As we navigate another wave of the pandemic and brace ourselves for the impacts of the COVID-19 delta variant on businesses, clients may be searching for ways to hedge risks associated with supply chain challenges. Indeed, CIBC has seen disruptions across our client base that have started to impact earnings and affect companies’ ability to meet credit or loan obligations.
Fortunately, when we can work through these challenges together in real time, we have a better chance of lowering your risk profile so you can return to focusing on business operations. One way to do this is through education and commodities hedging. Keith Rofrano, who leads CIBC’s Capital Markets’ Mid-Market Solutions Group Opens in a new window. in Chicago says, “It always starts with education. The goal of any hedge is to reduce uncertainty. And in the case of commodities, there isn’t a tradable market for each one. So, what we look for in those situations is a way to tie your volatility to some correlated market and give you that offset you need.”
One of our clients — a manufacturer of grain silos for the agricultural industry — demonstrates some very common challenges, as well as how partnering with CIBC can provide solutions. The company has to arrange its manufacturing well ahead of time; however, cost fluctuations move quicker than their ability to reprice. After some analysis, we determined that their cost is highly correlated to hot-rolled steel, which has increased by 300% over the past 12 months. After establishing that, we worked to quantify the risk associated to their net margins under several market scenarios and offered ways to hedge, making the company able to withstand excessive further volatility.
Most manufacturers look to balance the costs they can pass through with costs that can be pulled forward by buying inventory early. In the last 18 months, however, we have observed clients front-loading their inventory out of fear they won’t be able to get it a year from now, or because they don’t want the price to run away from them. As Keith notes, “In their minds, they are hedging by pre-buying. But while they may have the right intentions, the client is now using capital and potentially paying an interest expense. It’s an inefficient hedge, because they’re paying for their inventory with credit. So, it’s not that clients aren’t looking for ways to hedge, it’s that they sometimes need to be educated on the most efficient ways to hedge.”
In addition to reducing risk, hedging can also help some clients lock in gains or get ahead in other ways. For example, my Commercial Banking colleague, Katie Ehrhart, has a marine transportation company client who does a lot of fuel hedging. “Last year, when prices were down quite a bit, they were able to lock in some advantageous terms,” Katie says.
Elsewhere, the construction industry is experiencing supply disruption challenges from a few angles. This industry alone contributed $684 billion to the U.S. economy in the first quarter of 2021 Opens in a new window., up $10 billion from the end of 2020 as COVID-19 vaccinations were just starting to become available.
Builders need all kinds of base commodities, including metals and lumber — not to mention the fuel needed by heavy trucks and other equipment used on a site. And with an average 60% hike across all commodities prices over the last year or so, construction companies saw their operating costs skyrocket.
While some of those costs can be passed along to the developer, landlord or tenant, the threat of rising interest rates means consumers will eventually be more cautious about how they buy. They will borrow less, because their debt payments will go up, and that will reverberate quickly back into the chain.
For CIBC, the discussion doesn’t necessarily end with commodities. Raw materials that cannot be hedged or tied to a tradeable market are often part of the conversation, as well. One of our clients — a manufacturer of plastic parts for the auto industry — illustrates pain points experienced by all kinds of businesses right now. The company has a long-term contract with a major automaker, which allows price adjustments once a year in January to balance fluctuations in the cost of resin. The tight supply of raw materials due to the pandemic elicited a tremendous increase in costs for this client, which they are unable to pass along for several months, resulting in a 30% cut in profits. While hedging is not an option for resin, there were other tools we were able to offer to help the client through the challenge. Our US Mid-Market Solutions Group was able to bring a wealth of insight to the client, including market updates and pricing guidance. With more data and a better understanding of the situation, clients can more effectively forecast, plan and take action.
In many cases, clients are coming to CIBC in response to a pain point that exists primarily in 2 categories:
- There’s a kink in the supply chain, and they need access to credit in order to prepay for inventory.
- Their costs are escalating, and they’re looking for a hedge.
The increased supply chain and commodity risk may also exacerbate other risks such as interest rate risk and foreign exchange risk. Consider the following questions:
- Do you need to buy additional inventory and use your credit line to pay for it? That’s interest rate risk.
- Are your suppliers overseas? That’s foreign exchange risk.
- Do you have commodity exposure in your supply chain? That’s commodity price risk.
For our clients experiencing issues from the supply disruptions, we’re here to help. As a trusted partner to your business, we take initiative in digging deep into your financials to help find the root cause.
This information-gathering process is important for us. Once we have a clearer picture and understand a client’s exposure, we can offer solutions.
The above examples and countless others — whether they were challenges or opportunities for our clients — all have one thing in common: early and open communication with bankers. In a best-case scenario, companies contact CIBC as soon as possible to say, “Here’s what we’re seeing.” Being an early consultant to help tackle the problem — especially when a solid relationship is already in place — maximizes our ability to propose solutions.
If you’d like to learn more about our banking relationships or how to manage your own commodity, interest rate or foreign exchange risks, please feel free to reach me at 216-456-2982 Opens your phone app. or at Robert.Walker@cibc.com Opens your email app..
