Flexibility Breeds Content
Loan: $40,000,000
Client: Public company
Location: Southeast
Budget:7.0%
Project: Line of Credit
Benefit to Borrower: $458,000 Over 3 years
Borrower Situation
The Fed has just raised interest rates for the first time in years. LIBOR has risen to 3.5%. Our client wants to buy an interest-rate cap for three years at 7.0% to cover the remaining term of its loan, and has budgeted $500,000 for the purpose.
CIRM Solution
CIRM has a more attractive idea. We propose instead to implement a detailed plan, utilizing LIBOR fixing options, that reconfigures risk protection to the client’s benefit. In the first year, we calculate, self-insurance will be prudent: No cap is needed, and none is purchased, producing immediate cash savings. In year two, however, market conditions will become less friendly. For year two, we advise buying greater protection, a lower cap, at 5.50%. Then if conditions improve, for year three we will purchase a higher cap, without sacrificing overall three-year protection.
Result
Despite rising interest rates, CIRM’s deployment of LIBOR fixing options keeps year-one interest costs below 4.50%. When interest rates peak in year two, the 5.50% cap kicks in, giving our client a rate of return of 43%. Year three’s higher (and unused) cap produces still further economies.
