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Interest Rate Swaps and Caps: 2023 Pricing Guide

How to hedge interest rate risk

When it comes to your business loan, the interest you pay is made up of two parts: the Loan Margin that was agreed upon initially, and a variable interest rate that changes periodically. Interest rate risk arises from fluctuations in the variable rate, which is often based on benchmarks such as Base Rate, LIBOR, SONIA, or EURIBOR. To mitigate the risk of rising variable rates, you can consider using interest rate hedging products such as an interest rate cap or interest rate swap (swap rate).

In this article, we aim to help you optimize your interest rate risk management by providing a better understanding of these products.

How Loan Margin with Banks work

Rate Risks for your Business

An increase in the variable interest rate based on benchmarks such as SONIA, LIBOR, or EURIBOR can have a significant impact on the financial health of your business, negatively affecting your income statement and cash flow. Hedging is like an insurance policy that provides more certainty about future cash flows and profitability, especially with interest rates expected to rise further in the EU (up to 4% by December 2023) and the UK (up to 4.75% by September 2023).

Have you conducted cash flow forecasts and analyzed how a 1% increase in interest rates could affect your business’s debt covenants? Have you considered hedging your interest rate risk with swaps or a cap?

Hedging offers several benefits, including better management of interest covenant ratios and debt service coverage ratios specified in your facility agreement: A rising rate environment can put businesses with variable rates at risk, resulting in covenant pressure or, worse, breaches. Our models can provide insights into the impacts of recent rate hikes on your cash flows and profitability.

Improved financial performance: Control volatility and risk, protecting your business from unexpected changes in rates

Increase efficiency: Your business will benefit from an end to end solution that integrates risk analysis with cost savings

Our Role

VUCA enables you to identify and assess the efficiency of you interest rate strategy. This includes:

  • Identifying the true value at risk from Interest Rate exposures
  • – Assess historic transaction costs
  • – Sensitivity analysis to market volatility
  • – Simulated hedge analysis to access the effectiveness of prior strategies
– Assist with registering a Legal Entity Identifier (LEI) for the Borrower
– MIFID, EMIR, FATCA, ISDA, Long Form Confirmation etc
  • – Develop Strategy (model cashflows against covenants, balance risk V cost)
  • – Get indicative prices from market
  • – Select provider(s) based on price, rating and/or other factors
  • – Review Facility agreement for Hedge clauses
  • – Commercial view on Long form Confirmation or ISDA
  • – Confirm with Cap Provider and Borrower that all parties are ready to trade
  • – Circulate Term Sheet and indicative price on morning of trade
  • – Manage trade call so that purchase is managed professionally
  •   and price agreed is benchmarked
  • – Receive transaction summary from provider
  • – Review Confirmation for Key Terms
  • – Co-ordinate the payment if necessary 

Interest Rate Hedge Example

Hedge Interest Rate Swap

Managing the risks associated with variable interest rates (SONIA, LIBOR, or EURIBOR) on debt can be a complex and expensive task for some treasurers. At VUCA Treasury, we partner with our clients to level the playing field when negotiating with banks. We operate in the market daily and provide the expertise needed to manage this risk effectively.

Banks offer a significant amount of hedging material, including various products and their pros and cons, which can be overwhelming. At VUCA, we guide companies through the process and conduct stress test analysis to identify the upper limit of their rate exposure. Based on this, we build the optimal hedging solution. We remain independent throughout the process, ensuring that the banks stay honest in their pricing, and we’re always on your side.

We’ve included a timeline below to show how long it typically takes to implement a hedge. Delaying the return of your documents to the financial institute can hold up the KYC process by days, so it’s essential to act promptly.

Interest Rate Hedge Timeline for SONIA, LIBOR & EURIBOR

Timeline for hedging SONIA LIBOR or EURIBOR

How do banks hedge interest rate risk? As an independent and unbiased treasury consultancy, Vuca’s mission is to ensure that our clients make informed decisions. As practitioners with multi-decade experience in the financial and capital market divisions of major global banks, we have the inside track on how banks structure and price derivatives. We leverage this insight to ensure that our clients get the most competitive terms when they look to buy an Interest Rate Cap. For an optimum result you should contact us as early on in the process as possible, preferably before you speak with your bank

Our client, McGarrell Reilly, who we worked with on their Charlemont Square project in Dublin 2, said “We are really pleased to have placed our interest rate caps in a timely and efficient manner and I would like to thank our advisor, Vuca Treasury, for delivering such a great result for the business”.
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McGarrell Reilly

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