COVID-19 impacts on future debt issuances
- June 25, 2020
Corporates | Kennett Square, PA
SummaryDriven by the COVID-19 pandemic, U.S. Treasury rates reached all-time lows. Treasurers can take advantage by swapping floating rate debt to fixed and hedging future debt issuances out as far as two years.
- Treasurers can take advantage of today's low-rate environment by swapping floating rate debt to fixed and hedging future debt issuances out as far as two years.
- Companies elect to hedge future issuances for two primary reasons: low prevailing rates and affordable pricing.
- To benefit from this low-rate environment, you must navigate many nuances of hedging future issuances, including product selection, pricing, and accounting treatment.
Markets began 2020 on an incredibly volatile note, driven most recently by increasing concern over a possible global pandemic of COVID-19. While equity market drops grabbed the headlines, treasury professionals closely watched as U.S. Treasury yields plummeted to all-time lows at the 10- and 30-year tenor, dipping to 0.499% and 0.885%, respectively (as of March 9, mid-day). On the 10-year yield, rates have now fallen 113 basis points since February 12 as a result of global growth concerns and elevated potential for the Federal Reserve to cut short-term rates leading to a lower long-term target rate. While volatility has reduced some capital markets activity, firms continue to see attractive long-term rates in the bond market. Treasury teams can take advantage of this even lower-rate environment by swapping floating rate debt to fixed and hedging future debt issuances out as far as two years.
Navigating product selection
If you wish to benefit from this low-rate environment, you must navigate many nuances of hedging future issuances, including product selection, pricing, and accounting treatment. Specifically, you must decide between treasury-based hedges and swap-based hedges. Treasury-based hedges, such as treasury locks, may better align with your firm’s specific issuance risk, particularly for investment-grade companies. Swap-based hedges however, such as forward-starting swaps, offer far more flexibility should anticipated issuance dates become delayed. Additionally, while short-dated (under three-to-six months) hedge pricing may favor treasury locks, hedging longer term with treasury locks may cost significantly more than using forward-starting swaps due to market structure.
If you wish to benefit from this low-rate environment, you must navigate many nuances of hedging future issuances, including product selection, pricing, and accounting treatment.
Applying accounting treatment
Accounting treatment on pre-issuance hedges can also pose challenges. If applied correctly, gains and losses on these hedges can be amortized over the life of the hedged debt, allowing for smoother earnings. Unfortunately, qualifying for this type of hedge accounting treatment can be challenging depending upon your level of certainty over timing, tenor, and quantum of debt issuance. In the worst case, improper structuring of the hedge may lead to a missed forecast under hedge accounting — bringing your firm closer to becoming ineligible to apply this treatment at all.
Locking in lower rates
Despite these challenges, companies elect to hedge future issuances for two primary reasons: low prevailing rates and affordable pricing. For example, today’s 10-year treasury is 0.499%, and a firm can lock in a 3-month forward rate on the 10-year treasury at 0.481%, representing a 1.8 basis point drop in the yield. While during traditional periods, where the yield curve is upward sloping, you would normally see a positive spread between today’s rate and the forward rate, the inverted yield curve enables you to lock in a lower rate today for a future issuance. In fact, the forward premium to hedge future issuances is at or near all-time lows across a broad spectrum of maturities. As shown in the chart below, in the last few years this premium has been as high as 10-12 basis points, though it is negative in the current environment.
The bottom line
Current markets present unique opportunities to lock in low rates on future financings. As quickly as rates have fallen, they may rise just as quickly with the development of a COVID-19 vaccine and measures implemented to slow and stop the spread of the virus. Chatham is ready to help you think through the implications of the current market conditions on your future financings.
Chatham Financial corporate treasury advisory
Chatham Financial partners with corporate treasury teams to develop and execute financial risk management strategies that align with your organization’s objectives. Our full range of services includes risk management strategy development, risk quantification, exposure management (interest rate, currency and commodity), outsourced execution, technology solutions, and hedge accounting. We work with treasury teams to develop, evaluate and enhance their risk management programs and to articulate the costs and benefits of strategic decisions.
Ready to talk about your hedging strategy?
Complete the form below to speak with an advisor about your financial risk management strategy.
Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.
Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.20-0052
Our featured insights
Recent economic data fuels hope for recovery
Despite uncertainty caused by rising COVID cases and the possibility of new global variants, strong March nonfarm payroll numbers and continued vaccine progress have increased investor confidence, raising hopes there is light at the end of the tunnel.
Tumultuous first quarter culminates with a wave of buoyant optimism
After enduring Q1 volatility, including the GameStop frenzy and a severe spike in energy prices during the Texas freeze, the quarter wrapped up on a high note with the freeing of the Ever Given, the S&P 500 ending over 4,000, and blockbuster manufacturing PMI and March jobs reports.
The top 5 benefits of ChathamDirect’s approach to support and client success
ChathamDirect’s unique approach to client support enhances the solutions our clients depend on and ensures you enjoy consistently satisfying experiences whenever you engage with us.
Managing interest rate risk on future debt issuances
The ongoing upward trend in U.S. Treasury yields has many corporates concerned about interest rate risk on future debt issuances. To successfully hedge this risk, it is important to understand best practices concerning hedge structure and pricing.
Signs of economic expansion emerge while Powell holds steady
Jobless claims and supply chains show signs of economic expansion while Powell holds steady.
Markets react to inflation projections as the Fed maintains course on interest rates
March Madness is in full swing in the financial markets, with brackets already busted as investors reacted last week to growing concerns of inflation risk while the Fed announced rates are likely to remain at current levels through 2023.
Interest rates continue rising amidst positive inflation data and COVID-19 stimulus
The House of Representatives approved the Senate-passed $1.9 trillion COVID-19 relief bill on Wednesday, with President Biden officially signing it into law on Thursday afternoon. The bill will bring relief to hard-hit industries, extend unemployment benefits (which otherwise would have expired...
Rates and reserves increase
Optimism around vaccine rollouts continues alongside improved job market numbers. Inflation continues to put moderate upward pressure on rates, trends around dollar weakening and commodities strengthening continue, and officials advance the transition away from LIBOR.