Asset and liability management: It’s a big topic with many components and moving parts. And with interest rates expected to rise, more attention is being paid to the matter. A recent NeuGroup Assistant Treasurers Group of Thirty peer group featured sponsor HSBC’s Strategic Solutions Group providing examples of what they are seeing from their client base. The meeting also featured a member who implemented an ALM program at his company which showed measurable improvements and sustained management’s support for ALM (often an insurmountable task for treasury).
During the HSBC’s presentation, members were urged to make the argument for ALM more realistic and less theoretical. HSBC suggested moving away from the business-school case for talking about ALM to developing metrics that can get people to buy in to ALM hedging. Members concurred that convincing management to consider ALM hedges is difficult. As compared to FX risk, interest rates are often thought of as less risky.
One way to get that buy-in? Start by looking at correlations. Members were given an example of how closely correlated interest rate changes were to a company’s financial results. Using regression analysis can show how strong correlations are. In the example presented, the company’s business was cyclical, and hedging worked to reduce risk due to the strong relationship between P&L and interest rates. As shown, a downward move in interest rates of 200bps resulted in a $93 million loss if left unhedged. Also, swapping a portion of your fixed debt to floating can help mitigate unexpected interest rate movements and improve the stability in a company’s earnings.
Generally speaking, the ALM process has different answers for different companies. Banks don’t agree on how to approach ALM so one member company took the initiative and started its process by first looking into the future for items such as financial needs. The member explained that the company segregated cash into buckets to determine what to do with it. The ultimate decision was to focus on the core side of business, which included close to $25 billion in cash and debt. They dabbled with both Monte Carlo and efficient-frontier analysis in their approach.
One difficult hurdle for this company meant establishing a working ALM model and measuring results. The company’s new process that followed their ALM project included quarterly governance meetings that generated “a lot of discussion.” In measuring its treasury’s achievement the member points to the ALM framework developed that facilitated decisions on both sides of the balance sheet. It allowed the company to be more prescriptive on the amount of cash given out to investors – whether it be dividends or buyback. The company also moved from 10 percent floating to 50 percent floating gross debt, reaching one of their initial goals.
Treasury will continue to be challenged to make ALM more palatable for executive management; however, adding structure and accountability to the process will increase the confidence in the value of an ALM hedge program. Now may be the time to take a more aggressive stance with management on ALM hedging given the likelihood of rising market interest rates later this year.