Clarifying some of the terminologies in floating rate deals.

When we offer private credit investments we generally offer them specified as either a fixed rate deal or specified as a floating rate deal.  

In fixed rates deals, it is pretty straightforward, investors know they are receiving a fixed rate of return per annum, paid according to the payment schedule, that’s generally monthly or quarterly depending on the deal.  

When we do floating rate deals we use the term BBSW.  

We often get asked what is 1M BBSW or 3M BBSW?  And why is BBSW used?

1M simply stands for 1-month BBSW or 3M stands for 3-month BBSW.  

So what is BBSW and why is it used?  

BBSW stands for the Bank Bill Swap Reference Rate.

It is the short-term floating rate benchmark of the financial markets which is used to determine where short-term rates from 1 month out to 6 months are set on a daily basis.  

It is calculated and published by the Australian Stock Exchange (ASX) by averaging the rates at which bank bills are currently being traded between the prime banks in Australia at each of the monthly maturities out to six months.  

Essentially this is where the banks will lend to each other for each of those short terms, for 1 month out to 6 months.  

From a credit risk perspective, it reflects short-term lending for major bank credit risks. 

In a rising interest rate environment you would expect the 3-month BBSW to be set slightly higher than the 1-month to reflect any potential pricing in of the chance of a rate increase within the two-month period between those two rates. 

When we look at the 1-month BBSW, it reflects the 1-month lending rate between the banks.  So if interest rates continue to go upwards, you would expect BBSW to be moving higher up until market expectations start to change whereby the market may start to take a more negative view on future rate movements, then you would expect BBSW rate sets to start to fall.

To bring this back to our floating rate private credit deals.  BBSW is used given it is the floating rate benchmark of the financial markets.  

If a private credit deal is being shown as paying a set margin above BBSW, the reference to the floating rate benchmark that is BBSW tells you that it is a floating rate deal, whereby each monthly or quarterly payment will vary as they are set off the BBSW at the start of that particular month or quarter.   For example, a deal paying 1-month BBSW + 5%, will mean you receive the 1-month BBSW from the start of that month + the 5% set margin.  The floating rate component of the deal is the BBSW referencing, whereas the set margin above the BBSW is locked in for the full term of the deal.

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