Notes to the Financial Statements
June 30, 2015
Note 18 Derivative Financial Instruments
The fair value balances and notional amounts of the State's derivative instruments outstanding at June 30, 2015, classified by type, and the changes in fair value of such derivative instruments for the year then ended are as follows (amounts in thousands; debit (credit)):
| Changes in Fair Value | Fair Value at Year End | ||||
|---|---|---|---|---|---|
| Classification | Amount | Classification | Amount | Notional | |
| Governmental activities | |||||
| Cash flow hedges: | Deferred | Non-current | |||
| Pay-fixed interest | outflow of | portion of LT | |||
| rate swap | Resources | $(5,340) | Obligation | $(3,361) | $55,620 |
Objective and Terms of Hedging Derivative Instruments
The following table displays the objective and the terms of the States'
governmental activities hedging derivative instruments outstanding at June 30,
2015, along with the credit rating of the associated counterparty (amounts in
thousands).
| Notional | Counterparty | |||||
|---|---|---|---|---|---|---|
| Amounts | Effective | Maturity | Credit | |||
| Type | Objective | (000's) | Date | Date | Terms | Rating |
| Pay-fixed interest rate swap | Hedge of changes in cash flows of the 2005 GO bonds | $15,620 | 4/27/2005 | 6/1/2016 | Pay 3.99% receive CPI plus .65% | A3/A- |
| Pay-fixed interest rate swap | Hedge of changes in cash flows of the 2005 GO bonds | 20,000 | 4/27/2005 | 6/1/2017 | Pay 5.07% receive CPI plus 1.73% | A3/A- |
| Pay-fixed interest rate swap | Hedge of changes in cash flows of the 2005 GO bonds | 20,000 | 4/27/2005 | 6/1/2020 | Pay 5.2% receive CPI plus 1.79% | A3/A |
| Total Notional Amount | $55,620 | |||||
The fair values of interest rate swaps were estimated using the zero-coupon method. This method calculates the future net settlement payment required under the swaps, assuming that the current forward rates implied by the yield curve correctly anticipate future spot interest rates. These payments are then discounted using the spot rates implied by the current yield curve for hypothetical zero-coupon bonds due on the date each future net settlement on the swaps.
Credit Risk
As of June 30, 2015, the State had no credit risk exposure on any of the
swaps because the swaps had negative fair value. However, should interest rates
change and the fair values of the swaps become positive, the State would be
exposed to credit risk in the amount of the swaps' fair value.
Basis Risk
The State's variable-rate bond interest payments are based on the CPI
floating rate. As of June 30, 2015 the State receives variable-rate payments
from the counterparty based on the same CPI floating rate.
Termination Risk
The State or the counterparty may terminate any of the swaps if the other
party fails to perform under the terms of the contract. If any swap is
terminated, the associated variable-rate bonds would no longer carry synthetic
interest rates. Also, if at the time of termination the swap has a negative fair
value, the State would be liable to the counterparty for a payment equal to the
swap's fair value. Under the 2005 swap agreements, the State has up to 270 days
to fund any required termination payment.
Rollover Risk
Because all of the swap agreements terminate when the associated debt is
fully paid, the State is only exposed to rollover risk if an early termination
occurs. Upon an early termination, the State will not realize the synthetic rate
offered by the swaps on the underlying debt issues.
Hedging Derivative Instrument Payments and Hedged Debt
As rates vary, variable-rate bond interest payments and net swap payments
will vary. Using rates as of June 30, 2015, debt service requirements of the
State's outstanding variable-rate bonds and net swap payments are as follows
(amounts in thousands):
| Fiscal Year | Variable-Rate Bonds | Interest Rate | ||
|---|---|---|---|---|
| Ending June 30, | Principal | Interest | SWAP, Net | Total |
| 2016 | $15,620 | $1,732 | $945 | $18,297 |
| 2017 | 20,000 | 1,367 | 687 | 22,054 |
| 2018 | - | 690 | 350 | 1,040 |
| 2019 | - | 690 | 350 | 1,040 |
| 2020 | 20,000 | 691 | 349 | 21,040 |
| $55,620 | $5,170 | $2,681 | $63,471 | |