• cross-currency swaps
  • derivatives
  • overlay strategies

Johnson & Johnson makes $15bn swap bet to boost income


Johnson & Johnson is following in the route of PayPal using derivatives to increase returns on cash and securities investments. Nicholas Dunbar and Manpreet Singh report.

by Nicholas Dunbar & Manpreet Singh

Published: 18 September 2019

US healthcare giant Johnson & Johnson used derivatives to slash its net interest expenditure by $392 million in the first half of the fiscal year 2019, which is the largest decrease since 2014. The saving amounts to four per cent of the company’s net earnings for the period.

“Net interest expense was lower by $132 million, primarily driven by the positive effect of net investment hedging arrangements and certain cross-currency swaps”,  Chris DelOrefice, VP of investor relations at Johnson and Johnson said during Q2 2019 earnings call, referring to the decline in interest costs versus the same quarter a year earlier.

Johnson & Johnson’s notional amount of hedges and derivatives in 2019 increased by 33% to an all-time high of $65.5 billion. Cross-currency swap notional alone doubled to $15.3 billion in 2019, up from just $2.3 billion at the end of 2017. At the same time, the company reduced its foreign currency debt to $5.62 billion, a decline of 10.5% from the previous year.

Johnson & Johnson sold $22.5bn of securities to fund its Actelion acquisition

Traditionally, corporate treasuries enter into cross-currency swap contracts with banks in order to hedge foreign currency debt exposures. Communications conglomerate AT&T has the largest reported position in these derivatives among S&P 500 companies at $40 billion notional, but this closely tracks the group’s foreign currency borrowings.

But Johnson & Johnson typifies a new trend where treasurers are looking at innovative methods to increase cash and securities returns during a period of low interest rates. In such cases, the derivatives no longer have a debt hedging function.

For example, Paypal, the US payments company, boosted its interest income by $45 million with an effective interest rate of 1.52 per cent at the end of 2018 by holding $10.7 billion notional of FX contracts ‘not designated as hedging instruments’. The company used FX swaps to earn dollar-denominated returns on its assets in the euro area.

However, Johnson & Johnson’s use of derivatives is bolder than PayPal’s. Even as it built up its cross-currency swap trade this year, the company reduced its cash & cash equivalents as well as marketable securities by $4.4 billion, to the lowest level since 2014. The total amount of investments at the end of June closely matched the notional of the cross-currency swaps, suggesting that some sort of overlay strategy was being used.

The decision to use the swaps may have been prompted by Johnson & Johnson’s $30 billion all-cash acquisition of Swiss pharmaceutical company Actelion in early 2017. Johnson & Johnson sold its entire $22.5 billion portfolio of government and corporate bonds to help fund the deal. Using derivatives would have compensated for the lower yield on the remaining cash.

So far the swap strategy hasn’t had a dramatic impact on returns, with an effective annualised interest rate of just 1.9% in 2019, compared to an effective interest rate of 3.1% in 2018. However, the company also reported an unrealised $313 million gain on cross-currency interest swaps in 2019 compared to $150 million in 2018. If this gain were realised in income, the effective interest rate would be 3.5%, which compares favourably to other S&P 500 companies.

According to a company filing, the unrealised gain is the effect of net investment hedges and is recognised in Accumulated Other Comprehensive Income (AOCI). In its accounts, Johnson & Johnson doesn’t provide further detail on what the $15 billion of swaps are actually hedging. A Johnson & Johnson spokesman declined to comment.