Interest During Construction (IDC) in Project Finance

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Interest During Construction (IDC): A Practical Guide Using BlueGamma’s Forward Rate Curves

In project finance, Interest During Construction (IDC) refers to the interest expense that accrues on debt during a project’s construction phase. Because most projects don’t generate revenue until they’re operational, IDC is often capitalized—added to the project’s total cost rather than paid out immediately. This capitalization approach allows projects to fund construction without the immediate cash flow strain of interest payments. IDC is particularly crucial in sectors like real estate and infrastructure, where large capital investments are needed upfront.

To calculate IDC accurately, you can use BlueGamma’s forward rate curves—including EURIBOR, SOFR, and SONIA. These forward rates provide market-aligned data that reflects current interest rate trends, allowing for precise IDC projections.
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What is Interest During Construction?

Definition: IDC is the interest cost that accrues on a project’s debt during its construction phase. Rather than paying this interest immediately, many projects choose to capitalize it, meaning that IDC is added to the project’s total cost. This approach allows for smoother cash flow management during construction, avoiding the burden of periodic interest payments until the project is operational and generating revenue.

Purpose: Capitalizing IDC enables projects to proceed with funding construction without immediate cash flow pressures. Once construction ends, the accumulated IDC is integrated into the total project cost, which can then be repaid over time as the project generates revenue.

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Calculating IDC with Forward Rates

When IDC is calculated with floating interest rates, the accrued amount varies over time based on rate fluctuations. Floating rates, such as SOFR or EURIBOR, are used widely in project finance as they reflect market conditions and often align with loan structures. To calculate IDC precisely, models must account for both the debt drawdown schedule and the forward rates over each period.

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1. Basic IDC Formula

For each period, IDC is calculated by applying the floating rate to the cumulative debt drawn:

2. Cumulative IDC

As construction progresses, IDC is calculated on the cumulative balance of debt drawn:

‍‍3. Compounding IDC (if applicable)

Many projects compound IDC, meaning the interest accrued in one period is added to the debt balance in the next period. For compounding IDC, include previously accrued IDC in the balance:

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Applying BlueGamma’s Forward Rate Curves for Floating Rate IDC

BlueGamma’s platform provides forward-looking interest rate curves, enabling accurate IDC calculations with market-aligned data. Here’s how to use these curves to model IDC effectively:

1. Download Curves: Access BlueGamma’s platform to download interest rate curves like EURIBOR, SOFR, or SONIA, selecting the maturity that aligns with your project’s debt reset frequency (e.g., 1-month or 3-month).

2. Embed Curves in Your Model: Load the downloaded curves into your Excel model to update IDC projections directly. With BlueGamma’s Excel add-in, you can also pull in real-time updates, keeping IDC calculations aligned with current rates.

3. Calculate IDC Across Construction Period: For each period, apply the forward rate from BlueGamma’s data to the cumulative debt balance, capturing IDC changes as interest rates fluctuate.

4. Stress-Test IDC with Rate Scenarios: Model base, high, and low IDC scenarios using different rates from BlueGamma’s data. A base scenario might use the current forward curve, while high and low cases apply rates adjusted by a specified margin, helping you understand potential IDC fluctuations.

Additional Steps: Adjusting Debt Balance and Resculpting Debt with Updated IDC

When IDC is capitalized, it’s added to the project’s debt balance, as there’s no cash flow during construction to pay it down. This additional debt affects the repayment structure, requiring adjustments to fit within financial constraints like Gearing ratios and Debt Service Coverage Ratios (DSCR).

1. Add IDC to Debt Balance: Each period, include the calculated IDC in the debt balance, increasing the financed amount to be repaid post-construction.

2. Resculpt Debt Structure: Adjust the repayment schedule to ensure the revised debt balance meets Gearing and DSCR targets, optimizing debt payments as needed.

3. Update with Forward Rates: As BlueGamma’s forward curves change, IDC and debt balances may adjust. Iteratively update IDC, debt amounts, and repayment schedules to keep the model responsive to current interest rate conditions.

Example IDC Calculation with Forward Rates

Suppose a project has a $50 million debt drawdown with a floating rate tied to 1-month SOFR. Using BlueGamma’s SOFR forward curve, you’d calculate IDC over multiple construction periods as follows:

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1. Period 1 IDC

• Drawndown = $50 million
• Month 1 SOFR Rate = 0.5%

2. Period 2 IDC with Compounding (if applicable)

• Cumulative Balance = $50,250,00 (initial debt + Month 1 IDC)
• Month 2 SOFR Rate = 0.55%

3. Repeat for Each Period:

Continue applying the forward rate to the cumulative balance across each period.

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Why Use BlueGamma’s Forward Curves for Floating Rate IDC?

BlueGamma’s interest rate data enhances IDC modeling by providing:

• Market-Accurate Forward Rates: Access real-time interest rates for IDC calculations, reflecting actual market conditions.

• Dynamic Scenario Analysis: Test multiple rate scenarios to anticipate IDC variations across best, worst, and expected market conditions.

• Seamless Integration with Excel: Use BlueGamma’s downloadable data or Excel add-in to pull in rates directly, simplifying updates to IDC projections.

By integrating BlueGamma’s forward rate data into your IDC calculations, your model gains precision, capturing the effects of interest rate fluctuations during construction and providing a clearer picture of project financing need