Debt Portfolio Interest Rate Swap Policy

Policy ID

024-0048

Effective Date

Wednesday, October 3, 2018

Division

Finance & Administration

Office of Primary Responsibility

Finance

Summary of Policy

The purpose of the policy is to establish guidelines for the prudent use of swaps within Dartmouth College's current swap portfolio as well as potential future swap transactions.

Affected Parties

All Groups

Policy Statement

Purpose

The purpose of the Interest Rate Swap Policy ("Policy") is to establish guidelines for the prudent use of swaps within Dartmouth College's current swap portfolio as well as potential future swap transactions. This policy is overseen by the Finance Committee of the Board of Trustees and covers only swaps that are used within the debt portfolio. Swaps and other financial instruments that are within the investment portfolios are governed by the Investment Policy and overseen by Dartmouth's Investment Committee.

Philosophy Regarding the Use of Swaps

Interest rate swaps can be used as appropriate risk management tools and not for speculative purposes. An appropriate swap should be intended to accomplish at least one of the following:

  • Reduce interest expenses; considering the period of time,
  • Hedge against and manage interest rate, tax, basis and other risks, and/or
  • Help optimize the capital structure, such as fixed versus floating interest rate target allocations.

Permitted Instruments

The following are financial products that are authorized as part of the Policy. However, every transaction requires approval according to Dartmouth's Signature and Requisition Authority Policy.

  • Fixed or Floating Interest Rate Swaps – Used to reduce or increase variable interest rate exposure, depending on the desired outcome.  These swaps can be effective immediately or be forward-starting.
  • Interest Rate Caps – Financial contracts which limit or bound exposure to interest rate volatility. Options on Swaps – Sales or purchases of options to commence or cancel interest rate swaps. Basis Swaps – Swaps used to manage the floating rate basis or tax risks.
  • Rate Locks – Used to hedge upcoming fixed rate bond issues, typically based on interest rate swaps.

Management of Swap Transaction Risks

Before entering into a swap transaction the following risks must be evaluated as a means to understand the potential impact on Dartmouth's balance sheet, cash flow, and its future financial management (including loss of flexibility, management complexity, and credit strength). On an ongoing basis these risks are also to be monitored by the Treasury Department in the context of Dartmouth's debt portfolio:

Basis Risk
In a fixed payer swap, basis risk arises from a mismatch between the floating rate received on the swap versus the floating rate paid on the underlying bonds. Basis risk can also result from entering into a swap where both parties exchange floating rate, but different, indices. To mitigate basis risk, any index used as part of a swap shall be a recognized market index, including but not limited to the Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Index, the London Interbank Offered Rate (LIBOR) or the Secured Overnight Financing Rate (SOFR).  [With the upcoming phase-out of the LIBOR benchmark scheduled for the end of 2021, Dartmouth will seek to ensure the necessary amendments to its LIBOR based swaps match as closely as possible to the underlying debt.]

Interest Rate Risk
Interest rate risk is the risk that costs associated with variable rate exposure could increase as a result of changes in market interest rates. Additional yield curve rate risk can be created by entering into certain types of swaps because their cash flow performance depends on the future shape of the relevant yield curves (i.e. the relationship between short-term and long-term  rates). Before any new swap can be entered into, the cash flows must be stress-tested in multiple rate environments.

Tax Risk
Tax risk is the risk that tax laws will change such that the value of tax-exemption decreases. Tax risk is present in most variable rate tax-exempt debt issuances. Any transaction using a percentage of a taxable index, instead of a tax-exempt index, must have a significantly lower cost of funds (e.g., percent of LIBOR swaps) or there must be enough concern with the tax-exempt benchmark that a taxable index is preferred.

Amortization Risk
The amortization schedules of the debt and associated swap should be closely matched for the duration of the swap. Mismatched amortization schedules can result in a less than satisfactory hedge and create unnecessary risk. The expected impacts of any potential swap transaction will be modeled over the life of the transaction and should include any potential impacts on the current debt portfolio.

Termination Risk
Dartmouth shall consider the merits of including a provision that permits optional termination at any time over the term of the swap (elective termination right). In general, exercising the right to terminate a swap should be expected to produce a benefit to Dartmouth, either through receipt of a payment from a termination, or if a termination payment is made by Dartmouth, a conversion to a more beneficial debt instrument or credit relationship. It is possible that a termination payment by Dartmouth may be required in the event of termination of a swap due to a counterparty default (in which case Dartmouth may seek to replace the defaulting counterparty) or following a decrease in Dartmouth's credit rating or early retirement of debt.  Dartmouth will carefully evaluate ratings based triggers when negotiating new ISDA documentation, and will monitor its counterparty ratings relative to the triggers while the transactions are outstanding.

