One topic that aroused curiosity at PDI events last year was talk of borrowers not being sufficiently hedged against interest rate rises – and finding their costs increasing substantially as a result.
The backdrop to this of course was the long period of low – including ultra-low and even negative – interest rates, which kicked in following the global financial crisis in 2008. If ever there was a period in history when borrowers might be forgiven for complacency around interest rate rises, this was arguably it.
But the notion that a “new normal” had settled – in this case that interest rates of more than a couple of percent were consigned to the past – was fanciful at best. When inflation started to spike in 2022, and higher interest rates became the weapon of choice in countering that trend, it was clear that the so-called era of easy money was over.
So how did this affect borrowers who had taken out loans in the good times, only to run headlong into the bad times? It depended on who you’d borrowed from, according to Jackie Bowie, managing partner and head of EMEA at Chatham Financial, a global financial advisory services and technology solutions firm.
She says large global sponsor borrowers tended to have interest rate hedging policies in place throughout the very low interest rate period – especially where the loans had been committed by “traditional” lenders, including banks, with conservative approaches. These lenders often made hedging mandatory as a condition of the loan – typically to cover around two-thirds of exposure – particularly for larger deals.
However, Bowie tells us that “some of them still got a little caught out because they hadn’t hedged enough. It’s not that they were completely unhedged, but they were maybe under-hedged, both as a percentage of their notional debt outstanding and also when it came to the term.”
Some borrowers may only have hedged for two or three years, perhaps thinking the higher-rate environment was likely to be a brief phenomenon, only to find themselves trapped in a higher-for-longer scenario.
One example of this more relaxed attitude was demonstrated by the so-called “springing hedge”, a provision that meant borrowers didn’t have to take out a hedge in order to get the loan, unless interest rates rose to a predetermined threshold, whereupon the hedge would be triggered.
The problem with this was that hedges are based on the forward curve of interest rates, not their current level. As a result, Bowie recalls borrowers coming to Chatham Financial with a totally unrealistic impression of the rate they would be able to hedge at. A costly mistake, it could be argued.
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