22 July 2008
INTEREST RATE SWAPS
In the 2008-09 financial year, the AOFM does not plan to undertake any interest rate swap activity. Also, at this stage no swap activity is envisaged in future years and swaps on its books will be allowed to mature without replacement. However, if market conditions permit, existing swap positions may be unwound.
Since 1997 the AOFM has undertaken domestic interest rate swaps to reduce the cost of its debt portfolio by reducing its average term to maturity.
Such swaps have generated direct savings to the Australian Government of around $2 billion over this period.
These savings resulted from a positive term premium between the market interest rates on longer and shorter term debt. However over recent years the term premium has declined and no significant term premium is currently evident in the yield curve.
The savings provided by the swaps undertaken by the AOFM have also declined. This decline has been exacerbated by increased credit spreads that have affected bank bill swap rates over the last financial year. Swaps generated a net accrual cost in 2007-08 and are likely to do so again in 2008‑09.
In response to these developments the AOFM has progressively adjusted its portfolio management benchmark and reduced its use of interest rate swaps. In 2007-08, it executed only $300 million in swaps, the last in November 2007.
In the 2008 annual review of its portfolio, the AOFM decided, in the absence of evidence of a significant term premium, to stop undertaking new interest rate swaps. As indicated above, swaps on its books will be allowed to mature without replacement, or positions may be unwound if market conditions permit. The longest dated swap currently in the portfolio is due to mature in May 2017.
The AOFM will continue to report on its website, and in its annual report, on the performance of its total portfolio of assets and liabilities, including outstanding interest rate swaps.