Hedging BBSY: How to Lock In Your Base Rate for 1 to 5 Years, and the Tools That Do It

A BBSY facility gives you transparent, market-based pricing. It also gives you full exposure to the market. If 90-day BBSY rises by 1%, the interest on a $5 million facility rises by $50,000 a year, and there's nothing in the loan itself to stop it.

Hedging lets you separate those two things. You keep the BBSY facility, with its transparency and flexibility, and use a separate contract to fix or cap the BBSY part of your rate for a period you choose. This article explains the tools, works through examples from one to five years, and covers what you need from a bank to do it. If you're new to BBSY, start with BBSY Explained and how BBSY is set each day.

What You Can and Can't Hedge

Your all-in rate on a BBSY facility has three parts: BBSY, the customer margin and the line fee. Hedging only deals with the first. The margin and fees are set in your facility agreement and are managed by negotiating with your lender, not by hedging.

Hedging protects you against a rise in the market base rate. It doesn't protect you against your bank lifting its margin at review, and it doesn't make borrowing cheaper. It makes it more certain.

You Need a Hedging Limit, Not a Loan

A common misconception is that you can only hedge with the bank that lends to you, or that you need a loan facility with a bank before it will hedge for you. Neither is true.

To hedge, a bank needs to approve a hedging limit (sometimes called a treasury, markets or derivatives limit). That is a credit approval in its own right, separate from any lending limit. It exists because a swap can move against you: if rates fall and you exit early, you may owe the bank a break cost. The hedging limit is the bank's assessment of how much of that risk it's prepared to take on you.

What you do need is:

• An approved hedging limit. The bank assesses your financial strength, the size and term of the hedges you want, and any security, just as it would for a loan, but sized to the potential break-cost exposure rather than the full notional amount. Larger amounts and longer terms use more of the limit.
• A genuine interest rate exposure. Banks hedge to manage risk, not to let customers speculate. You'll need to show what you're protecting: BBSY debt with another lender, debt you're about to draw, or another real exposure to short-term rates.
• Hedging documentation. Usually an ISDA Master Agreement or the bank's own master derivatives agreement, plus a confirmation for each trade.

So a business borrowing on BBSY from one lender can hedge with a different bank, provided that bank approves a hedging limit and the business wants to reduce its exposure to interest rate risk. Doing so can be useful: your hedge isn't tied to your lender, so a later refinance doesn't automatically force you to break it. The trade-offs are that the hedging bank may want security, which your lender may need to agree to share, and that some facility agreements require hedging to be placed with the lender. Check your facility terms first.

The Hedging Tools

• Interest rate swap. The most common tool. You pay the bank a fixed rate and the bank pays you the floating rate (usually BBSW) on an agreed notional amount. The floating payment offsets the BBSY you pay on your loan, so your net cost is the fixed swap rate plus your margin. Swaps cost nothing upfront, but can have a break cost if you exit early.
• Interest rate cap. An insurance policy on rates. You pay an upfront premium, and if BBSW goes above the agreed strike rate, the bank pays you the difference. If rates stay low or fall, you get the full benefit. Because you've paid the premium upfront, you owe the bank nothing more, so a bought cap often needs little or no hedging limit.
• Collar. You buy a cap and sell a floor at the same time. The floor premium pays for some or all of the cap, so collars are often structured at zero upfront cost. Your rate is held between a ceiling and a floor.
• Forward-start swap. A swap agreed today that starts on a future date. Useful when you know you'll be borrowing later, such as at settlement of an acquisition or completion of a development, and want to lock in today's rates.
• Swaption. An option, for an upfront premium, to enter a swap at a set rate on a future date. Useful when the borrowing is likely but not certain.

The alternative is a bank fixed-rate loan, where the fixed rate is built into the loan itself. That's simpler, but it ties the fixed rate to that lender, can bundle a less visible margin into the rate, and usually carries its own break costs.

Worked Examples: Fixing BBSY for 1 to 5 Years

The examples below use a $5 million facility with a customer margin of 1.20% and a line fee of 0.60%, so 1.80% sits on top of BBSY. Swap rates are illustrative only, not market quotes, and include a typical bank credit charge. Real rates change every day.

