Thursday, May 01, 2014

Mind Numbing

Here is complex bankruptcy story, as detailed by Bloomberg.  The Gherkin tower (the building shaped like a football) in London became the highest profile London property bankruptcy since Canary Wharf in 1992.  It looks like the borrower's hedging backfired, causing its liabilities to increase:
Deloitte said in an April 24 statement that the defaults stemmed from the building’s complex, multi-currency capital structure. “Adverse interest rate and currency movements have caused the total senior liabilities secured by the property to increase materially,” the firm said.

Rate swaps allow borrowers to keep payments within a fixed range even if interest rates fluctuate more widely. When rates fall, customers might pay higher costs for the swap to keep payments within the agreed range.
The building, bought for 600 million pounds in 2007, was valued at 473 million to 520 million pounds in 2012.  I can't quite figure the debt, but think it's near 550 million pounds. 


reitspot said...

Any idea how these rate swaps work for the borrower? "When rates fall ... might pay higher costs ... to keep payments within the agreed range"? Fine, but how did that "increase senior liabilities"? It seems like if you're just keeping payments within a range, then nothing would have "increased" necessarily ... it just stayed high despite a drop in rates.

I was curious, so I grabbed a term sheet just now from Credit Suisse for a possible $15m swap agreement related to a floating rate mortgage on one of our buildings, and I have NO idea how this works. Something to do with payoff = index rate minus strike, and there's a cap rate/strike that varies based on termination date ...

Rational Realist said...

I don't fully know how the swaps work, and unfortunately I don't think many borrowers buying this protection do either. Bankers sure know how they work.