Refinancing risks and the potential effect on IRR
Hedging and Capital Markets
Infrastructure | London
Read a recent case study for one of our infrastructure clients, looking to hedge their interest rate exposure via a 35-year interest rate swap.
- Our client was purchasing an asset with a long dated, 35-year fixed revenue stream.
- As is typical for this type of project the debt funding is sourced for the construction period (in this case 10 years) and then converts to the investment term.
- To match the term of the interest rate exposure to that of the revenue stream, the debt is hedged via a 35-year interest rate swap.
- The financial sponsor intended to refinance at the 10 year point, likely into a 25 year fixed rate bond issue (GoC + corporate spread).
- Evaluation of timing slippage on the refinancing, and repercussions for the targeted internal rate of return (IRR).
- Detailed pricing analysis of the basis risk between swap spreads (which impacts the termination cost of the swap) versus the financing costs linked to a corporate bond spread.
- Risk of swap spreads moving down relative to corporate spreads and jeopardising refinancing assumptions feeding into a reduction in assumed IRR at the time of the initial financing.
- Ensure the swap rates (mid-rate and credit spreads) are managed appropriately.
- Our client obtained “at-market” swap executions and minimized swap credit spreads, therefore reducing the potential termination cost that may arise at the 10 year refinance point.
- Our client is now able to manage the effect that a potential movement in swap spreads could have on IRR at the time of refinancing.
- Our client’s IRR assumptions were fully supported by the market analysis we carried out and the risk evaluation appraisal of the refinancing point.
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This material has been created by Chatham Financial Europe, Ltd. and is intended for a non-U.S. audience. Chatham Financial Europe, Ltd. is authorised and regulated by the Financial Conduct Authority of the United Kingdom with reference number 197251.
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An interest rate swaption is an option that provides the borrower with the right but not the obligation to enter into an interest rate swap on an agreed date(s) in the future on terms protected by the swaption.