Post on 19-Mar-2018
DATA-DRIVEN APPROACH TO
LOW-COST FUNDING Jim Colby
May 15, 2016
© 2015 by Honeywell International Inc. All rights reserved.
1
Integration and Planning Underway
DISCUSSION TOPICS
• Desired Debt and Interest-Rate Portfolio
• Tactical and Timing Considerations
• Conclusions
• Q&A
© 2015 by Honeywell International Inc. All rights reserved.
2
Debt Influences Cash Flow, WACC and Firm Value
EQUITY VALUATION THEORY
• Cash Flow and Cost of Capital Drive Stock Valuation
Valuefirm = FCFt
(1 + WACC)t or
FCF1
(WACC - g) t =1
t=n
Valueequity = Valuefirm - Valuenet debt
FCFfirm: Free cash flow (before interest, but after taxes)
WACC: Weighted average cost of capital
g: Long-term average FCF growth rate
© 2015 by Honeywell International Inc. All rights reserved.
3
Diversifying Funding Currency Can Be Beneficial
BENEFITS OF FINANCING IN FOREIGN CURRENCIES
• Reduces Impact of Currencies on
Valuation
• Diversifies Investor Base,
Enhancing Liquidity
• Reduces Earnings Translation
Risk
• Reduces CTA Volatility
• Potentially Lower Interest Rates
($ Mil.) USD EUR in USD Total USD USD EUR in USD Total USD $ %
FCF1 1,000 1,000 1,200 2,200 1,000 1,000 1,000 2,000 (200) (9.1%)
Enterprise Value 44,898 40,816 (4,082) (9.1%)
Net Debt 6,000 - - 6,000 6,000 - - 6,000 - 0.0%
Equity Value 38,898 34,816 (4,082) (10.5%)
WACC 8% 8.0%
g 3.1% 3.1%
EUR/USD FX Rate 1.2000 1.0000
Enterprise Value 44,898 40,816 (4,082) (9.1%)
Debt - 5,000 6,000 6,000 - 5,000 5,000 5,000 (1,000) (16.7%)
Equity Value 38,898 35,816 (3,082) (7.9%)
Fictitious Example Showing Impact Of Foreign Debt On Valuation
EUR Businesses ChangeEUR Businesses
© 2015 by Honeywell International Inc. All rights reserved.
$400
$900
$900 $800
$300 $216 $51
$550 $600 $600
2016 2017 2018 2019 2020 2021 2022 2023 2027 2028 2033 2034 2035 2036 2037 2041
US CP US Bonds Eurobonds Euro CP
$750
$2.8B
Debt Portfolio Diversified by Maturity and Currency
Debt Maturity Profile At March 31, 2016
4
$3.6B
$1.1B
$2.0B
$1.4B
$1.7B
($M, Eurobonds Shown as
USD-Equivalent)
$1.1B
$850
$1.0B
Backed by Committed Credit Facilities
Of $5.5B ($4.0B 5-Yr/$1.5B 364-Day)
© 2015 by Honeywell International Inc. All rights reserved.
5
Liquidity and Interest Rate Decisions Are Separate
BIFURCATING LIQUIDITY FROM INTEREST RATE RISK
(0.50)
-
0.50
1.00
1.50
2.00
2.50
3.00
3.50
4.00
3 Months 2 Years 5 Years 10 Years 30 Years
Cost of Liquity and Interest Rate Certainty in USD
Interest Rate Spread Vs Libor
Cost of Interest
Rate Certainty
Cost of
Liquidity
Cost of Interest Rate Certainty1 'A' Bond minus Swap Rate (Last 10-year)
Tenor 3m 3Y 5Y 10Y 30Y
Current 13.0 55.0 78.8 120.1 174.6
Percentile 55% 46% 45% 46% 61%
Average 23.5 79.5 97.4 134.8 166.9
Max 500.0 364.2 376.8 424.8 489.6
Min -12.2 8.4 14.4 28.9 46.4
Cost of Liquidity1
Interest Rate
Certainty
(0.40)
(0.20)
-
0.20
0.40
0.60
0.80
1.00
1.20
1.40
1.60
3 Months 2 Years 5 Years 10 Years
Cost of Liquity and Interest Rate Certainty in EUR
Interest Rate Spread Vs Libor
Cost of
Liquidity
1 Source: Bloomberg, HSBC, Honeywell
© 2015 by Honeywell International Inc. All rights reserved.
