How is swap breakage cost calculated on a CRE loan?

Mechanics of swap breakage at loan payoff

Swap-priced bank loans (often called 'fixed-via-swap' or 'synthetic fixed') use a separate interest-rate swap between the borrower and a swap counterparty (often the lender's affiliate) to convert a floating-rate bank loan into a fixed-rate exposure. At loan payoff, the swap must be unwound, and the swap's mark-to-market value at payoff date drives the unwind cost.

Calculation: the swap counterparty calculates the present value of the difference between the swap's contracted fixed rate and the current market swap rate for the remaining term, multiplied by the notional and remaining payment cycles, discounted at current market rates. Most ISDA swap documentation gives the counterparty discretion in calculation methodology within commercial reasonableness.

Direction: when current market rates have fallen below the swap's fixed rate, the borrower owes breakage (the counterparty's hedge is in the money against the borrower). When current market rates have risen above the swap's fixed rate, the counterparty owes the borrower (the borrower's swap is in the money).

Practical sponsor planning: the swap-breakage cost on a swap-priced loan is in addition to any prepayment penalty in the loan documents. Many sponsors are surprised when the bank loan's prepayment penalty section appears benign (a small step-down) but the swap breakage on the same loan dwarfs the stated penalty. Always model both numbers when evaluating a swap-priced bank loan against a fixed-rate alternative.