One to watch for those borrowers – particularly property investors – who have term loans with the usual covenants built in (i.e interest cover and ‘loan to value’ cover) plus an ‘Interest Rate Management’ contract (commonly known as a SWAP) running alongside.
Just seen a case this week where the annual covenant tests are due and the bank have added in to the equation the costs of severing the SWAP deal – with presumably the legitimate argument that in theory if the loan was called to a halt, for whatever reason, these costs would be incurred.
These break costs can not only be signficant (particularly at times of low interest rates) but can also be unpredictable and difficult to understand – not something you really want in a covenant test – when a breach of the covenant can have serious implications for the business. In the ‘worst case’ scenario it could lead to the loan being called in, or at another level (and most likely) it would trigger an attempt by the bank to re-price the deal. Such moves in costs are a threat to property investors as their income tends to be linked to periodic rent reviews so an increase in borrowing costs cannot easily be passed on.
Worth checking and knowing when your bank are going to be ‘testing your covenants’ anyway – if you also have a SWAP deal this is one to be wary of.