Interest cost reduction

DESCRIPTION:

  • A public entity that is highly indebted (90% floating rate) and has an ambitious cost reduction objective, requires an in-depth interest rate risk analysis.
  • As part of the conclusions of the analysis, Variance identifies a market opportunity based on 2 points: (1) short-term yield curve inversion, and (2) long-term interest rates historically low.
  • Variance proposes hiring several hedges (i.e. swaps) and selling several swaptions to fix the interests to be paid by the client in the following 4 years.
  • The yield curve inversion in the short-term, together with all income from swaptions sold, allows the client fix an interest rate which is lower than the Euribor rate (Euribor at 1.53% vs. fixed rate at 1.05%).
  • Variance supports the client along the restructuring hiring process to ensure that all trades are executed in the best conditions.
  • After the execution, Variance closely monitors swaptionsÔÇÖ prices for an eventual buyback.

BENEFITS:

  • The client completely eliminates interest rate risk for the following 4 years.
  • The client reduces financing cost down to 48 basis points under the Euribor rate at the hiring time, which brings EUR 750k savings in interests.
  • Variance provides trade execution transparency and helps the client to be in a good position to negotiate with the financial institution.
  • The client outsources the follow-up of sold swaptions to Variance, which monitors the market looking for good opportunities to buy back.

 

Chart: Annual interest expense under different market scenarios
The chart shows annual interest expense for different Euribor values. Euribor was at 1.53% at the time. The dashed red line represents the interest cost as projected by the market when the analysis was carried out.