Any interest in hedging?
Friday, 15 June 2012
The hedging argument in freight tends to revolve around container rates, but Barclays Rob Riddleston says logistics companies should hedge against interest rates too
Barclays’ economists expect the base rate to rise from the current low of 0.5% to 1.0% by the end of 2013 and to 2%, 3% and 3.5% by the end of 2014, 2015 and 2016 respectively.
But forecasts are just that, and there may be more false dawns before rates tick up, as the unquantifiable impact of the European debt storm continues to rewrite the history books.
Logistics companies have become accustomed to the low interest rate environment and while firms are increasingly hedging against exposures to foreign exchange and commodities, fewer are engaging in interest rate hedging.
It is however almost inevitable that rates will rise at some point and logistics businesses should be prepared. Some may argue that such pro-activity is a little premature given they’ve not had to worry about a change in the base rate since March 2009, but it is not uncommon to see farsighted management teams planning 3 to 5 years ahead.
You don’t have to go far back in history to see how a similar interest rate environment caught some US corporate treasurers out.
Even before the tragic events of 9/11 the Federal Reserve’s Open Market Committee had already begun to reduce the Fed Funds rate in the preceding period, from a high of 6.5% to 3.5% as the US economy began to falter. The rate continued to fall, bottoming out at 1% in 2003/04 before rising quickly in the space of just 2 years to 5.25%. This left many treasurers who had reduced their level of hedging during 2003/04, in an uncomfortable position.
The key for UK logistics companies is to learn from the US experience and to plan for potential interest rate rises. The main issue is that current fixed rates are significantly more expensive than base, which puts a lot of borrowers off doing anything to protect themselves.
We have seen a number of borrowers take advantage of capped tracker loans, which are designed to give borrowers the benefit of some of the positive features of both a floating and a fixed rate – low rates while they last with the added certainty that they will never pay more than a pre-determined cap.
Rather than a conventional uncapped 5-year loan of base + 3.5%, a borrower could choose to pay base + 4.0% with the total payable capped at 6.5%. The borrower gets same rate protection in exchange for a small increase in the loan margin.
For example, if base averages 4.0% over the period, the borrower with a conventional loan would pay an average coupon of 7.5% whilst the borrower with capped tracker loan would pay 6.5% for example, a saving of £500,000 over the life of a 5-year £10 million facility. Of course, actual savings will differ between businesses but, those which constantly evaluate risks, seek professional advice and access to solutions to combat these will be better placed to navigate the challenging economic environment.
- Rob Riddleston is Head of Transport and Logistics for Barclays Corporate and a member of the judging panel for the 2012 Global Freight Awards
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