Companies are locking in current low interest rates for future bond sales, hoping to benefit from cheap refinancing costs when their debt comes due, says Wsj.com.
As finance chiefs and treasurers struggle to project an outlook for the coming quarter in the wake of the coronavirus pandemic, being able to quantify the cost of borrowing in the coming years can guide them as they look at their companies’ debt-maturity schedule.
Businesses, including online marketplace eBay Inc., energy producer Dominion Energy Inc. and animal-health company Zoetis Inc. disclosed in recent weeks that they entered into such rate locks on future debt—called pre-issuance hedges—with banks and other financial institutions. While the banks earn a fee for their service, companies potentially save money if rates go up in the meantime.
The Federal Reserve slashed its benchmark interest rate to near zero in March, providing companies with the ability to raise cheap capital. The U.S. central bank announced a host of additional measures aimed at propping up company finances, including a pledge to buy corporate bonds.
Companies not only rushed to the market to sell debt, but also entered pre-issuance hedges, said Amol Dhargalkar, a managing director at Chatham Financial Corp., a financial services firm. Chatham Financial serves as an adviser to companies entering into these hedges and other derivatives.
Businesses also are locking in rates for longer periods now—for between five and 10 years—compared with previous cycles when they would often hedge only a year or two out, Mr. Dhargalkar said.
“Prudent chief financial officers and treasurers are looking at the current rates and whether they could refinance their businesses at those rates, and many are doing it,” Mr. Dhargalkar said.
Jim Chapman, the finance chief of Richmond, Va.-based Dominion Energy, in March locked in rates for about $1 billion in bond issuances planned for between now and 2027. Mr. Chapman, who refinances several billion in bonds a year, didn’t hedge the full amount of what he plans to sell in debt, but a significant proportion.
“If rates go to zero in 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 upside in securing the 1% is bigger than the potential cost,” Mr. Chapman said.
The risk of negative interest rates in the U.S. is limited. Federal Reserve officials in recent weeks have said the central bank isn’t considering cutting rates below zero, in contrast with the European Central Bank, which has held rates negative since 2014. In the U.K., senior officials are reviewing negative rates as a potential tool to support the economy.
Despite the depth of the economic decline—U.S. gross domestic product fell at a 5% annualized rate in the first quarter—rates could go back up as the economy recovers, Mr. Dhargalkar said. Fed officials lifted rates four times in 2018 before starting to reduce them in July 2019 before the beginning of the pandemic.
Parsippany, N.J.-based-Zoetis, which makes vaccines and medication for livestock and pets, said it has hedges for an anticipated issuance to refinance $1.35 billion of senior notes with a rate of 3.25%, which are set 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 with the locked-in rate, the change in fair value of these hedges can be recorded as part of other comprehensive income on the balance sheet. Once the debt issuance is completed and the hedge closed out, it may be amortized to interest expenses over the lifetime of the underlying debt.