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Traditionally, when borrowers wanted or needed to enter into a hedge with a bank other than their lenders, the only option available was an independent interest rate cap due to the credit implications (this is because swaps can have breakage costs).
Since a cap’s premium is paid for up-front and therefore will never become a liability to the borrower, lenders were keen on independent caps, and not having to allow for security being assigned to a hedging counterparty, as would be the case for a swap.
Whilst a cap is a viable hedging product and one we recommend to clients regularly, the lack of options for independent hedging until now meant that an upfront cash outflow was the only possibility. A huge benefit of the client’s lender being able to provide hedging was the availability of hedging options for the client: a cap, swap or even a combination of both. We are pleased to inform you that independent hedging clients can now also enjoy this benefit:
We are now able to add swaps to our offering of independent hedging!
With a minimum notional amount of £2 million, you will be able to enter into a swap with cash collateral ranging from 0.75% to 4% depending on the tenor of your hedging. Any cash collateral amount held with the swap provider will earn you interest at fixed deposit rates. As an example:
On a £2million swap for five years, you will need to pay a cash deposit collateral amount of c.£80K (on which you will receive interest at c.3.55%). Indicatively a five year swap rate including margin is 3.70%. The independent swap works like any other swap – you will pay a fixed rate and the swap provider will pay the floating rate. This turns your loan into a fixed-rate-loan, but with greater flexibility.
With cap premiums being ‘expensive’ at prevalent market rates, we often have clients only looking at considerably higher strike rates due to the smaller premiums. Clients can now explore hedging at levels much closer to the market rates without an ‘expensive’ upfront cash outflow, i.e with an independent swap!
Comparing the up-front cash outflow for an independent swap and caps at various strikes (using same hedge parameters as above):
| Fixed/strike rate | Up-front cash outflow | |
| Swap | 3.70% | £80,000 |
| Cap | 3.70% | £135,000 |
| Cap | 3.80% | £125,000 |
| Cap | 4.00% | £117,000 |
If you would like to discuss any of the above in further detail, please get in touch and a member of our team will be able to assist you.
If you have not previously read our article on independent interest rate caps, please click here.
You can view GBP swap rates on our Daily Market Rates sheet by clicking here.
You can reach us on 0207 183 2277 or at info@vedantahedging.com.
