Back-to-back interest rate swaps explained in 3 minutes

Banks use back-to-back swaps to meet borrower demand for long-term fixed-rate loans. With back-to-back swaps, the bank enters a floating-rate loan and a fixed-rate swap with the borrower and then a second, offsetting swap with a dealer counterparty.

Key takeaways

• Learn more about interest rate swaps
• Discover back-to-back interest rate swaps and how they work
• Understand who uses back-to-back interest rate swaps

The swap rate includes a swap fee, which the bank earns to cover the costs to originate and service the swap and for the additional extension of credit.

The difference between the wholesale rate (reflecting the bank's credit quality and dealer mark-up) and the retail rate (reflecting where the bank gets done with their customer) is equal to the fee that the bank earns. Within two business days of executing the swap, the dealer pays the bank. The swap fee depends on the size of the transaction, how long or the tenor of the transaction, and the creditworthiness of the customer.

Who uses back-to-back swaps?

Here are a few practical examples of back-to-back interest rate swaps:

• A commercial real estate investor who wants long-term fixed-rate financing is provided a floating-rate loan and a swap
• A company wants to lock-in the rate on an "evergreen" portion of its credit line and the bank offers a swap
• A borrower who wants to lock-in a rate on future financing is offered a forward-starting swap

Size and term vary, but generally back-to-back swaps are $1 million or greater in notional and five years or longer in term.

Summary

Using back-to-back swaps, a bank can:

• Meet its customer's financing preference without taking on unneeded interest rate risk
• Provide the customer with a two-way prepayment on the swap versus a one-way prepayment, as typically found in fixed-rate loans
• Earn fee income enhancing the bank's return on capital
• Level the playing field with larger financial institutions offering swaps and non-bank lenders offering long-term fixed-rate debt

Since 2001, Chatham Financial has partnered with banks of all sizes to help launch, run, and grow successful customer back-to-back swap programs. As a result we are the largest and most experienced non-bank provider of back-to-back swap support to regional and community banks.

Back-to-Back Swap Program Benchmark Statistics Report

Interested in seeing how your interest rate swap program stacks up relative to your peers? Perhaps your financial institution is not yet using swaps to win more commercial loan business, but would find value in reviewing and analyzing Chatham's Back-to-Back Swap Program Benchmark Statistics Report.

Send us a message

Contact Chatham if you are looking to learn more about back-to-back interest rate swaps.

Disclaimers

Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.

Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.

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