EURIBOR

What it means

EURIBOR is the reference rate at which banks in the euro area lend euro to each other. It is published for several maturities and serves as the base from which the interest on a floating-rate corporate loan is calculated.

It is not an ECB rate. Monetary policy pulls it up or down, but the number itself comes from the market, from the submissions of panel banks, and an administrator runs it under the European benchmarks regulation.

EURIBOR is not the final loan rate and cannot be compared with the annual percentage rate. It is only one part of the price: the margin is added to it, and the cost of the loan also includes arrangement, administration or commitment fees. Two offers with the same margin over EURIBOR can therefore cost the company different amounts.

How it works in practice

The contract states the rate as EURIBOR for an agreed maturity plus the bank margin. At the end of every interest fixation the reference rate is recalculated and the instalment changes from the next period, while the margin stays unless the bank reserved the right to adjust it.

A rise in the rate lifts interest costs and can break covenants tied to interest cover. Companies protect themselves with hedging, meaning an interest rate swap or a cap on the rate.

We book interest on a floating-rate loan from the bank’s notice of the new rate, not from our own estimate. Interest for the period up to the year end goes into that year’s expenses even when the bank collects it only in January, which is a routine accrual. At every rate reset we also update the instalments in the cash-flow plan.

What to watch out for

The cash-flow plan is built on today’s rate. After the reset the instalment grows, the company misses the agreed interest cover ratio, and the bank gains the right to call the loan or raise the margin, which costs more than the rate rise itself.

Many contracts contain a floor under which a negative EURIBOR counts as zero. A company hedging with an interest rate swap that has no matching floor then pays the full margin to the bank when rates fall, plus the swap difference against the fixed rate. Loan and hedge terms are therefore compared together, especially when refinancing.