Many borrowers have been shocked to learn that the cost of caps has doubled or, in some cases, tripled since the beginning of this month. The primary drivers of the spike in premiums are:
- Rate Expectations – The market’s near-term prediction for the path of floating rates is now 20-40bps higher due to the anticipated impact of higher oil prices on inflation, and therefore fewer rate cuts by the Fed. This increases the expected payout (aka the intrinsic value) of the cap.
- Volatility – The market has grown increasingly uncertain about the duration and potential for further escalation of the Iran conflict. The market charges you for that uncertainty in the cap premium.
The below table compares the cost of various cap structures a month ago to today. We’ve quoted these premiums in basis points of loan amount.
Volatility can spike suddenly but often takes months to settle. This means that even if a resolution to the Iran conflict were reached today, cap costs are likely to stay elevated for a while.
Need help navigating the impact of rising cap costs? Reach out to the experts at pensford@pensford.com or (704) 887-9880.