Collateral Posting Risk
Collateral posting risk is the risk that Dartmouth will be required to post collateral upon the downgrade of its credit rating or other trigger events at a time when the market value is negative to Dartmouth. In all swap transactions, and based on Dartmouth's high credit quality, Dartmouth will pursue high level of collateral thresholds, and the potential requirement to post collateral must be outweighed by the benefit of executing any swap transaction. Similar to counterparty risk, a diversity of counterparties helps mitigate potential collateral posting exposure.

Counterparty Risk
Counterparty risk is the risk of a failure by one of Dartmouth's swap counterparties to perform as required under a swap. To mitigate this risk, Dartmouth will diversify its exposure among highly rated swap counterparties and require termination and collateralization provisions.  See Appendix A for collateral Threshold Amounts Based on Credit Rating.

Financial Statement Implications and Risk
The potential financial statement and resulting credit impact of any swap will be evaluated prior to entering into any swap.  This would include expected balance sheet and income statement impacts stress tested in different rate environments. Evolving accounting treatment, additional auditor procedures, and other potential reporting costs of swaps will also be considered when evaluating cost/benefit.

Methods of Soliciting and Procuring Swaps

Swaps can be procured via competitive bids or on a negotiated basis with counterparties or credit support providers having credit ratings of 'A' or 'A2' or better from Standard & Poor's or Moody's, respectively.

Competitive
The competitive bid should include a minimum of three firms.

Negotiated
Swaps may be procured by negotiated methods in the following situations:

  1. A determination is made that due to the complexity of a particular swap, a negotiated bid would result in the most favorable pricing;
  2. A determination is made that, in light of the facts and circumstances, a negotiated bid will promote Dartmouth's interests by encouraging and rewarding innovation; or
  3. A determination is made that a competitive bid would likely create market pricing effects that would be detrimental to the interests of Dartmouth.

Approval, Terms and Documentation

Prior to entering into a swap, Dartmouth must receive approval from the Chair of the Board of Trustees and the Chair of the Finance Committee (which may include a delegation of authority to an Authorized Representative to enter into one or more swaps). Dartmouth will also secure an opinion from legal counsel that the swap is a legal, valid, and binding obligation of Dartmouth and that entering into the swap complies with applicable State and Federal laws.

Each interest rate swap shall contain terms and conditions as set forth in the International Swaps and Derivatives Association, Inc. (ISDA) Master Agreement, as amended, and such other terms and conditions including schedules, credit support annexes, and confirmations as deemed necessary.

All Documentation will be overseen by the Treasury Department.

Reporting Requirements

Internal Reporting
Periodically and no less than annually, the Finance Committee of the Board of Trustees will receive a report detailing the status of all swaps. The report shall include a list of all swaps with notional value and interest rates, a list of counterparties (and credit support providers, if applicable) and their respective credit ratings, and other key terms.

External Reporting
The Dodd-Frank Act has imposed regulations on the swap market. Pursuant to the act, U.S. Commodity Futures Trading Commission ("CFTC") finalized the Swap Data Recordkeeping and Reporting rule (17 CFR Part 45), which requires counterparties to swap transactions to report the terms of those transactions to a new type of regulated entity, Swap Data Repositories, which will allow the Commission to receive and analyze data. Dartmouth or its counterparties will report all swap transactions.

Qualification for CFTC External Business Conduct Safe Harbor and Commercial End User Exception to Clearing Requirements
This policy is intended to constitute the written policies and procedures contemplated by 12 CFR
23.434(c)(1). Additionally, in order to qualify for the commercial end user exception to clearing requirements, swaps shall only be entered into to hedge or mitigate commercial risk within the meaning of 17 CFR 50.50(c). The Treasury Department will periodically review this Policy to confirm continuing compliance with the foregoing and will provide a copy of this Policy to any entity serving as a swap advisor to Dartmouth.

Appendix A

Threshold Amounts Based on Credit Rating
Specific threshold amounts by counterparty are based on the cumulative mark-to-market value of the swap(s) and the credit rating of the counterparty or its credit support provider. To limit and diversify Dartmouth's counterparty risk and to monitor credit exposure to each counterparty, Dartmouth may not enter into a swap with an otherwise qualified counterparty unless the cumulative mark-to-market value owed by the counterparty (and its credit support provider, if applicable) to Dartmouth shall be less than or equal to the applicable threshold amount, or unless otherwise approved by the Finance Committee.  The threshold amounts are as follows:

Counterparty Long Term

Debt Rating

(S&P / Moody's)

Threshold Amounts1

(millions)

AAA / Aaa

$50

AA+ / Aa1

$50

AA / Aa2

$50

AA- / Aa3

$30

A+ / A1

$20

A / A2

$10

A-/A3

$5

BBB+ / Baa1 and below or Unrated

$0

Downgraded Rating
If the credit rating of a counterparty or its credit support provider is downgraded such that the cumulative mark-to-market value of all swaps between such counterparty and Dartmouth exceeds the maximum permitted by this policy, the counterparty must post collateral or provide other credit enhancement that is satisfactory to Dartmouth to ensure compliance with this policy.

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1 net of collateral posted