Hedging during the pandemic: a must-have conversation
Even though rates are low, there’s value in seeing how much potential risk there is to long-term rates.
Abby Farrell has a mantra for CIBC commercial banking clients in this low interest-rate environment: find your balance by talking to your banker.
As Executive Director and Head of Rates and Commodities Distribution, Farrell helps clients with a host of structured products to suit their financing needs. But she also sounds like a mindfulness guru for companies seeking balance between locking in a competitive advantage and managing risk.
Hedging has been a hot topic for CIBC clients over the last year, Farrell said.
“The conversations I’ve had with companies over the past 12 months have changed really drastically,” said Farrell.
When the pandemic hit the U.S. in full force in March 2020 and the Federal Reserve cut interest rates to zero, “all of a sudden most CFOs and companies that would be looking at hedging saw a lot of value in the lower rate environment and locked in hedges at that point in time,” she said.
Then came a roughly 9 month period of “complacency” as companies dealt with operating their businesses in a new pandemic normal and the sense that rates would be staying at zero in the near term.
But since January, the narrative in the market has changed and the trend is looking at rates moving higher, “so now we’re very much seeing larger, more sophisticated companies coming back in and layering on hedges. Even though rates are still low and expect to remain low for another 2 years or whatever it might be, our clients see that value and they see how much potential risk there is to long-term rates.”
Indeed, CIBC’s economics team has noted that, “inflationary pressures are poised to heat up as the post-vaccine surge in demand accelerates the recovery, closing the output gap faster than the Fed is currently estimating.”
“A lot of companies are finding it’s a good time to lock in,” said Meg Fisher, Managing Director and St. Louis Market Head for CIBC US Commercial Banking.
Fisher and Farrell worked with a client on a hedging strategy shortly after the company made an acquisition, adding significantly to their debt burden and placing them out of their comfort zone.
“They like the ability to have predictability in their cash flow,” Farrell said. “Because they don’t like to carry a lot of debt, they’re thinking, ‘What if a year from now, we want to pay down debt faster?”
Farrell helped create a 5-year swap with a twist: in a year, they have the right to reduce the size of the hedge by about 20 percent. “They have this ability to partially cancel the debt, and where it works for them is that we’re meeting their specific needs, but we’re actually doing it with a product that right now is relatively cheap.”
Layering hedges is a great way to counteract the feeling that you’re betting, or taking on more risk than you’re comfortable with, Farrell said, where you’re putting hedges in place every 12 months or reviewing the strategy that often.
“It’s been a very active topic for quite a while with rates this low,” added John Falb, Managing Director and Upper Midwest Region Head, CIBC U.S. Commercial Banking. “There’s been a good constant dialogue with companies over this last year and it’s still happening.”
While the strategy isn’t for everyone — many of CIBC’s clients plan for a longer view of 3 to 5 years — the discussion is important because, “there are a lot of ways to get to an optimal place to be,” Farrell said.
“You should feel like you’re bringing some certainty to your business, so you can go and focus on all the other drivers that actually make your business special and drive revenue for your company.”
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