Loans with “Required” Swaps

Often a bank will include a “hedging requirement” in a variable LIBOR rate-based loan offer.  This requires the borrower enter into an interest rate swap upon closing the loan. Banks have an incentive to recommend the most expensive (biggest and longest) swap for every situation, regardless of whether that makes the most sense for the borrower.  In some instances it may be more effective and cheaper for a borrower to consider an interest rate cap instead to fulfill the hedging requirement.

If you understand the motivation and incentives of the bank regarding such a a hedging requirement for a loan, you can choose a hedge that is advantageous to you, the borrower, not just to the bank.

Bank’s Profit Motive

A bank will say that the swap requirement in a loan is there to protect the bank by protecting the borrower from rising rates.  The real purpose of a swap requirement is to force the borrower to buy a swap from the bank so the bank can earn a larger profit from the loan.

Logic (and law) of the Swap Requirement

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 risk to enter into a swap with a borrower.  If you ask a bank to produce any computations about how the swap reduces the bank’s risk, it is unlikely you will get a satisfactory answer.

By law, a bank cannot force a borrower to enter into a swap with itself (see the OCC’s “anti-tying” statute here  The borrower has the right to enter into a hedge with the provider of their choice, yet the lending bank knows that in almost no case will another bank offer a borrower a swap without collateral (and the lending bank holds all the collateral). So what can you do?

DAG will help you negotiate the best deal from your bank

DAG can help you fulfill the bank’s requirements for a hedge while making sure you are getting the best deal available.  We help clients choose the right swap, not just the one that makes the bank the most money.  We will analyze the economic environment, and the interest rate markets to determine the optimal hedge to fit a borrower’s needs.  We then help clients negotiate and execute the best pricing and terms from their bank.

Getting the Best Rate

You need to know what’s available in the current market in order to get the best price.  But swaps do not trade on an exchange like stocks, and rates and prices are not published.  Every swap agreement has custom structure created to match its loan, so how do you know if you are getting a good rate?

DAG uses the same live-pricing data and computer models the banks do, to insure our clients receive the best deal possible when entering into a swap.  By creating price transparency, DAG minimizes the cost of the transaction, and simultaneously reduces your interest rate expense.

Even a small change in a swap rate will have a large impact on a borrower’s interest cost (click here to see what just a.01% change in your swap rate is worth).

Negotiating Swap Agreement Contractual Terms

There are also many non-economic terms in a swap agreement (ISDA Master Agreement) to negotiate.  Many of the contract terms relate to possible early termination of the swap.  And since the termination value on a swap can be sizable, these terms need to be carefully negotiated.  Most borrowers (and their lawyers) are unfamiliar with swap agreements, so it is difficult for them to know what they can and cannot negotiate. That’s why you need DAG to handle your hedging transaction.

Consider both swaps and caps before making a commitment

DAG wants you get the best protection for your needs. Don’t commit to a swap without also considering the potential advantages of using an interest rate cap.  A cap can often be a more cost effective way to fulfill a hedging requirement than a swap.  Caps tend to have lower profit margins than swaps since they can be purchased from a third party bank, leading to more price competition.

We have expert swap and cap contract advisors.  We have helped hundreds of borrowers design and negotiate thousands of hedging programs and swap agreements.  We know the important terms in the agreement and what borrowers should push to change to their advantage.

DAG supports you throughout the negotiation and execution process, and can also provide accounting support during the life of the swap.

DAG simplifies and maximizes value in the swap execution process by:

Determining the right hedge structure to match your loan, and your risk appetite

Negotiating terms to the borrower’s advantage

Negotiating the best price with live pricing data and sophisticated computer modeling

Designing the swap to comply to achieve Hedge Accounting

Have peace of mind knowing you have achieved the best possible result with DAG handling your hedging transaction.