6
Segregate By Currency And Explicitly Consider Cash
HOW DO WE CALCULATE FLOATING RATE
EXPOSURE?
• Segregate By Major Currency
- Correlations Between Interest Rates In Different Currencies Uncertain
• Net Floating Rate Exposure
- Short-Term Debt + FRNs + Fixed Debt Swapped To Floating – Floating
Rate Debt Swapped to Fixed + Current Maturities Of Long-Term Debt
• Net Debt
- Total Debt - Cash
© 2015 by Honeywell International Inc. All rights reserved.
7
Floating Rates Historically Cheaper, But Rates Are Historically Low
FLOATING RATES HAVE OUTPERFORMED HISTORICALLY
• Realized Floating Rate Performance (Grey) And Projected Floating Rate Performance
(Blue) Versus Fixed Rates (Red)
• Treasury Yields (T-Bills) From 1962 - October 1988 And Swap Rates (Libor) Thereafter
Source: Bloomberg, Mizuho
© 2015 by Honeywell International Inc. All rights reserved.
8
Forward Rates Never Incorporate Interest Rate Downturns
SWAP PERFORMANCE IN PREVIOUS HIKING CYCLES
Source: Bloomberg, Barclay’s, Honeywell
© 2015 by Honeywell International Inc. All rights reserved.
9
Trade-Off Between Interest Expense and Interest Rate Risk
TRADE-OFF BETWEEN FIXED AND FLOATING RATE RISK
Considerations
• Cash Balances
• Pension Liabilities
• Cash Flow/Earnings Cyclicality
• Savings Today Vs Costs
Tomorrow
• Credit Rating and Leverage
• Risk Tolerance
• Forecasting Ability
Source: Barclay’s, Honeywell
© 2015 by Honeywell International Inc. All rights reserved.
10
Cost of Waiting Can Be Compared to Interest Rate View
THE COST OF WAITING
10-Year Cost of Waiting 5-Year Cost of Waiting
0.0%
0.2%
0.4%
0.6%
0.8%
1.0%
1.2%
1.4%
1.6%
1.8%
5Y 4Y 3Y 2Y 1Y
Current Swap Rate Forward Swap Rate
0.0%
0.3%
0.5%
0.8%
1.0%
1.3%
1.5%
1.8%
2.0%
2.3%
2.5%
10Y 9Y 8Y 7Y 6Y 5Y 4Y 3Y 2Y 1Y
Current Swap Rate Forward Swap Rate
5-Year
Wait Period Spot Rate Fwd Rate (Breakeven) Distance to Breakeven
1-Year Wait 1.05% 1.25% 20 bps
2-Year Wait 0.95% 1.35% 40 bps
3-Year Wait 0.85% 1.45% 61 bps
4-Year Wait 0.74% 1.56% 82 bps
10-Year
Wait Period Spot Rate Fwd Rate (Breakeven) Distance to Breakeven
1-Year Wait 1.51% 1.69% 17 bps
2-Year Wait 1.44% 1.78% 34 bps
3-Year Wait 1.35% 1.88% 53 bps
4-Year Wait 1.25% 1.97% 72 bps
5-Year Wait 1.15% 2.06% 91 bps
6-Year Wait 1.05% 2.13% 108 bps
7-Year Wait 0.95% 2.19% 125 bps
8-Year Wait 0.85% 2.22% 137 bps
9-Year Wait 0.74% 2.31% 157 bps
Source: Bloomberg, Mizuho
© 2015 by Honeywell International Inc. All rights reserved.
11
Interest Rates are At Historic Lows – Where Do They Go Next?
INTEREST RATE TRENDS
Source: Bloomberg
© 2015 by Honeywell International Inc. All rights reserved.
12
Consider Breaking Yield Curve Into Components
INTEREST RATE EXPECTATIONS
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
LIBOR
Driven by expectations for Fed policy
Driven by expectations for longer term economic environment
Considerations
• Direct and Indirect China
Concerns
• Brexit Risk
• Uncertainty About Changes In
Monetary Policy Transmission
Mechanism
• U.S. Inflation
• U.S. Growth
Considerations
• Inflation Expectation
• Real Interest Rate
Expectations
• Savings Vs Investment Trends
• Foreign Interest Rates
• Short-Term Rate Expectations
© 2015 by Honeywell International Inc. All rights reserved.
13
How Fast Can Rates Increase And How High Can They Really Go?
