Insight & Analysis

No excuse for losing interest

Published: Feb 2024

Interest rates are expected to fall this year, but that doesn’t diminish the importance of having a complete view of company exposures.

Person changing an upward arrow to a downward arrow in interest rates

Chatham Financial’s State of Financial Risk Management Report provides an insight into how US public companies rate interest rate hedging in terms of its importance.

Despite 88% of the companies surveyed for the report having some sort of exposure to rates in the form of floating rate debt, potential future issuance of debt, or interest-bearing assets on the balance sheet, fewer than half (42%) were hedging that risk.

Exposure to interest rates rose year-over-year across all revenue bands, with the smallest companies least likely to have a hedging strategy in place.

Varian Medical Systems is a radiation oncology hardware and software manufacturer based in California. The company employs 11,000 people across 70 locations worldwide and had revenues of €911m for Q1 2024 (fiscal year).

John Plecque, Head of Treasury at Varian Medical Systems believes US rates will only be cut by between 50 and 75 basis points this year due to the underlying strength of the US economy. “Consumer confidence has continued to improve, driven by the recent strong performance of the equity markets,” he explains. “Therefore, from the Fed’s perspective there may appear to be fewer downside risks that could develop as a result of keeping rates higher for longer.”

Plecque also believes treasurers have become more focused on the benefits of hedging interest rates. “The velocity and magnitude of the Fed’s rate actions caught some treasurers by surprise,” he says. “As a result, companies with higher debt profiles required more immediate actions to mitigate their interest rate risk. That risk appears to have been modestly reduced given the expectation that lower rates should come throughout 2024.”

When asked which instruments are being used to hedge interest rate risk, Plecque mentioned the more common use of treasury locks – a hedging tool that effectively secures the current day’s interest rates on government securities – and interest rate swaps. “Options and other instruments are usually less widely used,” he adds.

This view is in line with the findings of the Chatham Financial report, which found that 84% of companies with an interest rate hedging strategy were using swaps exclusively, while a further 6% were using a combination of swaps and options.

The past two years have been a case study on how interest rates have a very real and direct impact on corporate businesses and even those corporations without debt can be impacted due to interest rate differentials causing foreign currency volatility.

“Interest rates affect so much more than simply interest expenses,” says Juan Enrique Arreola, Senior Manager Risk Advisory at GTreasury. “They fundamentally change the flow of capital throughout the multinational landscape. High performing, strategic treasurers are thinking holistically about their debt lifecycle management and interest rate hedges are a key tool to optimising their cost of capital.”

Interest rate hedging can be multi-faceted and go beyond use of financial instruments. Smart management of liabilities can include preparing strategic, proactive responses to the debt maturity wall, rating agencies and debt investors engagements, while also reviewing debt management frameworks, interest rate derivatives policies and derivatives counterparty panels.

Matthew Weller, Global Head of Research at Forex.com reckons corporations are integrating interest rate hedging into their broader financial planning and capital structure decisions, which helps align hedging activities with corporate financial goals and investment plans.

“Increased knowledge and sophistication in understanding the nuances of interest rate movements and their implications is evident in the strategic application of hedging instruments, where decisions are based on a comprehensive analysis of the company’s interest rate exposure, balance sheet structure and the macroeconomic environment,” he says.

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