The recent round of European bank downgrades and the reviews under way for more are of growing concern to hospitals with interest rate swaps. Here are a few tips on how to manage counterparty risk and stay on top of swap portfolios.
1. Know your rights:
Typically, swap credit support agreements require the bank to post additional collateral if its ratings fall below a predetermined level. The exact formula varies among agreements, some have no requirements at all.
2. Monitor counterparty ratings:
Hospitals should monitor bank ratings and be prepared to enforce their rights under the swap agreement in the event of a bank downgrade. Don’t wait for a phone call — counterparties are not required to inform the hospital of collateral they owe. If the hospital already has a swap policy in place, determine what are the minimum ratings for counterparties and if they need to be revised. If there is no swap policy yet, get one drafted by a third party –you’ll get brownie points with rating agencies.
3. Get third party valuations:
Most banks provide end-of-month valuations, but a financial advisor with swap experience should be able to send you daily, independent valuations. If you owe the bank, a bank downgrade will not affect you (this is the situation for most hospitals with pay-fixed swaps). If the bank owes you (swap is in the money), you may be entitled to collateral.
4. Trust, but verify:
Banks make a surprising number of calculation errors. An independent valuation is likely to catch and correct these errors.
5. Know your options:
Should you decide a termination is in the cards, there may be several options available, each with different economic and accounting implications. Here again, an experienced swap advisor can make sure these options are properly identified and understood.
Swaps have always been, and always will be, a “buyer beware” situation. Hospitals must be proactive to avoid costly surprises.