Loans with Required Interest Rate Swaps
Often a bank will include a hedging requirement in a variable-rate loan offer. Typically, this implies that the borrower must enter into an interest rate swap upon closing the loan. Banks have an incentive to recommend the most expensive interest rate swap for every situation, regardless of whether that makes the most sense for the borrower. In some cases, however, it may be more effective and less expensive for a borrower to consider an interest rate cap to fulfill the hedging requirement. DAG consultants understand the motivation and incentives of the bank regarding such a hedging requirement for a loan. As your independent advisor, DAG helps you choose a hedge that is most advantageous to you, the borrower.
Bank’s Profit MotiveA bank will suggest that the interest rate swap requirement in a loan is there to protect the bank by protecting the borrower from rising rates. However, it is misleading for the lending bank to say that the purpose of the swap requirement is to reduce the bank’s risk on the loan by reducing the borrower’s interest rate risk. A bank actually takes a risk to enter into an interest rate swap with a borrower. If you ask a bank to produce any computations about how the interest rate swap reduces the bank’s risk, it is unlikely that you will get a satisfactory answer. In fact, the real purpose of an interest rate swap requirement is to compel the borrower to buy an interest rate swap from the lending bank so that bank can earn a profit on the interest rate swap.
Law Regarding an Interest Rate Swap RequirementBy law, the lending bank cannot force a borrower to enter into a swap with that bank. Under the OCC Anti-Tying Statute, the borrower has the right to enter into a hedge with the provider of their choice. However, the lending bank knows that another bank will not offer the borrower an interest rate swap without collateral, and the lending bank holds all the collateral. So what can you do to protect your interests?
DAG Helps Clients Favorably Fulfill Hedging RequirementsDAG can help you fulfill the bank’s hedge requirements, while ensuring you are getting the best deal available. DAG helps clients choose the right interest rate swap or interest rate cap, not just the hedge that makes the bank the most money. DAG analyzes the economic environment and the interest rate markets to determine the optimal hedge to fit a borrower’s needs. DAG then helps clients negotiate and execute the best pricing and terms from their bank.
Getting the Best Rate In order to get the best price, you need to know what is available in the current market. But interest rate swaps do not trade on an exchange like stocks, and rates and prices are not published. Every interest rate swap agreement has a custom structure designed to match its loan. So how do you know if you are getting a good rate?
To ensure that clients receive the best rate possible when entering into an interest rate swap, DAG uses the same live-pricing data and computer models that the banks use. By providing price transparency, DAG minimizes the cost of the transaction, and simultaneously reduces your interest rate expense. Getting the best rate is critical, because even a small change in a swap rate will have a large impact on a borrower’s interest cost.
To see the value of a mere 0.01 percent change in your swap rate, try DAG’s Swap Rate and Value Calculator.
Negotiating Contractual Terms in Your Interest Rate Swap AgreementIn addition to the swap rate, an interest rate swap agreement contains numerous non-economic terms, which are also negotiable. Many of these contract terms relate to possible early termination of the swap. And since the termination value on a swap can be significant, these terms need to be carefully negotiated.
DAG’s expert advisors specialize in interest rate swap and interest rate cap contracts. DAG’s advisors have helped hundreds of borrowers design and negotiate thousands of interest rate swap agreements and hedging programs. DAG advisors understand the critical terms in the agreement, and DAG helps borrowers negotiate these terms to their advantage.
Contact DAG today to learn how we can assist in executing your interest rate swap.
DAG is an independent financial advisor serving the corporate, non-profit, tax-exempt and municipal debt markets. With DAG executing your hedging transaction, you can rest assured that you have achieved the best possible result.