Tags:
  • cash management
  • FX derivatives
  • Hedging

US companies boost interest income with emerging market cash

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Wal-Mart, Coca-Cola and IBM are earning high interest rates by holding treasury cash in emerging markets and hedging the FX risk, a EuroFinance study shows.

by Nicholas Dunbar & Manpreet Singh

Published: 2 December 2019

As US interest rates and corporate credit spreads have declined this year, one would expect the interest income that US-based companies earn on their cash and bond holdings to decline as well. However, treasurers at some of the biggest multinationals have found a way to buck this trend.

According to a EuroFinance study of their quarterly disclosures, companies such as Wal-Mart, Coca-Cola, Qualcomm and IBM are all earning an effective interest rate on their cash of 3.3% or more. At the other end of the scale, multinationals such as Eli Lilly and Dow DuPont are earning less than 1%.

According to filings, Wal-Mart has 100% of its cash and market securities holdings in foreign subsidiaries and it is earning the highest effective interest rate at 4.4% among the top 30 S&P 500 index companies as ranked by their amount of cash holdings at the start of the year. Coca-Cola and Caterpillar had 94% and 87% of their cash and marketable securities held in foreign subsidiaries, according to filings.

The three-month LIBOR rate and 10-year US treasury yield have fallen since the start of 2019. The current rate stands at 1.9% and 1.74% respectively. Credit spreads on investment grade corporate bonds tightened by 50 basis points during the same period. While some companies such as Cisco Systems are still earning 3% or more on corporate bond portfolios accumulated in the past, others with predominantly cash investments have used more creative approaches to boost returns.

Derivative hedges

Treasury teams at US companies have learned to exploit the fact that short-term interest rates in major emerging market countries are significantly higher than US money markets. By keeping their cash offshore they can beat their peers who invested in corporate bonds.

However, keeping cash offshore involves additional risks, particularly the possibility of devaluation of local currencies against the US dollar. Similar to Johnson & Johnson, treasurers at the top-performing companies use FX derivatives as part of their interest income-boosting strategy.

For example, Wal-Mart said it had $2.2 billion of cross-currency swaps designated as net investment hedges, while Coca-Cola had $11 billion notional of “foreign currency economic hedges” on its $14.4 billion offshore cash holdings. IBM, which doesn’t disclose the amount of cash held offshore, said it uses “global treasury centres to manage the cash of its subsidiaries”. It reported holding $8.2 billion of currency swaps and forward FX contracts as an economic hedge.

As a result of such techniques, the average effective rate for the 30 companies surveyed increased to 2.28% on an annualised basis from 2.20% the previous year. The effective interest rate is calculated by dividing annualised net interest income earned by the company during the year by the cash and securities balance of the company at the start of the year. The total amount of cash and securities held by the 30 companies was $970 billion.

The use of emerging market cash strategies by treasurers comes amid a sell-off of bond portfolios. Between December 2018 and the third quarter of 2019, the median cash holdings of the 30 companies rose by $936 million while their median bond holdings fell by $1.8 billion.