The BBSY–BBSW difference appears because most swaps pay you BBSW, while your loan charges BBSY Bid, which is BBSW plus 0.05%. Some banks will write the swap against BBSY directly. Either way, check that the floating leg of the swap matches the base rate in your loan.

How to read the terms:

• 1 year. Short-term certainty, for example to get through a budget year or a period of tight covenants. Cheap to exit, but you're back on floating rates in 12 months.
• 2 years. Covers a typical review cycle. A good fit when you expect to refinance or sell within a few years.
• 3 years. The most common choice for mid-market facilities, often matching the facility term. Long enough to ride out a rate cycle, short enough to keep break-cost risk manageable.
• 4 years. Suits investment property and stable businesses with longer leases or contracts behind them.
• 5 years. Maximum certainty for long-dated assets. Also the highest break-cost risk if your plans change, because there are more years left to value.

What Happens When Rates Move

Take the 3-year swap above, fixing the all-in rate at 6.60%. Suppose BBSY is currently 4.81%, so the unhedged all-in rate would be 6.61%:

• BBSY rises 1%. Unhedged, your rate goes to 7.61% and annual interest rises by about $50,000. Hedged, you stay at 6.60%. The swap pays you the difference.
• BBSY falls 1%. Unhedged, your rate falls to 5.61% and you save about $50,000 a year. Hedged, you stay at 6.60%. You pay the difference into the swap. That's the cost of certainty.

Break Costs: The Risk to Understand

A swap has a market value that changes as rates move. If you close it early, for example because you sell the asset or repay the loan, that value is settled in cash.

Say you enter the 5-year swap at 4.85% on $5 million. Two years later you sell the property, and 3-year swap rates have fallen to 3.85%. You're paying 1% more than the market for the remaining three years, so closing the swap would cost roughly $140,000 (1% × $5 million × about 2.8 years, discounted). If rates had risen by 1% instead, the bank would pay you a similar amount.

Break costs are the main reason not to over-hedge. Hedge the debt you're confident you'll still have for the full term, not the maximum you might borrow.

Examples Using Caps, Collars and Layering

• 3-year cap. Buy a cap at 5.50% on $5 million for an illustrative upfront premium of $25,000 (0.50%). Your worst-case all-in rate is 7.35% (5.50% + 0.05% + 1.80%), and if BBSY falls, your rate falls with it. You can repay the loan at any time with no break cost on the cap.
• 3-year zero-cost collar. Buy a cap at 5.50% and sell a floor at 4.25%, with no upfront premium. Your all-in rate stays between 6.10% and 7.35% for three years.
• Layered hedging. Hedge 50% for three years, 25% for five years and leave 25% floating. You get certainty on most of the debt, keep flexibility to repay part of it, and avoid putting everything on one rate on one day.
• Forward-start swap. You're settling an acquisition in six months with a new $8 million facility. A 3-year swap starting in six months locks in the base rate now, so the deal's numbers don't change before settlement. The rate will usually be slightly different from a swap starting today, reflecting where the market expects rates to be.

Things to Check Before You Hedge

• The bank's credit charge. Every swap rate quoted to you includes a margin for the bank. Ask for the mid-market rate alongside the rate quoted, so you can see what you're paying.
• Match the hedge to the loan. Notional amount, reset dates (30, 90 or 180 days), start and end dates, and any amortisation should line up with the facility. A mismatch leaves you partly unhedged.
• The break-cost terms. Understand how the bank calculates them, and what happens to the hedge if the loan is refinanced or repaid.
• Lender requirements. Some facilities require a minimum hedged percentage, or that hedging is done with the lender. Check before going to another bank.
• Accounting and tax. Hedges can affect your financial statements and tax position. Speak to your accountant about hedge accounting and tax treatment before you trade.

How We Help

We structure your BBSY facility so it can be hedged cleanly, with rollover dates, terms and any amortisation that a hedge can match, and we help you approach banks for a hedging limit, including banks other than your lender. Decisions on whether to hedge, and how much, should be made with the bank's markets team and your own financial adviser. Where your current margin is the bigger issue, we tender your facility across our panel of 60+ lenders. Learn more about mid-market commercial finance, our commercial refinance service and the Glenclair Pricing Index.

Book a free, no-obligation consultation and we'll look at your exposure to rising rates and what it would cost to hedge it.