The BF Goodrich-Rabobank Interest Rate Swap Case

1. Is this an attractive alternative for the savings banks?

Early in 1983, BF Goodrich, diversified manufacturer of tires and related rubber products, needed $50M to fund its ongoing financial needs. It could have borrowed this amount from its committed bank lines, with borrowing cost above the prime, which was 10 5/8 %. It wanted borrow longer term with fix rates not to compromise its future flexibility. But long-term bond rates for BF Goodrich subclass, which was BBB Industrial, were in the range of 12.75-13%, being quite high. Rabobank, a major Dutch banking organization consisted of more than 1000 agricultural cooperative banks, was proposed to syndicate a large fixed rate Eurobond issue with the ultimate intention of swapping interest payment with a US corporation, BF Goodrich.

According to the pair of bilateral swap agreements with the Morgan Guaranty Bank, intermediary guarantor, swap agreement included these provisions:

Morgan’s AAA rating lowered credit risk. Morgan received from BF one time fee of $125k and annual fee for each year Morgan’s AAA rating lowered credit risk. Morgan received from BF one time fee of $125k and annual fee for each year

MB=>BF
8 years of semiannual payments
$50M . (LIBOR-x)
x: discount rate
MB=>BF
8 years of semiannual payments
$50M . (LIBOR-x)
x: discount rate
MB=>Rabo

$5.5M once each year for 8 years to cover 10.7% fixed annual coupon of $50M
raised MB=>Rabo
$5.5M once each year for 8 years to cover 10.7% fixed annual coupon of $50M raised Rabo=>MB
8 years of semiannual payments
$50M . (LIBOR-x)
x: discount rate
Rabo=>MB
8 years of semiannual payments
$50M . (LIBOR-x)
x: discount rate
BF=>MB

$5.5M once each year for 8 years to cover 10.7% fixed annual coupon of $50M raised BF=>MB
$5.5M once each year for 8 years to cover 10.7% fixed annual coupon of $50M raised BF Goodrich note sold in the US Bond Market.
Amount: $50M
Maturity: 8 years
Coupons: Semiannually LIBOR+.50%
BF Goodrich note sold in the US Bond Market.
Amount: $50M
Maturity: 8 years
Coupons: Semiannually LIBOR+.50%
Rabobank issued a bond in the Eurobond market
Amount: $50M
Maturity: 8 years
Coupon: Annual fixed at 10.7%

Rabobank issued a bond in the Eurobond market
Amount: $50M
Maturity: 8 years
Coupon: Annual fixed at 10.7%
BF=>MB
$5.5M once each year for 8 years to cover 11% fixed annual coupon of $50M raised BF=>MB
$5.5M once each year for 8 years to cover 11% fixed annual coupon of $50M raised Market Rates at the time of the BF Goodrich – Rabobank Swap| | |
Security| Rate|
3 month T-Bills| 8.07%|
3 month LIBOR| 8.75%|
7-10 year AAA floating rate notes | LIBOR+.25%|
7-10 year AAA fixed rate Eurobonds | 10.70%|
7-10 year BBB fixed rate notes | 12-12.5%|

Eventually, from Rabobank’s perspective, fixed rate borrowing and short swap position enabled it to enjoy a floating rate debt. Because Rabobank will pass 11% cash flows coming from Morgan Bank to bondholders and left with the payments of LIBOR-x. This rate is far below the rate, if it borrowed from the markets, that is LIBOR+.25%.

All in all, this is a pretty attractive borrowing option for the savings bank.

2. Is this a deal where everyone wins? If not, who is the loser?

The combination of BF Goodrich floating rate borrowing and its long swap position created a fixed rate debt for it. Its total payments LIBOR+.5% + 10.7% (semiannually compounded) minus its receipts of LIBOR-x left it with payments of 11.2% + x%, that is lower than 12.5% assuming x