CASE STUDY 16
Good Swap, Bad Swap
Peter Shapiro Managing Director Swap Financial Group
The vast majority of interest rate swaps entered into by state and local governments are done for good reasons, most frequently to reduce the cost of debt service. The most commonly used swap structure is what is known as a synthetic fixed rate financing. This structure consists of the issuance of floating rate bonds, generally tax-exempt variable rate demand bonds or auction rate bonds, which are accompanied by a swap where the issuer pays a fixed rate and receives a floating rate designed to offset the floating rate paid on the bonds. The net result is a fixed rate equal to the fixed rate on the swap, assuming the two floating rates match. To the extent that the two floating rates differ, the all-in fixed rate may be slightly more or less than the fixed swap rate.
In our experience, one of the best and most successful examples of the use of synthetic fixed rate financing is the program of the California Housing Finance Agency. CalHFA, as the agency is known, has entered into more than 100 such financings since 1999. The benefits for the agency and the public it serves have been manifold. As a result of the use of swaps and the lower fixed rates that swaps have made possible, according to the CalHFA, the agency has been able to expand its single-family lending programs to reach more than 50% more first-time homebuyers than it could have without the use of swaps, and it has ...