Europe real estate market update—30 March 2020

Why are LIBOR and swap rates not following the central bank rates down?

• Despite extraordinary central bank action, GBP and EUR swap rates have not trended notably lower.
• On the contrary, the EUR 3-year swap rate vs. 3-month EURIBOR has actually risen 15 bps since the beginning of March.
• Moreover, 3-month £ LIBOR and 3-month EURIBOR are trading above the respective 3-year swap rates.
• On a similar note, despite the Fed lowering the target rate to 0%-0.25%, USD 3-month LIBOR has now climbed to 1.45%.
• What seems to be driving these developments is a rush for cash in all major currencies, in particular USD.
• The high demand for cash causes withdrawals from money market funds and liquidation of any positions with term structures.
• Supply of funds in the form of both short- and long-term lending is low, and as a result high premiums need to be paid to attract term deposits/borrowing.
• Furthermore, swap rates are also likely reacting to an increase of supply in government borrowing that is bound to happen due to fiscal intervention in response to the crisis.
• At the margin, this increased borrowing will compete with the demand for cash from other market participants, hence putting upward pressure on interbank and swap rates.

I hedged my interest rate risk with a cap and would like to switch to a fixed-rate swap now that swap rates are below LIBOR. What should I be aware of?

• If your cap is with a third party bank (i.e., not your lending bank), then it is unlikely you would be able to enter a swap as there is no credit relationship in place. You may want to consider lowering the strike of the cap to provide better protection, but this would require the cap premium to be paid (it is likely the existing cap will not have much, if any, value left).
• If your cap is with your lending bank, then switching to a fixed-rate swap is very feasible. It is important to be aware of the following:
  • Credit spreads have increased, so while the swap rate looks very attractive you need to be sure that the bank counterparty is not charging such a spread that it negates a large part of the benefit of the new hedge.
  • If there are likely to be changes in the debt profile, ensure that these are accommodated within the swap profile where possible to mitigate the risk of termination/restructuring costs.
  • Check your loan documentation to see if there is an interest rate floor within the definition of LIBOR. If so, consider how this impacts the swap, and whether the floor should also form part of the swap (hedge accounting implications also). Read more on negative rates and LIBOR floors.

I am taking an interest payment deferral on my debt for two quarters. How will this impact my hedge/derivative?

Ideally, the hedge should continue to match the profile of the debt. While we are not aware of exactly how these capital and interest payment holidays will be documented as yet, it should be the case that the swap interest is also deferred on the same timeframe as the underlying loan interest.

I am a EUR-based investor with exposure to GBP. How should I consider managing my existing hedges and future exposure?

The short answer is—depending on the rate at which your existing hedges were struck, they may be "in the money" and be a cash asset at the moment. We have worked with many clients this week as they take cash out of existing hedging positions where they can—cash liquidity being more critical than future hedging (for now). While counterparties are taking larger than normal spreads to terminate these derivatives (which we can benchmark), it can still be worthwhile to explore any cash value payout. The long answer is detailed in this piece about FX in the current environment.

What is the status with LIBOR transition and should I continue to prepare?

As it currently stands, the drive to move away from LIBOR toward SONIA as the benchmark rate continues, and the final deadline remains in place (end 2021). However, based on the statement from the FCA last week, it looks like some of the interim milestones might shift. They continue to encourage all new lending to reference SONIA. However, with the expectation that new lending volume is likely to be materially curtailed, it might be more difficult to gauge the speed at which this transition is happening. We suggest that while it is not top of mind for everyone, the planning to deal with legacy loans and derivatives for the transition continues throughout this period.

Should you have any questions on the above, or other market impacts of the recent movements, we are here to assist in any way we can.