FACTORS INFLUENCING SHORT-TERM RATE VIEW
Source: SocGen
• Direct and Indirect China Concerns and Brexit Risk Delay Fed Hike
• Election in Fall
• Low Inflation Provides Excuse to Wait
• Late in Cycle (See Below)
© 2015 by Honeywell International Inc. All rights reserved. Real Rates and Inflation Expectations at Historical Lows
LONG-TERM RATES DRIVEN BY REAL RATE AND
INFLATION EXPECTATIONS
14
© 2015 by Honeywell International Inc. All rights reserved.
15
Can Model Assumptions About Factors Influencing ST and LT Rates
YIELD CURVE SEGMENTATION APPROACH
Expected number of Fed hikes in 2016 1 UST Model Current Market Difference
Expected number of Fed hikes in 2017 2 2s 0.94 0.71 (0.23)
Peak Fed fund rate in this cycle (reached in 5y) 1.5 5s 1.48 1.20 (0.28)
Long run real Fed funds rate (10y forward 20y) 1 10s 1.67 1.76 0.08
Long run inflation expectation (PCE, 10y forward 20y) 2 30s 2.79 2.62 (0.17)
Inputs Output (%)
Source: BofA, Honeywell
© 2015 by Honeywell International Inc. All rights reserved.
16
Foreign Rates Have Had Major Influence On 10-Year UST Since 2001
REGRESSION ANALYSIS APPROACH
Regression Statistics
Multiple R 0.866035336
R Square 0.750017204
Adjusted R Square 0.735867234
Standard Error 0.005528186
Observations 57
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.016536165 0.002069372 7.990912 0.00000 0.012385531 0.020686799 0.012385531 0.020686799
1y Forward CPI Rate 0.079141112 0.053198027 1.48767 0.14276 -0.027560618 0.185842842 -0.027560618 0.185842842
3mL 0.111195956 0.060950359 1.824369 0.07374 -0.011054984 0.233446895 -0.011054984 0.233446895
GLB Bond Yield 0.606446139 0.09880552 6.137776 0.00000 0.408267363 0.804624916 0.408267363 0.804624916
Sources: GS internal as of 4-May-2016. Past performance is not indicative of future results. Backtesting analysis/simulated results are for illustrative purposes only. GS provides no assurance or guarantee that the strategy will operate or would have operated in the past in a manner consistent with the above backtesting analysis. Backtested and/or past performance figures are not a reliable indicator of future results.
• Foreign Interest Rates Biggest
Driver According to Regression
• 3M Libor Has Some Influence
• CPI Expectations Insignificant
• Model’s Projection Driven By
Bank Forecast of Foreign Rates
© 2015 by Honeywell International Inc. All rights reserved.
17
Swap Spreads Have Turned Negative – Will They Revert?
SWAP SPREADS
Recent Swap Spread Drivers
• Central Bank Selling USD Reserves To Support Local Currencies
• Fixed Debt Swapped To Floating More Offsetting Interest In Swapping To Fixed
• Regulatory Impact – Limitations On Proprietary Trading To Exploit Market Anomalies
• Reduced Derivatives Risk Premiums In Cleared Market – Should Swaps Trade As A
Credit Spread Above Treasuries As Much As Before?
© 2015 by Honeywell International Inc. All rights reserved.
18
More Complicated Now
SWAP PRICING CONSIDERATIONS
• Roll-Out Of Regulations Globally Has Resulted In Big Pricing
Discrepancies Among Banks (CVA, FVA, LCH IM, Market Risk,
ROIC)
• Long-Term Swaps May Need to Be Collateralized And Will Be
Expensive If They Are Not
• Consider Funding Costs Of Counterparty
• May Want To Syndicate Swap
• Need To Comply With Dodd-Frank Requirements
© 2015 by Honeywell International Inc. All rights reserved.
19
Every Company’s Situation Is Unique
CONCLUSIONS
• Determine Optimal Debt And Interest-Rate Portfolio
- Currency Composition
- Debt Maturity Profile
- Cost Of Liquidity Versus Cost Of Interest Rate Certainty
- Quantify Trade-Offs Between Fixed And Floating Rate Debt
• Develop Tactical Plan To Migrate From Current Portfolio To
Desired Portfolio
- Model Assumptions (Segment Yield Curve, Regression Analysis, Fed,
Real Interest Rates, Inflation Expectations, Swap Spreads)
- Factor In Cost Of Waiting