Geistesblitz 02/19

Geistesblitz 02/19

Initial Situation

In the current interest rate environment, the demand for interest rate hedges for longer-term financings remains very high. Short to medium-term interest rate hedges, on the other hand, are relatively rare. Many variably financed companies do not use supplementary hedging instruments such as interest rate swaps, interest rate caps or tailor-made solutions.

The main arguments put forward against interest rate hedging in the current environment are mostly a) the costs involved and b) the limited flexibility. With regard to the costs (e.g. the swap rate which is higher than the money market rate or the premium of the interest cap), it is also criticised that these arise irrespective of whether the interest rate hedge subsequently brings benefits. In terms of flexibility, an interest rate hedge would generate special benefits if it was only activated when the interest rate level (e.g. the swap rate for the remaining maturity) reaches a previously defined level.

With the “interest cap with contingent premium”, the current Geistesblitz represents an attractive opportunity for companies to reduce their interest rate risk of a rising 3-month Euribor without having to accept additional costs today.

Market Overview (February 15th 2019):

  • 3-month Euribor -0.3090% p.a.
  • 5-year Swap 0.1600% p.a.
  • 5-year Swap (with 0%-Floor) 0.4100% p.a.

The following chart shows the performance of the 3-month Euribor and the 5-year swap rate over the last 5 years.

Interest cap with contingent premium

Product description

Your customer has a financing requirement of EUR 5 million for the next 5 years. The interest payments are based on the 3-month Euribor. He wishes to take advantage of the still very low interest rate level and remain financed on a variable basis. In the medium term, your customer expects low capital market interest rates and assumes that they will not rise significantly until there is an imminent increase in ECB key interest rates.

In the initial situation, we continue to assume that the customer, either based on his own risk assessment or on the initiative of the financing bank, wishes to set an upper interest rate limit if the swap rate for the remaining maturity increased significantly and reached (or exceeded) a previously defined level.

For the hedge, the customer is prepared to pay an annualised premium. However, the premium should be avoided, especially if interest rates remain low. In an environment of rising interest rates, on the other hand, an increase in the interest burden is acceptable for him. These objectives are reflected in the “interest cap with contingent premium”.  

Indicative terms and conditions

  • Maturity 5 years from spot
  • Payments quarterly, act/360
  • Cap on 3-month Euribor 1.00% p.a.
  • Contingent premium 0.00% p.a., if reference rate below 0.80%, otherwise 1.00% p.a.
  • Reference rate year 1 5-year CMS-Satz i.a.*
  • Reference rate year 2 4-year CMS-Satz i.a.*
  • Reference rate year 3 3-year CMS-Satz i.a.*
  • Reference rate year 4 2-year CMS-Satz i.a.*
  • Reference rate year 5 1-year CMS-Satz i.a.* 

*: The reference rates are fixed at the end of each quarterly interest period (“i.a.” = „in arrears“)

Benefits and risks from a customer perspective

  • Your customer locks-in an upper interest rate limit for his variable financing based on the 3-month Euribor.
  • Your customer continues to participate in low EUR interest rates. On the basis of current market data (current fixings), your customer reduces his interest burden by approx. 0.47% p.a. compared with the alternative 5-year swap rate.
  • Your customer will only pay a premium of 1.00% p.a. if the swap rate for the remaining maturity (approximately defined here as the reference interest rate) is fixed at or above 0.80%.
  • Based on current market data (forward interest rates), your customer would not have to pay the conditional premium in any of the interest periods.
  • The upper interest rate limit on the 3-month Euribor (excl. conditional premium) of 1.00% p.a. is 0.84% p.a. above the alternative swap rate.
  • If the reference interest rate is set at or above 0.80% at the end of the interest period, your customer must pay an interest cap premium of 1.00% p.a. for this interest period.
  • In the worst case, your customer pays a 3-month Euribor capped at the upper interest rate limit of 1.00% p.a. plus a conditional premium of 1.00% p.a. (in total 2.00% p.a.).

In a nutshell

The new Geistesblitz “interest cap with contingent premium” offers your customers the possibility of hedging against a significant rise in the 3-month Euribor. This is achieved by an interest cap that bears no premium in a restrained interest rate development. Whether based on their own risk assessment or on the initiative of the financing bank, an upper interest rate limit can thus be set, which remains free of charge depending on the interest rate development. Only if interest rates rise significantly – if the swap rate for the remaining maturity exceeds the predefined level – does a premium become due.


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