LBO model: swap rate
Say you are modelling a standard TLB, for example a EUR TLB.
When modelling the interest expense, would you take interest rate to be 5 year swap rate? Just as I understand the sponsor would look to refi the TLB at the 5 year mark and would also likely fix their floating exposure.
Or would you simply use the Euribor rate?
We don't typically swap to fixed. If this is for modeling test would assume it remains floating at your base rate + spread
thank you
okay, I thought sponsors had hedging policies where a certain percentage of drawn debt would have to be fixed?
I haven't seen that at the funds I've worked at. We did start to get some push this past year from lenders asking us to explore rate cap swaps to fix our interest payments, but we ended up not doing it and leaving everything as floating.
Cash spread + reference rate (SOFR, EURIBOR, etc.)* term loan(s) balance.
so for the purposes of modelling, you would enter the current LIBOR / EURIBOR rate, or would you use forward rates?
We don’t usually model swap until the sponsor clearly told us it is planned in the transaction. And you will surprisingly find out that many past LBO deals didn’t do any swap.
Why not just use swap rates? It seems like that would be the most accurate estimation as opposed to spot rates.
Agreed. We always use 3 or 5 year swap rates in the model even if we don’t swap
3 year swap rate for 5 year term loan (assuming you refi at 3 year mark) and 5 year swap rate for 7 year tlb ( refi at 5 year mark)?
Some colour from my personal experience: typically you wouldn't use swaps and just go with 3M EURIBOR instead (either today's 3M EURIBOR applied across full forecast period, or 3M EURIBOR spot curve applied to full forecast period). However, with increasing interest rates sponsors are starting to hedge a larger % of floating exposure and I have seen a couple situations where they would ask us for indicative swap rates including credit charges to incorporate in their models. Also, with the EURIBOR curve being inverted, it may be beneficial from a model return perspective to use a 4/5yr swap rate as that rate will be lower than 3M EURIBOR, hence resulting in (slightly higher) returns.
A bit less relevant, but just in general it wouldn't make sense for a sponsor to put a swap for the full tenor of a TLB or FRN. Since long-term debt goes current 1 year ahead of maturity, which substantially impacts ratings, you should assume debt is refi'd at least 1 year prior to maturity hence a swap tenor should also be assumed 1 year prior to maturity (i.e. 4yrs swap for 5yrs TLB/FRN).
Lmfao no one is hedging 4 years right now on an LBO. Within 2 years years the curve will be lower than the swap rate
Folks are. They want to take risk off the table, and with the curve being inverted it makes it attractive to hedge longer tenors. They may decide to go with a cap rather than a swap.
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