Managing Your Company's Interest Rate Risk

May 31, 2011
By David Shutley, Senior Vice President

What are the main risks to your company's success? For many companies, the uncertainty of rising interest rates is a key concern. In the below article, David Shutley, Senior Vice President at Atlantic Capital Bank, answers frequently asked questions about interest rate swaps and how they can be used effectively to manage a company's interest rate risk.

Q: How do I know if a swap is right for my company?
A: Interest rate swaps provide protection for companies that are concerned about the effect of rising interest rates on their budgets. These swaps typically work best to hedge term debt that is likely to be outstanding for three or more years, although large loans of shorter terms can also be hedged.

Q: When is a cap the right solution?
A: Caps can be a cost effective way to buy insurance against a spike in rates while still allowing the company the benefit of current low floating rates. A cap is typically only cost-effective for a 1-3 year period, after which it often becomes prohibitively expensive.

Q: How is a swap different from a fixed rate loan?
A: A swap is a separate contract from the loan and is more flexible than a fixed rate loan because the company can hedge all or part of the loan amount or all or part of the term. The swap contains two-way breakage payments, so it may become an asset or a liability during the life of the contract unlike a fixed rate loan, which cannot become an asset.

Q: What happens if I want to terminate a swap before its maturity date?
A: Depending on how interest rates have moved between the time the swap was closed, the breakage date, and the amount of time remaining in the swap, a breakage amount may be owed by the company to the bank or may be owed to the company by the bank.

Q: My last swap had a negative value. Why should I do one in 2011?
A: The primary purpose of a swap should always be to hedge against interest rate increases. In the past, your company's swap may have lost value due to declining interest rates. However, the rate environment today is very different from even a few years ago, and interest rates are currently near historic lows. The market predicts that rates will increase in the future, and if rates increase faster than expected, the swap will gain value. Conversely, if rates increase more slowly than expected, the swap will lose value.

Q: Why shouldn't I stay floating for now and worry about fixing my rate later?
A: Rates are very low from a historical perspective.  While Atlantic Capital does not make interest rate predictions, continued improvement in the U.S. economy and/or higher inflation expectations could cause rates to rise rapidly. One option for clients wishing to stay floating for awhile longer is a forward starting swap, where the client locks in to a rate that will start in the future. Until that date, the client's interest rate continues to float but the client knows they have protection once the forward date is reached.    

If you have additional questions about interest rate swaps or caps, please contact David Shutley directly: (404) 995-5829 or david.shutley@atlcapbank.com.

Click to view two interest rate swap case studies:  Interest Rate Swap Case Studies