Effective interest rates???

[forest]

I am reading the financial notes of Delegats Wines and notice that for a number of their loans the "effective interest rates" has dropped from around 9% in the 2008 fin year to just above 3% in the 2009 fin year.

Interest cost variations for companies with large borrowings can have substantial influence on the amount of profit, for this reason it would be nice to understand what exactly "effective interest rates" in this context means. Can somebody put some light on this for me.

Cheers Forest

[Steve]

The effective interest rate is based on the BKBM rate plus a margin.

With the drop in the RBNZ cash rate over the period, the BKBM rate will have dropped correspondingly and this is reflected in the significant drop in the interest rate that is being paid on the various facilities.

[forest]

Thanks Steve, but I think there might be more to it. What I gether is that the companies tax rate and possible inflation are also factors. Would really like to know a bit more so I can estimate the likely savings or extra cost in interest for the current fin year.

[Steve]

Thanks Steve, but I think there might be more to it. What I gether is that the companies tax rate and possible inflation are also factors. Would really like to know a bit more so I can estimate the likely savings or extra cost in interest for the current fin year.

Forest, IMO you may be reading a bit much into the use of the word 'effective' in this situation.

In terms of the current financal year, any change in the effective interest rate (BKBM + margin) would most likely be upwards should the RBNZ start to increase the cash-rate which would flow thru to an increased interest cost...

[Snoopy]

Thanks Steve, but I think there might be more to it. What I gather is that the companies tax rate and possible inflation are also factors. Would really like to know a bit more so I can estimate the likely savings or extra cost in interest for the current fin year.

Many companies with cross border exposure to costs and earnings use financial devices like hedging and interest rate swaps to change their effective interest rate. That means they can borrow in say US dollars but have fixed payments in NZ dollars to meet their loan obligations. That means they might borrow funds at say 2% in the US, but have repayments that amount to 7% when those borrowings are repaid in NZ dollars. Usually this stuff is disclosed in the annual report and provides another meaning to 'effective interest rates'.

SNOOPY

[forest]

Many companies with cross border exposure to costs and earnings use financial devices like hedging and interest rate swaps to change their effective interest rate. That means they can borrow in say US dollars but have fixed payments in NZ dollars to meet their loan obligations. That means they might borrow funds at say 2% in the US, but have repayments that amount to 7% when those borrowings are repaid in NZ dollars. Usually this stuff is disclosed in the annual report and provides another meaning to 'effective interest rates'.

SNOOPY

Thanks Snoopy, I start to realise that the "effective interest rate" term is a very loosly used and can mean a number of different things. Therefore it would have been helpfull when they choose to use this term if they would give use a definition of their version.
However in the DGL annual report I can not find any mention of borrowings overseas so for the moment I will assume all the loans are in NZ.

Forest, IMO you may be reading a bit much into the use of the word 'effective' in this situation.(Steve)

Steve, in the case of DGL annual report would it be as simple as the BKBM(similar to the inter bank cash) rate being close to 2.4% and an extra margin of about 0.8% giving an total interest rate of about 3.2% at the latest balance date (30 Jun).

[Lizard]

Many companies with cross border exposure to costs and earnings use financial devices like hedging and interest rate swaps to change their effective interest rate.

Yes, there are some of these that are covered in the notes to DGL report - mostly to cap the interest rate on some portion of the borrowings (from memory, at about 8.75%).

[forest]

Yes, there are some of these that are covered in the notes to DGL report - mostly to cap the interest rate on some portion of the borrowings (from memory, at about 8.75%).

Your right that there are interest rate swaps contracts, but would it be fair to assume that all loans are in NZ$ and that in the 1H10 fin year DGL would have paid about 3.2 -3.5% on the mayority of their loans?

[Lizard]

Your right that there are interest rate swaps contracts, but would it be fair to assume that all loans are in NZ$ and that in the 1H10 fin year DGL would have paid about 3.2 -3.5% on the mayority of their loans?

Seems fair enough to me. Though comes under the banner of "helpful" rather than "critical" in determining likely outcomes. The valuation of biological assets could add as much variability to the P & L.

[forest]

Seems fair enough to me. Though comes under the banner of "helpful" rather than "critical" in determining likely outcomes. The valuation of biological assets could add as much variability to the P & L.

That is true, but I do see a natural limit on the downsize risk.

If the grape prices are coming down for the next season and it looks like they are coming down substantially, then one would expect the value of vineyards to go down with it.
This I see as the risk on the down side.
Counter balancing this is that some of the vineyards are not producing or only partly producing, when the yield of those non mature vineyards increases so will their value.
Also one has too remember DGL is mainly in the business of making and marketing wine, growing grapes is partly carried out by independent third party grape growers. When the price of grapes comes down so will be the input cost for DGL.

[Snoopy]

Your right that there are interest rate swaps contracts, but would it be fair to assume that all loans are in NZ$ and that in the 1H10 fin year DGL would have paid about 3.2 -3.5% on the mayority of their loans?

I don’t think a company like Delegates would have interest rate swaps AND all of their loans in NZ dollars. Generally companies indulge in hedging and interest rate swaps to gain certainty in future cashflow as regards interest payments, regardless of what the exchange rate does in the future. If all of Delegate’s borrowings were in actual New Zealand dollars, there would be no need for any fancy financial arrangements.

SNOOPY

[Snoopy]

The valuation of biological assets could add as much variability to the P & L.

Very true. However, unless Delegates are putting some of their existing vineyards up for sale, the annual variation in asset values that must be brought through to the profit and loss statement is likely to be irrelevant to the future prospects of the company.

SNOOPY

[macduffy]

Getting back to the original question, it's possible that Delegats have a set-off arrangement whereby their creditor balances, which might be substantial at certain times of the year, are "set-off" for interest purposes against their borrowings.

Or it might be just a way of expressing the difference, as a percentage, in the amount of interest paid versus the amount of interest received. Amounts to the same thing really.

[forest]

Thank you all for your contribution to this tread. I find it very informative.

With possible hedging, swaps and or other financial arrangements its gets complicated.

What I am aiming to work out is the most practical way of estimating present year finance cost. I am using DGL as an example but ofcourse there are other companies where fin cost are a significant factor and therefore it would be usefull to do this type of exercise.