Context: Interest-rate volatility sparked by uncertainty over the economy and inflation has predictably pushed more treasury risk managers to consider pre-issuance hedging. It’s a replay of the response by NeuGroup members during the spring of 2023 as detailed in a NeuGroup Insights article that quotes a presentation by Chatham Financial: “Interest rates have been significantly volatile as inflation has remained elevated, geopolitical tensions have run high, and recession fears have grown.” Sound familiar? Corporates hedge pre-issuance interest rate risk primarily with treasury locks (usually for short-term hedges) and forward-starting swaps (used mostly for longer-term refinance risk). As explained by Chatham, a treasury lock offers a closer match to the underlying exposure, and a cash-settled forward-starting swap introduces swap spread risk but offers greater flexibility and pricing efficiency. A NeuGroup Insights article from 2020 offers more comparisons.
Member question: “Has anyone layered into treasury locks leading up to a new debt issuance to hedge their interest rate risk?”
Peer answer 1: “We did this in 2024; it was the first time we hedged a future issuance, so we had to build a process from scratch. I am happy to chat and share about the experience.”
Peer answer 2: “We have historically used forward-starting swaps vs. T-locks, so happy to talk through that perspective if it would be helpful.” In a follow-up, the peer added, “But it is not a clear-cut choice in the current environment with swap spread volatility. Ultimately, it comes down to comfort level using one instrument vs. the other.”
Peer answer 3: “Yes, we typically use Treasury locks vs. forward-starting swaps.” In a follow-up, the member said they prefer using a treasury lock because “we have found it a better match to our underlying exposure,” adding: - “Our credit spread does not always have a strong correlation with swap spreads.
- “We were burned with forward-starting swaps in the past where our credit spread moved higher at issuance while the swap spread moved tighter (we lost on the FSS more than we should have).
- “In the current volatile environment, I think there is greater risk with FSSs.”
NeuGroup Insights reached out to the questioner to learn more about the timing and context of his question about Treasury locks. Here is some of his answer: “We are considering pre-issuance hedging given the recent volatility in rates. Historically, we predominantly used swap locks (forward-starting swaps) for pre-issuance hedging given that they tend to be cheaper, pricing is more transparent, more flexible, and hedge accounting is easier (regression analysis).
- “But the recent swap spread volatility has made using swap locks increasingly untenable (we do not want to be in a position where we lose on the underlying new debt issuance and the pre-issuance hedge because swap spreads tighten more than Treasuries increase).
- “Consequently, we are exploring using Treasury locks to avoid the swap spread risk (basis risk) but need to ensure: we are getting efficient pricing on the way in and way out (forward drop based on the repo rate assumption and the roll/auction cost to get to the then-on-the-run treasury in the future); that we hedge to the correct effective/lockout date; and that the hedge accounting meets the accounting guidance standards.
- “The main challenges with Treasury locks (especially the longer time horizon) is that they tend to be expensive versus a swap lock, bank pricing is opaque and therefore the dispersion is high (~10bps from best to worst on a 10-year Treasury lock), and the hedge accounting is trickier (you have to build in the impact of the rolls and there is likely a mismatch between the coupon payments of the hedge and the future debt issuance).”
Input from peers. The member connected with two peers and shared these observations: “The time horizon for one was not long enough (did not hedge over any auctions) so it was not applicable to the situation we are contemplating, though they were able to provide useful guidance on the hedge accounting process they went through.
- “They also mentioned that they generally received the same pricing on the way in and the way out (unwind before the original effective/lockout date) but only used a small subset of their banks in the process.
- “The other company’s time horizon was more like what we are considering and, like us, they are serial hedgers. They were also able to provide helpful guidance on the hedge accounting process along with how they went about the bidding/pricing process with their banks.”
