ITEM 120-2011-R0903  Attachment #4

 

Variable Rate Interest Risk Management

 

1.       The risk of using a variable rate approach for the Series G Refunding Bonds is the volatility of the short-term interest rates paid to the bondholders. 

 

  1. As illustrated in Attachment #2, the trend line for short term rates has drifted between about 0.80% and 4.00% during the past decade – and rates have spiked to above 5.00%, for a one-week period, on a few occasions.

 

2.       MSU believes it can obtain approximately $1.5 million or more in debt service savings over its currently outstanding bonds (which have a rate of 5.13%) by issuing the Series G Refunding Bonds as a multi-modal issue.

 

  1. This is based on the assumption that the average for variable interest rates over the next thirteen years will be approximately the same as they have been in the past thirteen years.

 

3.       This targeted level of savings can be eroded if the actual variable rates are substantially higher than the historical trend, which averaged just 2.98% for the past decade.

 

4.       There are ways for MSU to mitigate this interest rate risk:

 

  1. Maintaining a strong management plan to closely monitor interest rate trends on a frequent basis. 

 

  1. Conducting periodic reviews of available options to fix the interest rates on the Series G Bonds, since, as each year passes the term of the Bonds is reduced, which moves the Bond closer on the yield curve (towards typically lower rates).

 

  1. Maintaining a budget reserve to fund the potentially detrimental costs incurred during a period in which interest rates erratically spike beyond historical levels.

 

5.       In addition, although not advisable at this time, an interest rate cap can be purchased as an “insurance policy” against higher rates.

 

a.       The cap is provided by a large financial institution who agrees to pay the portion of the variable rate in excess of a pre-determined “strike or cap rate”.

 

b.       Often a rolling, three-year cap is considered by variable rate bond issuers.  For example, a 3-year cap for a maximum rate of 5.00% currently costs approximately 45 basis points, or an additional 0.15% per cent per year.

 

6.       Under this proposal, it is MSU’s plan to consider on a quarterly basis whether to use an interest rate cap, change the mode of the Series G Bonds, or fix the rate for the remaining term.