Agency borrowers with floating rate caps may be able to unlock excess replacement cap reserves early. As short-term rates have fallen, cap costs have plummeted, making the cost to purchase a cap through loan maturity cheaper. In some cases, borrowers may be able to purchase a cap through maturity without coming out of pocket, eliminating the replacement cap escrow requirement and allowing their excess reserves to be returned to them.
Consider a $25mm 5-year Freddie floater originated in June 2023. Say the loan had a 4.50% cap strike requirement with an initial term of two years. Let’s assume after that initial cap expired, the borrower purchased rolling one-year replacement caps. Here’s how the replacement cap escrow requirement and reserve balance would have changed over time.
Notice that by December 2024, cap costs and therefore reserve requirements had dropped dramatically. However, by that point, the borrower would have already amassed over $250k in reserves. Even using those funds to buy one-year replacement caps, the reserve balance would have barely changed due to the immaterial cost of those replacement hedges.
The borrower’s current cap would need to be replaced by June this year and they’d have a couple options:
If you have an Agency floater with excess replacement cap reserves, you may be able to unlock those funds by purchasing a cap through loan maturity.
Need help determining if this is possible on your deal? Reach out to pensfordteam@pensford.com or (704) 887-9880 and we’ll run the analysis for you.