Agency Floaters & Cap Costs

Disclaimer * I work at a direct agency lender and have access to massive amounts of servicing data.

Just a PSA that if anyone here works at a shop that has taken on agency floating rate debt over the last few years, you need to be budgeting for your monthly escrow & reserve costs to increase anywhere from 10 - 15x in the coming months.

Agency floaters require servicers to mark-to-market their borrower's interest rate cap escrow amounts every 6 months. We're now seeing deals that originated in April/May/June of last year have reserve payments that are almost equal to their IO payments.

On one deal in particular:

Prior Month Payment - ~$151k total ($114k interest / $31k tax escrow / $13k reserves (replacement reserves + interest cap escrow)

Current Month Payment - $297k total ($127k interest (Increase in underlying index that is still below the strike rate) / $53k tax escrow / $116k reserves (replacement reserves + interest cap escrow).

Just because you purchased your rate cap before the massive price hike & not facing an immediate expiration does not mean you're insulated from this market. Cash-on-cash about to take a hit...

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Comments (10)

Jun 22, 2022 - 9:51am
Rumpus, what's your opinion? Comment below:

Do you have any sources you can share that explains this mark to market process?

I don't understand why your cap escrow would increase so much if you purchased the cap before interest rates increase. Seems to me like the market to market would benefit you and your cap would be worth more.

Edit: I think I've answered my question. Fannie Mae requires an interest rate cap, but if your cap term is less than the loan term then you are required to make monthly payments to buy a replacement cap. As rates increase, the value of the replacement cap increases which would increase the monthly payment amount. Is this what you're referring to?

Most Helpful
Jun 22, 2022 - 12:59pm
[email protected], what's your opinion? Comment below:

The mark to market isn't on the cap you bought, it's on the next cap you're going to need per the loan agreement.

Typically on floating loans with a cap you don't buy a cap for the whole period, you typically purchase a 3 year cap and then your bank will make you escrow money to purchase a similar cap when that one expires to cover the next 3 years/remainder of the loan. The banks look at current/future cap pricing to determine how much you need to escrow. If cap costs go through the roof (which they have) then the bank will force you to escrow more.

  • Analyst 2 in RE - Comm
Jun 22, 2022 - 1:34pm

After looking through loan agreements, it appears that the initial strike rate at closing also gets pegged as a ceiling for the replacement cap. I.E, if you closed with a 1.90% cap, your replacement cap cannot be for a strike rate greater than 1.90%.

What may have been viewed as a prudent, conservative insurance policy 1-2 years ago could turn into a massive ongoing liability for some of these borrowers. 

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  • Associate 3 in RE - Comm
Jun 22, 2022 - 2:36pm

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