Inside Third & Bond: Week 139
This week, the bloggers from The Hudson Companies hedge some interest rate risk… Third + Bond is entering the homestretch and so is this blog. We’re buttoning up our paperwork with the Department of Buildings. The contractor crews are getting sparse. The paint is dry. The trees are planted. As we sweat our way out…
This week, the bloggers from The Hudson Companies hedge some interest rate risk… Third + Bond is entering the homestretch and so is this blog. We’re buttoning up our paperwork with the Department of Buildings. The contractor crews are getting sparse. The paint is dry. The trees are planted. As we sweat our way out of the hottest July on record and many of you pack yourselves off to vacations, we’ve decided to dial down our reports to every other week. We’ll conclude ‘Inside Third + Bond’ when we get our TCO, which with our crossed fingers and held breath, shouldn’t be too long. With only a few postings left between now and then, we want to know: are there any topics that you, dear reader, are itching to hear about?
This week, itchy or not, you’re getting an update on our construction loan. Back in Week 14 we talked about pursuing a $25 million construction loan and in Week 27 we talked about caps, collars, and swaps. A 100 or so weeks later, we have extended the due date of the loan now held by Wells Fargo. The construction loan originally closed in the hands of Wachovia with a term date this year. But given all of the fun writing this blog, we stretched out construction for as long as possible, thus bypassing the original term date. Now it’s Wells Fargo’s turn to have measured fun with the fees we produced to extend the loan. Their real fun isn’t until we pay back the entirety of the loan which could be as soon as this year or as late as 2012.
As part of the loan extension, Wells Fargo asked that we purchase a cap on our interest rate. A cap for them means…
…we are taking less risk and so should be in a better position to pay them back. The first cap we obtained was purely our own idea. Would we have gotten a second cap? Maybe. Wells Fargo wanted a cap of 2.50%. Our previous cap was at 4.00%. When we bought the 4.00% cap, LIBOR was above 3.00% and we wanted protection against it going higher which it did briefly, before going much, much lower.
In securing a cap, we have to create a schedule of values as well as set the cap rate. This schedule reflects the amount we are capping at different points in time. Typically it reflects the amount of the loan we expect will be outstanding at these points in time.
The schedule proposed by Wells Fargo was conservative. For example, they didn’t have us paying back even a quarter of the loan until October of next year, 2011. The cost of the cap is tied to the rate and the amount outstanding, as well as larger market forces. Wells Fargo’s original schedule resulted in a cap cost of about $15,000 more than our proposed schedule. Fortunately, after discussion, Wells agreed to go with our cap schedule with a few minor modifications.
If you remember, or took a moment to review, our cap/collar/swap lesson from Week 27, then you also remember that we were leaning toward a swap/collar combo at the time. Back in March 2008, we planned to swap $15 million at a fixed LIBOR rate of 2.65% and let the other $10 million float (with a collar limiting the variation to between 2% and 3.5%). But a few weeks later we decided to forgo both for a simple cap. Glad we did since interest rates plummeted below the swap and floor rates. The 4.00% cap didn’t do a whole lot for us but that’s the way most insurance policies work out. The 2.50% cap we have now might well have a similar outcome. LIBOR hasn’t been above 2.00% since 2008. Just to give you a sense of the unexpected changes in LIBOR, here’s a look at one-month LIBOR for the last ten years for the month of July:
The insurance policy of a 2.50% cap might be overkill for a project that is nearly finished while LIBOR hasn’t even cracked 2.00% in more than a year. But it makes more sense than a swap right now and gives us some predictability vis-Ã -vis a shifting economy.
As for the photo at the top of this post, the art piece above the bed in this model condo, recovered from the construction scaffold mural, is our muralist’s take on the façade of Third + Bond.
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Our legal fine print: The complete offering terms are in an Offering Plan available from Sponsor. File No. CD080490. Sponsor: Hudson Third LLC, 826 Broadway, New York, NY 10003.
Hi Donald,
Well, we didn’t really get into the potential consequences because the cap was on the first loan extension term sheet we got from the bank (with strike tbd) and we thought it was a good idea so agreed. Probably if they hadn’t asked, we would have looked at doing a cap at a higher strike and thus paid a lower cap fee.
Yes, we have the cap because we don’t know with 100% certainty how long it’ll take to sell enough units to pay back the loan in full. The fact that construction is almost finished factors in because it puts us in a better position to sell–buyers don’t like unfinished product. How long will it take for LIBOR to work its way back up to 2.5% (been get a cap.
Thanks for the idea for the future post!
Randolph, wake up! This is material that we will be tested on in the final post – Week 162.
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T+B thanks for another great post. A couple of questions for you:
What were the potential consequences, if any, if you didn’t go with a cap, as they “asked”?
The insurance as “overkill” is really to address the unkown absorption time, not the fact that you are almost finished with the project, correct?
Suggested topic to cover – how are you modelling absorption today versus say 139 weeks ago?
Thanks!