This document discusses the risks of interest rate swaps that became apparent during the financial crisis of 2008. It outlines four major risks: counterparty risk when financial institutions like Lehman Brothers and AIG faced difficulties; basis risk when bond rates increased due to problems in the banking sector; rollover risk as the crisis eliminated providers of liquidity facilities; and collateral posting risk as rates moved beyond historical norms. Charts show the increases in Treasury yields and swap spreads during this period. The conclusion recommends issuing fixed rate bonds and swapping to a floating rate to avoid risks associated with bank support.

1. Lessons of ’08, Opportunities of ’10:Lessons of ’08, Opportunities of ’10:
Bonds, Swaps and the New EnvironmentBonds, Swaps and the New Environment
MassDevelopment
Current Topics in Tax-Exempt Finance Conference
October 29, 2010
Swap Financial Group
Peter Shapiro
76 South Orange Avenue, Suite 6
South Orange, New Jersey 07079
973-378-5500

2. Swap Financial
Group
2Swap Financial Group 2
Typical swap – ‘synthetic fixed’Typical swap – ‘synthetic fixed’
Swap Dealer
Fixed Rate
Bond Holder
Issuer pays Swap Fixed
Rate minus the
difference between the
two Floating Rates
Floating Index
Bond Rate
(Floating)
Issuer

3. Swap Financial
Group
3Swap Financial Group 3
Realized risk #1: CounterpartyRealized risk #1: Counterparty
Swap Dealer
Fixed Rate
Bond Holder
Lehman bankruptcy,
downgrades of AIG,
Ambac, Depfa, others
Floating Index
Bond Rate
(Floating)
Issuer

4. Swap Financial
Group
4Swap Financial Group 4
Realized risk #2: Basis riskRealized risk #2: Basis risk
Swap Dealer
Fixed Rate
Bond Holder
Bonds rates sharply
higher due to bank,
insurer problems
Floating Index
Bond Rate
(Floating)
Issuer

5. Swap Financial
Group
5Swap Financial Group 5
Realized risk #3: Rollover riskRealized risk #3: Rollover risk
Swap Dealer
Fixed Rate
Bond Holder
Bank crisis eliminates
many SBPA and LOC
providers, increases
costs sharply for new
facilities.
Floating Index
Bond Rate
(Floating)
Issuer

6. Swap Financial
Group
6Swap Financial Group 6
Common thread on risksCommon thread on risks
All three risks – counterparty, basis and
rollover risk – were created by the
meltdown of financial institutions
By contrast, muni credits have remained
very strong

7. Swap Financial Group
7
Realized risk #4: Collateral postingRealized risk #4: Collateral posting
 ‘Don’t worry – you’ll never have to post’ because:
– Your swap is insured
– Rates would have to move beyond any
historical experience
Swap Financial Group
7

8. 8
8
30-Year U.S. Treasury Yield30-Year U.S. Treasury Yield
2.00
2.50
3.00
3.50
4.00
4.50
5.00
5.50
6.00
8/3/06 12/1/06 3/31/07 7/29/07 11/26/07 3/25/08 7/23/08 11/20/08
Swap Financial Group
Yield(%)

9. 9
9
30-Year LIBOR Swap Spread30-Year LIBOR Swap Spread
-70.00
-50.00
-30.00
-10.00
10.00
30.00
50.00
70.00
90.00
8/11/06 12/9/06 4/8/07 8/6/07 12/4/07 4/2/08 7/31/08 11/28/08
Swap Financial Group
Spread(bps)

10. 10
10
The killer: Terminate swap, fix bondsThe killer: Terminate swap, fix bonds
1.00
2.00
3.00
4.00
5.00
6.00
7.00
8/9/07 12/7/07 4/5/08 8/3/08 12/1/08
Swap Financial Group
Yield(%)
30-Year Bloomberg Fair Value Municipal Yield
30-Year 67% of LIBOR Swap Rate
Spread = 75 bps
Spread = 339 bps

11. Swap Financial Group 11Swap Financial Group 11
Floating rate without bank supportFloating rate without bank support
Swap
Dealer
Fixed Rate
Bond
Holder
Floating Index
(SIFMA)
Bond Rate
(Fixed)
Issuer
• Issue fixed rate bonds
• Swap to floating (pay SIFMA ,
receive fixed)
• No bank LOC/liquidity cost
• No bank covenants
• No remarketing cost or risk
• No basis risk
• Key risk: counterparty risk
Pricing sweet spots:
5 year tax-exempt:
SIFMA – 20 to + 50