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Capital Markets

SocGen: You Have Less Floating-Rate Debt Than You Think

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September 11, 2019

BankingOne big eye-opener for many attendees at NeuGroup’s Tech20 2019 first-half meeting was sponsor Societe Generale’s suggestion that their floating-rate debt capacity was higher than they (most likely) currently thought it was—provided they hedge their FX, that is.

Why? Because, according to this view, the FX hedge program reduces one’s net floating-debt exposure. In addition, if you agree that a recession is coming, rates will be staying put or going lower, making floating debt even cheaper.

It pays to favor floating-rate exposure to interest rates now. Treasurers often fight against the bias that locking in fixed-rate exposure to interest rates is best. In fact, most studies show that relying on floating-rate debt is cheaper. Backtesting by SocGen showed that since 1990, a 10-year floating strategy was cheaper 100% of the time, with average savings of around 3% vs. a fixed-rate strategy.

Now it may be even better. In the US, for instance, an anticipated rising rate environment was suddenly paused by the Fed, and monetary policy indicators increasingly suggest that not only are we unlikely to see interest rates normalize any time soon, but they may well be headed down again. When the yield curve flattens or inverts, moreover, as it has, the timing to increase floating-rate exposure to ride interest rates lower cannot be better.

Include FX hedging program in offsets. Disciplined asset-liability management seeks to offset floating-rate liability exposure with floating-rate assets. Depending on a firm’s risk profile and appetite, the offsets can match completely, or the floating-rate assets can be seen as a means to increase floating-rate liability further. This is where Societe Generale’s insight caught our members’ attention, namely that the FX hedging programs—factoring the cost of hedging long cash-flow and balance-sheet exposures—for many US firms represent a floating-rate liability offset.

How it works: Decreasing USD rates increase cost of hedging. Seen from the perspective of FX swap points that comprise the forward rates of foreign exchange, a US firm paying very low EUR rates and receiving higher USD rates (that could be trending lower) represents an offset to floating-rate debt exposure. The reduction in carry gain (e.g., on EUR) or increase in carry cost (on MXN, for example), from a 100bps decrease in USD rates increases the ALM capacity for floating-rate debt exposure.

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