com
http://ftalphaville.ft.com/2014/05/12/1846972/guest-post-when-float-is-bad-in-portugal-but-good-in-omaha/
The 3 per cent annual payment that Metro do Porto gets through the fateful swap is of course akin to Buffetts float:
someone is willing to had you cash in return for you agreeing to take on some risks linked to a particular financial
market. In the case of Buffett, he sold puts on equity indices and credit default protection, including some exotic
variants. In the case of Metro doPorto, they sold puts and calls on Euribor.
Buffett collected about $9bn upfront, facing the risk that equities would collapse and that corporate defaults would
rise. Metro de Porto collected 3 per cent of the notional amount (initially 90m), each year, facing the risk that interest
rates would either dive down or shoot up.
When credit markets turned, Buffett had to make payments of around $3bn. As Euribor has tumbled post-crisis, Metro
do Porto is facing annualised payments of 40 per cent on the swap, due to an unusual snowballing effect in the way
the payments are structured.
The Portuguese believe that the whole situation is not fair, and thus want a get-out-of-jail card. Of course, at the
beginning they loved the idea of the float and complaints were absent. To not honor the contract would be akin to
Berkshire Hathaway walking away from the equity puts when they expire in 2019-2028 just because its not fair that
stock markets happen to tumble.
With stock markets around the world at or near historic highs, Mr Buffets derivatives now look like one of his greatest
ever trades. But it would have been possible to think that Metro do Porto was onto something similar before Europes
debt crisis hit and interest rates plummeted.
Average Euribor for 2007 was 4.3 per cent, and in 2008 it was 4.6 per cent. Even if you assumed some kind of shock
crisis would take Euribor below 2 per cent, say in 2009, but assume a quick recovery back to normal, say after a
year, the trade looked like genius: Porto gets 0.5 per cent deducted from the spread it pays at every quarterly swap
reset when Euribor is between 2 per cent and and 6 per cent. Porto would take those guys at Santander for 3 per cent
a year for about 12 of the 14 years.
So the float game can be an enticing and attractive one. After all, it is firmly behind the story of the worlds most
successful investor. But with upfront float comes potential future responsibilities. There are no free lunches in the
markets, and neither Santander nor anybody else is going to hand you 3 per cent annually without asking for
something contingent in return.
Mr Buffett too may look less saintly if Berkshire has to pay $20bn in cash between 2019 and 2028 as those put
options come due. Float-seekers should accept that hell can be a possible destination for those looking for instant
heaven on the wings of derivatives.