Corporate finance executives looking to cut their debt costs this year are likely to find one popular tool isn’t as attractive as it was when the Federal Reserve was aggressively raising interest rates in 2022.
Demand for so-called cross-currency swaps rose last year after the U.S. central bank moved faster than monetary-policy makers abroad to lift rates and cool down the economy, according to investment bankers and advisers. Under a cross-currency swap, a company exchanges principal and interest payments on its debt into another currency. A key goal of the transaction is to swap into a currency with lower rates, allowing a company to reduce its interest costs.
Market dynamics, however, are shifting. The Fed, which is set to announce its next rate decision on Wednesday, has signaled that it plans to slow the pace of hikes amid signs inflation has begun to fall from four-decade highs. By contrast, central bankers in Europe have said they have more work to do to tamp down rising prices. The European Central Bank and Bank of England are scheduled on Thursday to announce their latest rate-hike decisions. The Bank of Japan in January kept short-term rates unchanged, despite pressure from investors.
Swaps can lose their appeal to companies when the gap between interest rates in two countries, or central banks, narrows. That has begun to happen, for instance, between the U.S. and the European Union. The estimated savings on a five-year swap of a U.S. bond with a 2% coupon into euros was 0.98 percentage point last month, according to Chatham Financial, a financial risk advisory firm. That is down from 1.34 percentage points in December and 1.93 percentage points in May, when the spread between the two was at its widest in 2022, according to Chatham.
Corporate advisers said they expect cross-currency swap volumes to decline in the months ahead, assuming market expectations for future rate increases hold steady. “I would expect to see, in general, less activity,” said Amol Dhargalkar, managing partner and chairman at Chatham Financial, noting that savings are declining and many companies already took advantage of the market.
Still, for companies that used cross-currency swaps in 2022, the savings reaped by keeping interest costs under control weren’t insignificant.
which owns fashion brands including Coach and Kate Spade, expects to pay between $30 million and $35 million in net interest expenses during its 2023 fiscal year as a result of cross-currency swaps executed last year. During the prior fiscal year ended July 2, the company’s interest expenses totaled $58.7 million.
Tapestry in May essentially swapped out the entire value of its $1.2 billion U.S. bond portfolio so that it could take advantage of wide differentials in rates between the U.S. and other jurisdictions, with about half going into euros and the other half into Japanese yen. Under the terms of the contracts, Tapestry makes semiannual interest payments of 2.4% and 2.7% in euros and 0.1% and minus 0.3% in Japanese yen. By comparison, the company’s most recent bond issuance in December 2021 carried a 3.05% coupon.
Tapestry considered issuing debt in Europe instead of doing a cross-currency swap, but decided against it given the company’s relatively small presence in the region and the need for a roadshow to educate investors, executives said. The company generates less than 5% of its total revenue in Europe, the company said. Tapestry has only issued debt in the U.S.
“Our name is not as well known in Europe given the relative size. So as an early entree [into the region], this makes a lot of sense,” Chief Financial and Operating Officer
said, discussing the company’s decision to move forward with a swap.
For many U.S. companies, the combination of a strong U.S. dollar and rising interest rates for much of last year created a lucrative scenario to enter into cross-currency swaps, said
global head of market strategy at Kyriba, a treasury management software provider.
Swaps can also provide finance chiefs at global companies more predictability in their cash flows by protecting them from currency volatility, Mr. Stark said. The value of the dollar last year strengthened against other currencies as a result of the Fed’s aggressive steps to tackle inflation.
Demand for cross-currency swaps, while elevated in 2022, has been robust since a hedge accounting rule was adopted in 2017 by the Financial Accounting Standards Board, bankers and advisers said. That rule made it easier for companies to use cross-currency swaps and recognize the interest savings on their financial statements.
Companies don’t need to enter into swaps at the time they issue debt, but instead can opportunistically take advantage of interest-rate differentials when it makes sense for them to do so. “That was a huge part of the volume in 2022,” said Paula Comings, managing director and co-head of foreign exchange sales at
Mirion Technologies Inc.,
a provider of radiation measurement and detection systems, said in November it expects savings of roughly $2 million a year as a result of a cross-currency swap it entered into in October. The Atlanta-based company expects to spend $42 million on net interest costs in 2022, which includes some of the savings from its recently executed swap.
Under the terms of the company’s swap, Mirion exchanged a $115.6 million loan carrying a fixed rate of 7.66%, and in return received a €115.7 million loan carrying a fixed rate of 5.83%, according to a regulatory filing. The swap expires in March 2026.
The swap is aimed in part at helping the company reduce the effects of currency volatility on the company’s results, Chief Executive
said on a Nov. 1 earnings call. “Foreign exchange continues to be a headwind,” Mr. Logan said.
Third-quarter revenue rose 12%, to just over $160 million. Its net loss held steady at about $47 million. The company declined to comment beyond its latest quarterly results.
Write to Kristin Broughton at [email protected]
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