Companies are locking in current low interest rates for future bond sales, hoping to benefit from cheap refinancing costs when their debt matures.
As CFOs and treasurers struggle to project an outlook for the quarter ahead in the wake of the coronavirus pandemic, being able to quantify the cost of borrowing in future years can guide them when they review the debt maturity schedule of their companies.
Businesses including online marketplace
and animal health society
revealed in recent weeks that they have entered into such rate locks on future debt – known as pre-issue hedges – with banks and other financial institutions. While banks collect fees for their service, businesses potentially save money if rates rise in the meantime.
The Federal Reserve lowered its key rate close to zero in March, providing companies with the opportunity to raise cheap capital. The US central bank announced a series of additional measures aimed at supporting corporate finances, including a promise to buy corporate bonds.
Companies didn’t just rush to market sell debt, but also concluded pre-issue hedges, said Amol Dhargalkar, managing director of Chatham Financial Corp., a financial services company. Chatham Financial serves as an advisor to companies entering into these hedges and other derivatives.
Companies are also locking in rates for longer periods now – between five and 10 years – compared to previous cycles when they often only covered a year or two, Mr Dhargalkar said.
“Cautious CFOs and treasurers are looking at current rates and whether they could refinance their businesses at those rates, and many are,” Dhargalkar said.
Jim Chapman, the chief financial officer of Dominion Energy, based in Richmond, Va., in March froze rates on about $1 billion of bond issues planned by 2027. Mr. Chapman, who refinances several billion in bonds a year, hasn’t been covering the full amount of what it plans to sell as debt, but a significant proportion.
“If rates go to zero over the next seven years, we will have lost money,” he said. “If rates go up, we can still raise funds at around 1%. We think the benefit of getting the 1% outweighs the potential cost,” Chapman said.
The risk of negative interest rates in the United States is limited. Federal Reserve officials have said in recent weeks that the central bank do not consider cut rates below zero, unlike the European Central Bank, which has maintained negative rates since 2014. In the UK, senior civil servants are review of negative rates as a potential tool to support the economy.
Despite the extent of the economic decline, the gross domestic product of the United States fell at an annualized rate of 5% in the first quarter, rates could rise as the economy recovers, Dhargalkar said. Fed officials raised rates four times in 2018 before start reducing them in July 2019 before the start of the pandemic.
Parsippany, New Jersey-based Zoetis, which makes vaccines and medicines for livestock and pets, said it had hedges for a planned issue to refinance $1.35 billion worth of notes. first with a rate of 3.25%, which are expected to mature in 2023, according to a regulatory filing in May. Zoetis declined to comment further on its hedging strategy.
When the new debt is sold at the blocked rate, the change in fair value of these hedges can be recognized in other comprehensive income on the balance sheet. Once the debt issuance is complete and the hedge closed, it can be amortized into interest expense over the life of the underlying debt.
EBay said it began hedging against fluctuations in expected interest payments for future bond issues in the first quarter. The company, which has recorded a notional amount of $100 million for these swaps on its books, expects to issue debt in 2022, according to a filing. The exchanges will be terminated once eBay issues the debt, it said in its filing.
EBay used similar swaps to manage its interest rate risk for bonds issued in July 2014. The swaps helped modify fixed-rate bonds so that the interest payable on those bonds effectively became variable depending on a major benchmark – the London Interbank Offered Rate – plus a spread. , the company said in its filing. EBay did not immediately respond to a request for additional comment.
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