As you perform your planning and budgeting work for 2022, we encourage you to engage company leadership in a financial wellness check. To help with this process, we’re providing a discussion framework around market risks that will guide you towards a plan, bearing in mind shifting policies, currency volatility, and unpredictable commodity availability and prices.
Identifying interest rate risk is easy: Either you have debt, or you don't.
Quantifying the risk, on the other hand, is a challenge. What happens if rates rise more than forecasted or faster than anticipated?
Task 1: Consider how higher rates will impact your interest expense, especially in conjunction with rising labor and materials costs.
Task 2: Review the fixed vs. floating debt ratio and determine the need for any adjustments.
Task 3: Analyze the benefits of protecting against higher floating rates through swaps, options or hedging solutions.
Example:A $10 million floating-rate loan has been paying near-zero interest since the extraordinary Fed rate cuts of March 2020 in response to the COVID pandemic. Using current rates of 0.10% equates to annualized interest of $10,000. However, if the Fed raises rates by 25 basis points, that interest payment will jump to $35,000, a 250% increase from current levels; a 75 basis point hike would result in the interest jumping to $85,000, or 750% more than now.
Protecting a portion of your floating-rate debt through a fixed-rate swap, would neutralize interest rate risk and lock in an annualized fixed rate you can budget against, something that may become even more crucial as we move toward an unprecedented post-COVID Fed hiking cycle.
Foreign exchange: Tricky to assess exposure
While 2021 had no shortage of surprises, you should remain vigilant and prepare for currency volatility as global central banks prepare to move. CIBC’s Foreign Exchange team recommends incorporating a wellness check into your 2022 planning to make sure currency movement does not unnecessarily impact your business. A wellness check would involve a holistic review of your international business. Here are some questions to consider:
What is the risk of currency volatility and how is it generated?
Is the risk material? How do you determine when to hedge?
Are you able to forecast the risk?
Are you settling cross-border transactions in US dollars?
What are your risk management goals and how has your strategy performed?
Some companies settle in US dollars under the premise it helps them avoid foreign exchange (FX) risk, but the risk exists regardless of settlement currency.
Example:Company ABC has supplied a large client in Canada for the last decade. The Canadian business represents 22% of ABC’s total annual revenue. The trade between the two parties was settled in USD, with no FX conversions to execute. Over the last 10 years, the Canadian dollar weakened 24% against the USD, while strengthening +12% against the Australian dollar. While Company ABC had a superior product, it lost the Canadian client to a competitor in Australia who benefited from the 36% increase in competitiveness provided by the change in exchange rates. A CIBC risk analysis can identify and quantify your foreign exchange exposure, and recommend the most important steps toward creating an effective risk management strategy.
Consider the impact that record-setting commodity prices, like metals, energy and agriculture, may have on your bottom line.
Analyze how higher and more volatile input prices will impact your business.
Consider how supply-chain challenges can cause far-reaching issues for your business and your customers.
Analyze the benefits of protecting against volatile commodity prices through commodity swaps and options.
Example:A company that sells copper mugs used to make Moscow mules thinks it has no risk from record-high metal prices because the company plans to simply pass along any price increases to its retail customers. But there comes a point when a major price increase cannot simply pass along to consumers, especially when a major move happens quickly. Consumers may decide the item isn’t worth the cost or margins may become significantly compressed. Then that strategy results in a major loss of business. The company needs to quantify what can happen if copper prices continue their record run and customers are not willing to absorb the additional cost.
The goal of the exercise is to help your company’s leadership decide whether you have an effective strategy in place to address risks in the marketplace and to guide you towards options that may work better in a changing environment. Our teams can facilitate your year-end wellness check conversation and create tailored risk management strategies in line with your leadership’s objectives. To learn more, visit Commercial Banking. Or, visit Capital Markets.
If you want to talk to us about your year-end wellness check, contact CIBC’s US Mid-Market Solutions Group.
Jamie Worshtil, executive director of foreign exchange