Temporary liquidity relief in the Corona crisis using a Step-Up Swap
The Corona crisis presents banks and their
customers with new, difficult challenges. In recent weeks, all parties involved
have been working closely together to bridge liquidity bottlenecks of the
companies and soften the effects of credit agreement clauses.Figure 1: Possible restrictions of KfW
Promotional banks like the German KfW are
also providing Corona aid to companies under existing and new programmes.
Although the possibilities are manifold, there is not necessarily something for
every customer, as the following overview of possible restrictions shows.
In cases where the wide range of possible Corona
aids cannot be made suitable, a timely decision is mandated or only a flanking
solution is sought, derivative solutions can be used. These offer the advantage
that they can be tailored to the individual requirements of each company very
specifically. This is where the new Geistesblitz comes into play.
In the current issue of the Geistesblitz, we
use the example of an existing synthetic fixed-rate loan to present the
possibility of "taking the load off” with an individual solution. In this
case, your customer's interest burden is temporarily eliminated for 2 years by
means of a "Step-Up Swap".
Market Overview (11.06.2020)
- 3-month Euribor: -0,3580% p.a.
- 10-year EUR Swap: -0,1159% p.a.
The following chart shows
the performance of the 3-month Euribor and the 10-year swap rate over the last 10
Figure 2: Evolution of 3-month Euribor and 10-year EUR swap rate over
Step-Up Swap to optimise an existing interest hedge
Your customer has
an existing financing with a remaining term of 10 years. He pays the 3-month
Euribor plus a financing margin of 1.00% p.a. In the past, he has concluded a
fixed rate swap to hedge interest rates. In this swap, he exchanges his
variable interest burden (incl. financing margin) for a fixed rate of 2.00%
p.a. due to the higher interest rate level at the time.Figure 3: A Step-Up Swap supplementing
Our proposal is to eliminate the
entire interest burden of 2.00% p.a. for a period of two years (interest rate
0.00% p.a.) in order to achieve a noteworthy liquidity relief. This bonus phase
is followed by a compensation phase until the end of the term, during which the
client pays an increased fixed rate of 2.60% p.a.
The interest burden of the following
two years is eliminated purely synthetically through the supplementary interest
rate step swap. Both the underlying variable loan and the existing fixed rate
swap remain unaffected and will continue to be serviced as before.
Indicative terms and conditions:
- Notional: i.e.
2.5 Mio. EUR
- Maturity: 10 years
- Payments: quarterly,
- Client receives: 2.00% p.a.
- Bonus Phase
(years 1 to 2): 0.00%
Phase (years 3 to 10): 2.60%
Figure 4: Quarterly cash flows in the
bonus phase and the compensation phase
following chart shows a comparison of the cash flows between the current
"synthetic fixed rate" of variable loan and fixed rate swap (2.5 Mio.
EUR each) over the 10-year term and the new solution of a supplementary Step-Up
Swap as interest optimisation. With this interest swap there is a guaranteed
interest savings for 2 years (as seen on the left-hand side) and afterwards a
compensatory increase in the interest burden for the following 8 years.
Figure 5: Annual cash flows with and
without interest optimisation
Benefits and risks from a client perspective:
- In the first two years your
client pays 0.00% p.a. instead of 2.00% p.a. and can fully offset the existing
interest burden. In the bonus phase, he achieves an annual liquidity relief of
approx. EUR 50,000 (approx. EUR 100,000 in total).
- The existing loan and current swap
remain unaffected by this temporary liquidity relief.
- No additional market price risk,
because all future payments are known today. Any swap termination at a later
date can be carried out at conditions largely known in advance.
- In the 8 years of the compensation
phase, your customer pays 2.60% p.a. and thus a premium of 0.60% p.a. on his
previous interest burden of 2.00% p.a. This equals an annual additional interest
burden of approx. EUR 15,000.
- The market value of the swap
drops to approx. minus 4.80% at the peak (at the beginning of the compensation
phase). Early termination would be associated with a corresponding one-off
expense for the customer.
In the preceding example, the current debt service consists exclusively of
interest payments. The repayment occurs only at maturity. In the case of an
amortising notional structure, a temporary deferment of amortisation payments – in addition to an
elimination of interest payments – is fathomable. In the bonus phase, the customer receives the amortisation
payments from the derivative in addition to the interest payments in order to
service the existing loan. In return, once the bonus phase has expired, the
customer makes payments to the derivative in addition to the normal payments to
the loan in order to gradually reduce the deferred amortisation over the
remaining term. The interest coupon of the compensation phase and presumably
the required trading line will be higher. The existing loan and the current
swap remain unaffected also in this case.
In a nutshell
The new Geistesblitz
"Temporary liquidity relief in the Corona crisis using a Step-Up
Swap" shows your customer a possibility to eliminate his existing interest
burden of a (synthetic) fixed-rate loan for some interest periods. In the
current Corona crisis he can thus regain room to maneuvre – independent of the Corona aids such as those from
the KfW, for example. In return, the customer consents to pay a higher interest
rate after the bonus phase.
After the January Geistesblitz,
the variant presented here shows a further section of the many possibilities of
synthetic loan adjustment to meet the individual requirements of a company. For
further possibilities of using derivatives for liquidity management beyond pure
interest rate hedging, please contact us.