Real Estate Case Study: Interest Rate Risk Management

Our Client:
A real estate investment fund with global exposure focused on central city properties.

Situation:
The real estate investment fund was in the ramp-up period of their deal and were seeking to extend the financing to accommodate the investment stage. Following the fall in rates since the deal was first struck, the original hedging was deeply underwater. The lender was happy to extend new hedging, but was requiring the original trades to be terminated in favour of new transactions.

Summary:
Chatham Financial assessed the value due from breaking the original trades and, with the client, determined that this would generate a concern for the cashflows during this development stage. The client wanted the refinancing to occur and wished to take advantage of hedging the extension at new, historically low, interest rates. It was identified that the deal could tolerate an interest expense higher than the market rates and we analysed the impact of deferring the breakage payment over the extended life of the new trade. The bank remained keen on terminating the original trade and discussions on avoiding the upfront pain of breakage were extensive. Only after we detailed that the charges to be levied should be commensurate solely with the new risk involved did the bank yield in their stance and permit the trade to be restructured on a net basis. The added benefit of this route was an avoidance of any market movement that could otherwise have occurred between the exit of the original trade and the execution of the new one.

Outcome:
The transaction was extended successfully; with the blending of interest expense across the new trade being precisely calculated. The trading and credit charges applied were rational and there were no overpayments due to the trades being combined and traded as one net execution. The savings in transaction and credit charges were large, equating to nearly EUR 1mm.

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