The Right Hedge Accounting Solutions
A client was looking to hedge their new LIBOR-based loan with an interest rate swap. The unique aspect of the loan was that its interest payments were charged according to the monthly average of overnight-LIBOR plus a spread. The client wanted to make sure it received hedge accounting treatment on the swap.
After surveying the market, DAG found that the pricing for overnight-LIBOR swaps carried a significant premium to regular 1-mo LIBOR swaps. We advised our client that it would be make sense to enter into a regular swap, as long as we could prove that it would be an effective hedge for their loan and they could achieve hedge accounting.
DAG modeled the hedge performance of a regular 1-mo LIBOR swap against the client’s overnight-LIBOR loan using historical hypothetical LIBOR rates. We were able to demonstrate that the regular swap would prove effective and pass conventional effectiveness tests. Because the client was able to utilize a regular swap, they saved the pricing premium that the overnight-LIBOR swap would otherwise have cost them.