Money & Finance › Commercial real estate lending › Commercial real estate loans: how income property is financed
Swap loans: a floating bank loan fixed with an interest-rate swap
· Asset or instrument
Fact, law or dataA rule, statute, definition or measured number.
A bank loan that floats over SOFR, paired with a separate interest-rate swap so the owner's all-in payment is fixed.
See it on the Money & Finance map →How it works
Step 1: the bank lends at one-month Term SOFR plus a spread, say 2.25%. Step 2: the owner signs an ISDA swap with the bank, paying a fixed swap rate, say 4%, on a notional matching the loan balance, while the bank pays SOFR back. Step 3: the SOFR pieces cancel, so the owner pays 6.25% fixed. The swap is secured by the same deed of trust and cross-defaulted with the loan. Ending it early costs, or pays, its market value.
Why it matters
Banks can offer 7- to 10-year fixed payments without taking rate risk themselves. Owners get a fixed payment but take on an exit cost, or gain, that depends on future rates.
Facts, rules and data
Bank loan and ISDA documents, CFTC rules requiring dealers to disclose a swap's mid-market value, and the UK FCA's 2012–16 review of swaps sold to small firms, with about £2.2 billion in redress.
Debates and risks
Banks' markup inside the swap rate is rarely shown plainly, and many borrowers learn the exit cost only when they sell or refinance.
Inside this (1)
Connections (6)
▸Bank balance-sheet loans from community and regional banks are often fixed through Swap loans: a floating bank loan fixed with an interest-rate swapFact, law or data
The connection
Banks fund with deposits whose rates move with the market, so a 10-year fixed loan would leave them exposed, the mismatch that sank many savings and loans. Lending floating and selling the borrower a swap gives the owner a fixed payment while the bank stays floating and earns a swap fee.
When and why
Common at regional and larger community banks in the 2010s and early 2020s, on loans of a few million dollars and up.
How we know
Bank loan documents and ISDA confirmations; banks report customer swap income in their financial statements.
Debates and risks
Whether a swap beats the bank's own fixed rate depends on hidden markups and future rates, and is hard to judge at signing.
▸Swap loans: a floating bank loan fixed with an interest-rate swap pair a floating loan with Interest-rate swaps: trading floating payments for fixedFact, law or data
The connection
The swap is a separate contract with the bank or its affiliate, sized to the loan: same notional, same payment dates, often amortizing with it. The bank usually offsets it with a back-to-back swap in the dealer market, so it carries the borrower's credit risk but not the rate risk.
When and why
Regional and larger community banks in the US, documented under the ISDA Master Agreement with a schedule and confirmation.
How we know
ISDA Master Agreements and trade confirmations; banks' annual reports describe offsetting customer swaps.
Debates and risks
If the loan is paid off, modified or extended, the swap does not change automatically, and mismatches can cost the borrower.
▸Swap loans: a floating bank loan fixed with an interest-rate swap start as loans floating over SOFR: the benchmark rate that replaced LIBORFact, law or data
The connection
The loan floats over one-month Term SOFR and the swap pays the borrower that same rate, so the floating pieces cancel. Before 2022 these loans floated over LIBOR; amendments, ISDA fallbacks and the LIBOR Act moved them to SOFR.
When and why
US bank swap loans from 2021–23 on; the Fed-convened ARRC allowed Term SOFR swaps for end users hedging loans.
How we know
Loan and swap confirmations, the ARRC's 2021 Term SOFR recommendations, and the federal LIBOR Act of March 2022.
Debates and risks
Some loans have a SOFR floor the swap lacks, so when SOFR is very low the hedge leaks; who should bear that is argued.
▸Swap loans: a floating bank loan fixed with an interest-rate swap make the borrower a counterparty in Options and other derivativesFact, law or data
The connection
Signing the swap makes the owner a derivatives counterparty. The contract is marked to market: its value can be a liability or an asset, and it is settled at that value if ended early. The borrower must qualify as an 'eligible contract participant', and its guarantors may need to as well.
When and why
US property borrowers since banks popularized swap loans in the 1990s–2010s; in the UK, swaps sold to small firms became a 2012 scandal.
How we know
Commodity Exchange Act rules on eligible contract participants, ISDA documents, and the UK FCA's 2012–16 redress program, about £2.2 billion.
Debates and risks
How well banks explain swap risk to property owners, versus relying on boilerplate disclosures, remains contested.
▸Swap breakage: the cost (or refund) of unwinding a swap early is the exit cost, or refund, of Swap loans: a floating bank loan fixed with an interest-rate swapFact, law or data
The connection
In a swap loan the loan itself may be prepayable, but the swap is a separate contract that runs to its end date. Paying the loan off early means terminating the swap at its market value. Because the two are cross-defaulted and share the deed of trust, the bank collects any amount owed from the sale or refinance proceeds.
When and why
In US community and regional bank lending, where swap loans are common on 5–10-year commercial mortgages.
How we know
Loan agreements, ISDA confirmations and bank termination statements, plus CFTC rules requiring dealers to disclose swap valuations to customers.
Debates and risks
Borrowers often do not know the cost until they request a payoff quote, and banks' markups inside it vary.
▸Archetype: a bank refinance of a suburban office building often fixes its rate through Swap loans: a floating bank loan fixed with an interest-rate swapFact, law or data
The connection
Community and regional banks usually prefer to lend at floating SOFR rates, so to offer an owner a 5–10-year fixed payment they pair the loan with a swap. The owner gets payment certainty for budgeting and DSCR tests, and the bank earns a spread on the swap as well as on the loan.
When and why
Common in US bank refinancings of suburban office, retail and industrial buildings since the 2000s.
How we know
Bank term sheets and loan documents, and banks' disclosures of customer swap income.
Debates and risks
Whether a swap or a plain five-year fixed rate costs the owner less depends on hidden swap markups and on rates at exit.