From the beginning, it was commonly perceived that 2022 was going to be a challenging year for the U.K. commercial real estate industry. With both inflation and interest rates already on the rise, the ensuing war, energy crisis, and fiscal turmoil added massively to the economic uncertainty and have now caused the cost of borrowing to dramatically affect how property companies strategically handle their debt structure. To add insult to injury, the transition from LIBOR to SONIA went into effect on January 1st, and with it a whole new dynamic in how to calculate the cost of borrowing.
The Nature of LIBOR and SONIA
There is a key practical challenge with the elimination of LIBOR. The LIBOR index was published daily on various terms such as one, three and six-month forward-looking periods, but SONIA is published daily every morning. A loan which references SONIA over a period requires daily compounding, taking the realised fixing for each day in the interest period and compounding it for a calculation at the end.
The complexity that the new calculation method has added to the daily job of finance managers across the CRE industry should not be underestimated. Knowing exactly what is owed in interest cost by the end of any given period can no longer be taken for granted, especially with the rapid market changes we have witnessed this year. Moreover, it takes a tremendous amount of time and resources to manually enter changes of the SONIA reference rate into a spreadsheet and then updating and stringing together spreadsheet formulas to calculate the compounding effect. In addition, considering the economic environment we are in, the importance of proactively calculating and simulating interest cost models with a high degree of certainty has become increasingly important.
Is This the Perfect Storm?
So the question one might ask, has the time for implementing a debt and risk management system finally arrived? When interest rates effectively went to zero after the financial crisis in 2008-2009, the need for a debt system was fairly low. Managing loans and interest costs using spreadsheets was not very cumbersome. In fact, rates changed so infrequently that one rarely had to manually update the formulas. The new reality that has hit the UK CRE industry is therefore almost like a perfect storm. Not only has interest costs skyrocketed with no end in sight, the new SONIA calculation methods have made the daily management of a company’s interest costs extremely challenging and time-consuming.
At Nordkap we have worked on creating a user-friendly and secure cloud-based debt and risk management system for over 11 years. Currently 65% of all exchange listed CRE companies in Sweden work in our system and we know how to tackle SONIA. In our system, users can access the same data and run all of the required key metrics, simulation models and interest rate sensitivity analysis with just the click of a button. All the SONIA rate changes and daily compounding are done automatically and seamlessly which allows, once again, for a proactive management of the company’s cost of borrowing.
Watch Our Recorded Webinar
On September 30th, Fredrik Eriksson, Head of International Sales, and Johanna Sanderi, Financial Specialist, from Nordkap hosted a webinar on this particular issue together with Jonathan Lye, Director of Auxilium Financial Risk Management. In this webinar, we went through the above-mentioned challenges with a clear focus on the CRE industry in the United Kingdom.
Click here to access the recorded webinar.
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