Interest Rate Hedging. November 2007

Transcription

1 November 2007

2 ASSET = LEASE Deal Example LIABILITY = DEBT Airbus A320 cost $40m 85% floating rate debt : $34m Aircraft placed on lease for 7 years at fixed rental of $350k per month, priced at 5% Libor assumption Interest payable at one month Libor plus margin of 25 bps Interest Rate Cap Terms of Hedges Interest Rate Swap Strike rate : 5.00% Pay : Fixed at 5.00% Receive : Floating Notional amount Hedge term Initial notional at $34m, amortizing each month for term 7 years (lease term), effective upon delivery of aircraft Initial notional at $34m, amortizing each month for term 7 years (lease term), effective upon delivery of aircraft Benchmark interest rate 1 Month LIBOR 1 Month LIBOR Premium payable upfront Upfront cost of Premium No Upfront cost 2

3 Rising Interest Rate Environment (Rates increase above 5%) Interest Rate Cap When rates increase in excess of the strike rate of 5.0%, we are reimbursed in cash from our hedge counterparty Interest Rate Swap Obligation remains under the transaction to pay the fixed rate per the interest rate swap agreement Results in Interest Paid at 5% Interest Continues to be Paid at 5% Full protection is provided against interest rates rising beyond cap level of 5% Cost: The cost is the premium paid upfront; no additional cost incurred during hedge period. Premium amount depends on the desired protection level, volatility and hedge period. Accounting impact : Higher interest rates make the value of a cap increase, which results in a positive impact to Income Statement. Full protection is provided against interest rates rising beyond locked in fixed pay rate of 5% Cost: No cost upfront and no cost during hedge period. Early termination of swap may require a cost. Accounting impact : Higher interest rates do not increase the fixed pay rate and as a result, there is no impact to Income Statement. 3

4 Interest Rate Cap We benefit from lower interest rates, which results in lower borrowing costs. Falling Interest Rate Environment (Rates decrease below 5%) Interest Rate Swap The obligation remains to pay the fixed rate per the interest rate swap agreement. Interest is Paid at LESS than 5% Interest Continues to be Paid at 5% As interest rates move down, we have the opportunity to re-strike cap to lower rate. Much lower cost than breaking swap. Offers greater protection for future. Accounting impact : Lower interest rates make the value of a cap decrease, which results in a negative impact to Income Statement (limited to the amount of the upfront premium). To terminate an interest rate swap, there will be a break-cost payable to the hedge counterparty which is subject to market costs. Accounting impact : Lower interest rates do not decrease the fixed pay rate and as a result, there is no impact to Income Statement. 4

5 Graph below illustrates an interest rate cap with a strike rate of 5% over a 10 months. In months 1-4, as interest rates are higher than the strike rate, we receive compensation from our derivative counterparty. When rates fall during months 6 to 10, we pay the lower interest rate - we would not be able to do this if a fixed interest rate swap was in place. With caps, we benefit from lower interest rates. 9% Interest rate Cap with strike rate at 5% 8% 7% 6% 5% 4% 3% 2% 1% 0% We never pay more than 5%, but we can pay less as rates decline Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8 Month 9 Month 10 5

6 Illustrative impact from interest rates movements over term of the lease (Cap versus Swap with strike rate at 5%) Interest Rate Swap Interest Rate Cap Average monthly inflow or (outflow) from Swap Average monthly inflow from Cap Average monthly cost of Cap premium Average monthly inflow or (outflow) from Cap Average Gain or (Loss) per month (Cap vs. Swap) Total Gain or (Loss) for 72 month lease (Cap vs. Swap) If Interest Rates average 7% If Interest Rates average 3% $50,000 ($50,000) $50,000 0 ($9,722) ($9,722) $40,278 ($9,722) ($9,722) $40,278 ($700,000) $2,900,016 Sample Price of 6 year cap is $700k per Bloomberg. 6

7 Why did we change from Interest Rate swaps? The interest rate cap strategy is in place as a result of the lessons learned from the past, and the fact that one of the principal risks that aircraft lessors face is a FALLING INTEREST RATE ENVIRONMENT One of the principal reasons that many Pre- Sept 11 vehicles are under-performing is related to the hedging policies of interest rate swap employment they had in place at the time 7

8 Why did we change from Interest Rate swaps? Under many hedging policies, a fixed rate lease is required to be hedged by a fixed rate swap. When a fixed rate swap is entered into, an interest rate is locked in that is paid, and floating rate is received As interest rates rise and fall, the obligation remains under the transaction to pay the fixed rate per the interest rate swap agreement To understand the impact of this, we need to look at interest rate swaps that were entered into by ABS transactions in 1999 and 2000, when interest rates were high, and examine the fall-out 8

9 Why did we change from Interest Rate swaps? In 1999 and 2000, interest rates increased. Swaps purchased during this time locked in high pay rates at these levels. Then rates decreased significantly between 2001 and

10 Why did we change from Interest Rate swaps? In late 2001 through 2004, when the downturn came, the transactions were forced to mark to market many of their leases either by restructuring with the existing lessee or by repossessing and releasing to another lessee at the then market rate This meant that on the asset side instead of receiving the old lease rate which was equivalent to an interest rate around 6% to 7% the vehicles were receiving 3% to 4% However, on the liability side they were not able to mark the swap counterparties to market so they had to continue to pay 6% to 7%, resulting in a huge proportion of the leasing revenues of the vehicles going to the swap counterparties 10

11 The interest rate cap strategy is currently the best strategy for AerCap, allowing full protection against rising interest rates, while at the same time allowing the transaction to fully benefit from a falling interest rate environment, which is not permitted with interest rate swaps. 11