Rates have dropped—should you consider refinancing?
- March 9, 2020
Real Estate | Denver, CO
As rates fall dramatically, many borrowers consider the possible benefits of refinancing fixed-rate loans.
This is especially true in the fixed-rate residential loan markets, in which call protection for the lender is not typical. Many of our clients consider the trade-offs of prepayment penalties and defeasance premiums in return for locking in a lower current rate and extending the fixed-rate duration. While not as intuitive, borrowers should consider refinancing floating-rate loans with embedded floors.
As the forward curve has become flat-to-downward sloping, common practice over the last 24 months in the debt fund/bridge lending space has been to include floors at or near where LIBOR was at time of origination. Many floors were placed as high as 2.5% and, in the last six months, floor levels have been commonly set at 1.75%. Chatham has observed a significant number of floating-rate loans that were originated in late 2018 and the first three quarters of 2019 that have floors at 2% or greater.
With the recent, dramatic downward move in interest rates, accentuated by the Federal Reserve’s 50 basis points emergency rate cut on March 3, these floors are well above current LIBOR (0.863% as of March 6, 2020) and even further above where the forward curve implies LIBOR will be in the coming months (roughly 0.50%). Access current rates and forward curves at ChathamRates.
This has effectively converted many floating-rate loans to fixed at the floor level plus the spread. One of the more apparent advantages of floating-rate loans is prepayment flexibility. While many floaters do have lockouts for an initial period or fixed prepayment fees of up to 1%, floaters that were originated during the peak of loan floors are likely beyond the lockout period or will be soon. Chatham recommends that borrowers review their loan portfolios, and proactively evaluate loans with embedded floors that are not locked out and can be prepaid. Clients using Chatham Debt Management, our web-based solution created to organize, manage, and report on loan portfolios for real estate and infrastructure, can run a report to identify these potential loans.
In weighing the costs of terminating an existing loan, transaction costs for a new loan, and new spread and floor levels, it may very well be economically advantageous to refinance at this time. We recognize the steep drop in index rates is certain to have a significant impact on credit spreads across the leverage spectrum, but it is too early to determine the magnitude of that impact. It is also possible that lenders may be willing to renegotiate floor levels and spreads in existing loans if faced with the alternative of an earlier than expected refinance. At the very least, this is worth a conversation with your lender.
Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.
Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.
Our featured insights
On Friday, October 23, the International Swaps and Derivatives Association (ISDA) launched the IBOR Fallbacks Supplement and Protocol, which provides a framework for transitioning interest rate derivatives from USD LIBOR to SOFR.
Negative interest rates inch closer to reality in the UK as the Bank of England checks on banks’ readiness. The following summarises why the topic is being raised again and a reminder of previous Chatham insights on the subject matter.
In reviewing what has transpired in the commercial real estate (CRE) lending markets over the past six months, we found it helpful to re-read our market commentary as it was written at the end of each of the last three quarters.
After a record 20.4% monthly contraction in UK GDP in April, the expectation was that with some businesses able to reopen under strict conditions in May, there would have been a solid rebound in output.
Now that we’re halfway through 2020, let’s examine how we got here and what the second half of the year might bring.
Considerations around risk management and hedging start with the economic factors. But REITs (as SEC filers) applying U.S. GAAP accounting must also contemplate the financial reporting ramifications of their hedging decisions.
Despite the disruption caused by the COVID-19 pandemic, the UK Financial Conduct Authority is still advising all market participants to prepare for a discontinuation of LIBOR at the end of 2021.
This summarizes the impacts that COVID-19 has had on repo markets and SOFR, how market participants have responded, and the possible implications of the economic slowdown on the LIBOR-SOFR transition.