the marketable U.S. Treasury bond market which sits at only USD4.5 trillion.
"There is a perfect storm--refinancing and hedging activity on one side, and no one is at home on the other side in the corporate world," said Gay. If the mortgage lenders were doing this hedging at any point but the summer vacation season, swap spreads would be five to 10 basis points tighter, he added. The swap spread has jumped to 56bps from 30bps in May; 15bps would be a more normal spread, according to strategists. LIBOR-oriented issuers would save in this environment because the floating rate is artificially low.
Some issuers are paying attention and the new issues from floating rate borrowers, particularly highly-rated companies, have been getting great swap execution, said a debt syndicate banker, adding that he expects the LIBOR-based borrowers to continue to come to the debt markets as long as swap spreads keep widening. About half of the USD9 billion of new debt issuance two weeks ago was converted into floating, said another debt syndicate banker, pointing to deals by Wachovia, Lehman Brothers, Fifth Third Bank, IBM, First Data and International Lease Finance.
First Data, for example, entered a swap on half of each tranche of its USD1 billion offering on July 23. It issued USD500 million of five-year bonds with a 3.375% coupon and a 50bps spread to Treasuries, and USD500 million of 10-year bonds with a 4.41% coupon at a 65bps spread to Treasuries. First Data was able to obtain tight spreads in the bond market and excellent swap execution, said a banker that worked on the deal. It converted USD250 million of its five year bonds to LIBOR plus 10bps and USD250 million of its 10-year bonds to LIBOR plus 25bps, he said.
First Data, a Greenwood Village, Colo.-based financial transaction processing company, aims to maintain a 50-50 ratio of fixed to floating rate debt. The company did the deal to take advantage of favorable swap spreads and still-low interest rates, said Gary Kohn, director of investor relations.