Hedge mark-to-market (MtM) is the current market value of an interest rate derivative calculated from prevailing market rates. For a swap it is the present value of the difference between the fixed rate locked in and today’s rate for a swap with the same remaining term; for a cap it is the remaining optionality value.
How is a hedge marked to market?
For an interest rate swap, a swap entered at 3.50% when market rates have since risen to 5.00% has a positive MtM (an asset), because it locked in a below-market rate. If rates have fallen, the swap has a negative MtM (a liability).
For an interest rate cap, the MtM is the remaining optionality value given current rates, volatility, and time to expiration. Mark-to-market valuations are required for financial reporting, loan covenant compliance, and early termination decisions.
Why does hedge MtM matter to a borrower?
MtM values change every day with interest rate movements, changes in forward rate expectations, and the passage of time. A negative swap MtM means the borrower owes the bank a termination payment to exit early, for example to refinance or sell. A swap with a negative MtM of $2 million carries an additional $2 million prepayment cost that belongs in any refinancing or disposition analysis.
For caps, the MtM is the residual value, which matters when deciding whether to sell a cap back before expiration during a refinancing. Borrowers who do not monitor their hedge MtM regularly get sticker shock when they need to exit.
How hedge mark-to-market shows up in LoanBoss
LoanBoss tracks hedge requirements with live mark-to-market values and replacement cap costs, refreshed daily from Pensford’s institutional-grade rates data.
Frequently Asked Questions
When does a swap have a positive mark-to-market?
When market rates have risen above the fixed rate locked in, so the borrower holds a below-market rate and the swap is an asset. If rates have fallen, the MtM is negative and the swap is a liability.
What does a negative MtM cost the borrower?
The termination payment owed to the bank if the swap is exited early. A negative MtM of $2 million adds $2 million to the cost of refinancing or selling while the swap is in place.
Why does a cap’s mark-to-market matter?
It is the cap’s residual value, driven by current rates, volatility, and time to expiration, and it determines whether selling the cap back during a refinancing is worthwhile.
Related Terms
- Interest Rate Swap
- Interest Rate Cap
- ISDA
- Hedge Requirements in Loan Documents: Replacement Caps, Swap Mark-to-Market and What Lenders Test
Part of the LoanBoss CRE Debt Glossary. For hedging-specific terms, see Pensford’s resources.
Sources
- LoanBoss CRE Debt Glossary