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Short-Dated Interest Rate Caps: An Emerging Feature in European CMBS

This commentary looks at hedging agreements that do not expire on the same date as the loan termination date in European CMBS transactions. We further explore the potential challenges of such an arrangement in an environment of rising interest rates and increased hedging costs.

Key highlights include:
-- Due to increasing interest rates and the resulting increase in hedging costs, some European CMBS transactions will be exposed to liquidity issues.
-- Some CMBS loans may have greater capacity for borrowers to purchase new hedging agreements when required if there is still equity in the structure.
-- The risk profile of longer-term loans with short-term caps will not be fundamentally different than shorter-term loans with co-terminus caps where hedging needs to be agreed to extend the loans.

“The longer-term loans with short-term caps do not change the risk profile of the loan substantially compared with a shorter-term loan that has co-terminating hedging, and where the borrower has extension options conditional upon obtaining hedging. In both cases, hedging costs will continue to rise as interest rates rise”, said Sioban Sugrue, Assistant Vice President of European CMBS at DBRS Morningstar.