How to Choose a Rate Cap Broker

As a commercial real estate broker, lender, attorney or accountant, your floating interest rate borrowers frequently ask you, “How do I obtain the interest rate cap the lender is requiring?” You likely have a “short list” of rate cap brokers you’re comfortable recommending.  While you may have confidence in the the cap brokers ability to “get it done”, are you truly aware of the differences between the cap brokers you recommend? Should you care?

As a borrower, its critical that the rate cap is purchased in a cost effective, efficient and error-free manner. And, by cost-effective, we mean that the rate cap broker’s fees are transparent throughout the process and the rate cap structure is the optimal combination of buying a cap that’s in compliance with the lenders requirements and done so at the lowest available cost.

When asked who they should use to facilitate the purchase of a required LIBOR cap for a floating rate bridge or Agency loan, commercial real estate brokers, lenders, attorneys or other service providers typically refer a couple of rate cap brokers to call that they’ve had experience with or inquire within their firm about who they’re colleagues recommend. The following is a list of best practice rules to apply when choosing a rate cap broker to ensure the best outcome for you and the borrower:

Rule Number 1 :  The indicative cost of the cap cost (aka “premium”) should never, ever be a factor in the decision.  Why? There are simply too many variables and assumptions that go into calculating a rate cap’s cost, and the risk of these variables being inconsistent among cap brokers at any given moment in time is very high.  For example, a cap maturity date of  3-1-20 versus 4-1-20 can cause a cap quote to vary by 10% or more.  All known and qualified cap brokers receive the same level of competitive pricing from the cap banks. If you’re receiving two prices, from two cap brokers that vary significantly, ask yourself:

  • On what day and at what time of the day was the cap priced? For a true apples to apples comparison of price competitiveness, ask each cap broker for a price as close to the exact same time as possible.
  • Do the trade assumptions match? Term, notional, strike, index, start date, end date, day count and amortization, to name just a few, have a significant impact on the cap price.
  • Is the cap agent including its fee in the cap price? If yes, why? Wouldn’t the borrower be better served by knowing the cap’s cost separate from the cap broker’s fee?
  • Is the cap agent trying to win the business by showing a lower “out of market” price (bait and switch)? Regardless of your answer, how do you know?
  • Who likes surprises? When it comes to money, no one. Especially the CRE broker, lender, and most importantly, the borrower, i.e., the ultimate cap purchaser.

Rule Number 2: The cap broker should be in charge of the entire process of acquiring the cap, from initial information gathering, documentation distribution and completion to trade execution and confirmation. If you are being asked to explain a noteworthy change in the rate cap cost, gather information for the cap broker, shuffle documents between borrower and cap broker or explain rate cap related documents you don’t fully understand to your borrower, ask yourself:

  • Who is doing all the work, me or the cap broker? Is the rate cap broker completing all the onerous Dodd-Frank documentation, explaining it to the borrower, purchasing the required GMEI number, and gathering documentation for qualifying the borrower to trade with the cap banks, not to mention intermediating with the cap banks to address any issues that may arise in the qualification process?
  • Do I understand the liability I’m creating for myself by being involved in the process of acquiring the cap? What if the cap auction blows up? Am I being compensated for the liability I’m creating for myself?
  • How confident am I that the cap terms mirror those of the loan?

Rule Number 3: Is my borrower getting their money’s worth from the cap broker? In order to protect your trusted reputation, understand what level of service your borrower is receiving for the fee they’re paying. Is there a better deal elsewhere?

  • Rate cap brokers charge similar prices for their services. The difference is in what services are actually provided for the stated fee. Some charge extra for obtaining a GMEI number and renewing the number annually as well as charging for additional work if they have to complete “know-your-customer” Dodd-Frank documentation.
  • If the cap isn’t properly documented at closing, then the lender, broker, and borrower have a serious problem. The loan may not fund, the buyer loses their deposit, additional legal expenses are incurred; the list goes on and on.
  • The broker and borrower should not have to endure the experience of going through the process without expert advice.  And they certainly shouldn’t have to spend time filling out paperwork  that the cap broker can do on behalf of the borrower more efficiently.

Rule Number 4: The biggest cap broker isn’t necessarily the best. Choose your rate cap broker based on their ability to make the borrower’s interest their priority, responsiveness, their experience in capital markets, legal knowledge, ability to manage complexity and meet critical deadlines.

  • Large rate cap brokers who’s business model is based upon volume generally put their own process ahead of your, the borrowers’ and the lenders’ interests. They favor conducting a rate cap purchase around their operational constraints rather than on negotiating the lowest cost cap at the best terms for the borrower and lender.
  • Think about it: A rate cap broker conducting a large volume of transactions simply can’t tolerate a great deal of customization in their process and still operate profitably. As a result, the cap buyer is simply paying the cap broker to prepare the term sheet, send the documents prepared by the broker or cap agent, and schedule the competitive auction, if its a true “auction” at all. That’s easy money!
  • If another cap agent can obtain the cap at the same price, do all the leg work, negotiate a cap for purchase at the lowest available cost and superior legal terms, do so with seamless execution, all at a lower fee, why wouldn’t you recommend them to your borrower?

Pro tip: Use us and experience the difference.

 

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