February 13, 2019
Positive or Negative – You Can Help Yourself
Here’s a bit of a secret. Your interest rate swap carries a constantly changing value over its life and sometimes those values (positive or negative) can be very useful. It all depends upon your objective. The chart below shows what you can do with a meaningful value in either direction. However, like the warning that magicians offer to kids, “don’t try these tricks at home or without supervision.” In the case of swaps, beware of modifying or terminating without the advice of a professional. Here’s something to always keep in mind. Every time a bank touches a swap, it creates an opportunity for unseen additional bank profit at the expense of the borrower. Your swap advisor will make sure that you receive maximum value with no or minimal expense.
|Use the Positive Value to:||Use the Negative Value to:|
|Pay down principal*|
- The borrower may choose to apply the positive value of the swap against the loan balance and either float or replace the swap at current market rates. This reduces overall interest expense and can be very helpful if the borrower is looking to reduce its debt to get under a certain Loan-To-Value threshold.
|Reduce monthly payments (option 1)|
- The borrower could reduce its monthly payment (often dramatically) by terminating the swap and adding it to the principal balance. Now, instead of having to pay the negative value during the remaining term of the swap (probably the same as the loan term), the negative value is spread over the amortization of perhaps 20 or 25 years.
|Make partner distributions*|
- The swap could be terminated and the proceeds could be distributed to the ownership group. Again, the swap could be replaced at market rates or the debt could float.
|Reduce monthly payments (option 2)|
- The borrower could reduce its monthly payment by blending the negative value of the swap into a longer-term swap thus effectively extending the repayment period
|Fund new construction |
- Swap proceeds could be used to fund all or a portion the equity requirement on a new project, eliminating or mitigating the need for a capital call.
|Avoid paying for the unwind out of pocket when refinancing|
- When refinancing, the swap unwind can be blended into the new fixed rate as opposed to adding it to the loan amount.
|Lower the rate on new financing|
- The positive value of the swap could be applied to the fixed rate of a new loan to lower the rate.
*It should be noted that the termination of a swap may be limited under the terms and conditions of some loan agreements. If you are unsure, CMAC will review your documents and advise you.