The University recognizes all derivative instruments as either assets or liabilities on the Statement of Net Position at their respective fair values. Changes in fair values of hedging derivative instruments are reported as either deferred inflows or deferred outflows in the Statement of Net Position. Changes in fair values of investment derivative instruments, including derivative instruments that are determined to be ineffective, are reported as investment income on the Statement of Revenues, Expenses and Changes in Net Position. On June 30, 2015, the University held the following derivative instruments:
|* Securities Industry and Financial Markets Municipal Swap Index|
The fair value of the interest rate swaps was determined by using the quoted SIFMA index curve at the time of market valuation. The swaps were established as cash flow hedges to provide a hedge against changes in interest rates on a similar amount of the University’s debt. The University’s fixed-receiver hedges serve to hedge its fixed-rate Series 2015B bonds maturing in August, 2021. Future net cash flows for these hedging derivatives are as follows:
As discussed in Note 5, during the year ended June 30, 2015, the University refunded the associated variable-rate debt for the fixed-payer swaps. As such, the fixed-payer interest rate swaps are no longer effective hedges. In accordance with GASB standards, the University terminated hedge accounting at the time of the refunding and the $38.2 million deferred outflow balance was included in the net carrying amount of the refunded debt for purposes of calculating the economic gain or loss resulting from the transaction. Subsequent changes in fair value are reported as investment income in the Statement of Revenues, Expenses and Changes in Net Position.
In February 2011, the University entered into an interest-sharing arrangement with UVAF. Under the arrangement, UVAF agreed to make five annual fixed-premium payments to the University in exchange for limited financial support in the event the one-month London Interbank Offered Rate (LIBOR) falls within a certain range. The arrangement is for a notional amount of $50 million that expires on February 1, 2016, and may be terminated at any time by the mutual consent of the University and UVAF. As of June 30, 2015, the interest-sharing arrangement between the University and UVAF had a $0 market value.
The use of derivatives may introduce certain risks for the University, including the following:
Credit risk is the risk that a counterparty will not settle an obligation in full, either when due or at any time thereafter. The University would be exposed to the credit risk of its swap counterparties any time the swaps had a positive market value. As of June 30, 2015, the University had no credit risk related to its swaps. As of June 30, 2015, the University’s swap counterparties were rated at least A- from Standard & Poor’s or A3 by Moody’s Investors Service. To mitigate credit risk, the University limits market value exposure and requires the posting of collateral based on the credit rating of the counterparty. As of June 30, 2015, no collateral was required to be posted by the counterparties.
Interest rate risk for the University’s hedges is the risk that an unexpected change in interest rates will negatively affect the collective value of a hedge and a hedged item. When viewed collectively, the hedges and the hedged item are subject to interest rate risk in that a change in interest rate will impact the collective market value of both the hedge and hedged item. Conversely, the collective effect of the hedges and the hedged item serve to reduce cash flow variability caused by changes in interest rates. See Note 2 for interest rate risk disclosures related to the University’s investment derivative instruments.
Basis risk arises when different indexes are used in connection with a derivative resulting in the hedge and hedged item not experiencing price changes in entirely opposite directions from each other. The University’s interest rate swap hedging derivative instruments are deemed to be effective hedges of its debt with an amount of basis risk that is within the guidelines for establishing hedge effectiveness.
Termination risk arises when the unscheduled termination of a derivative could have an adverse effect on the University’s strategy or could lead to potentially significant unscheduled payments. The University’s derivative contracts use the International Swap Dealers Association Master Agreement (the Master Agreement), which includes standard termination events, such as failure to pay and bankruptcy. The Schedule to the Master Agreement includes an additional termination event. That is, the swap may be terminated by either party if the counterparty’s credit rating falls below BBB/Baa2 in the case of Standard & Poor’s and Moody’s Investors Service, respectively. The University or the counterparty may also terminate the swap if the other party fails to perform under the terms of the contract. If at the time of termination the swap has a negative market value, the University would be liable to the counterparty for a payment equal to the swaps’ market value.
Rollover risk arises when a derivative associated with a hedged item does not extend all the way to the maturity date of the hedged item, thereby creating a gap in the protection otherwise afforded by the derivative.
Market-access risk arises when an entity enters into a derivative in anticipation of entering the credit market at a later date, but is ultimately prevented from doing so. The University’s derivatives have no market-access risk.
Foreign currency risk is the risk of a hedge’s value changing due to changes in currency exchange rates. The University’s derivatives have no foreign currency risk.