Don't Panic!
Loan: $42,000,000
Location: Southwest U.S.
Budget: 6% LIBOR
Project: Strip Center Construction Loan
Benefit to Borrower: $700,000 Over 2-1/2 years
Borrower Situation
Due to a rising interest rate environment, the client is over budget from day one. Understandably, the banker and the client’s equity partner are eager to “do something” to protect their funding. Their idea – a single swap or cap – will cost over $700,000.
CIRM Solution
Our goal is to beat budget. Advising against either the cap or the swap, we instead plan a series of limited, forward-looking actions. We start with extremely short-term LIBOR elections. This means that as the amount outstanding grows, so do interest expense and rate risk. However, our monitoring reveals that LIBOR rates for future quarters are falling much faster than cash rates on current LIBOR fixes.
Three months into the project, we devise a one-year LIBOR election on $7,000,000 of balances, at a rate just above budget. This puts one sixth of the loan balance to bed for two-thirds of the term. Then, seven months into the project, we tailor a deferred swap to lock-in rates for a portion of the following year. This specially devised instrument guarantees that the entire construction budget will come in below budget.
Result
Better yet, by retaining a large share of debt at floating rates and monitoring carefully, we enable the client to slide down the flattening yield curve, to its distinct advantage – lower interest costs and greater flexibility.
The developer quickly redeploys the freed-up cash to other line items.
