Danger of ‘borrowing-through-swaps’

Bloomberg News have highlighted the case of Southern Water where financial engineering was used to ‘borrow through swaps’.

Paying to reduce the rate of hedging can be appropriate in certain circumstances. Vedanta Hedging advises a few borrowers where prevailing swap rates do not allow the borrower to adequately meet their interest-cover ratios to service the debt. In those cases, borrowers will sometimes ‘pay’ to reduce the value of the swap (for example from 4.20% to 3.75%).

However, the implications of this need to be carefully understood, and if this is used excessively, it can cause serious problems as the example of Southern Water shows.

There can also be important hedge accounting considerations of such hedging activity.

The article can be seen here:

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Abhishek