There is growing anticipation that the Federal Reserve (Fed) is moving closer towards the trimming of its massive bond-buying programme. The news is forcing companies such as Chinese state-owned enterprise (SOE) China Everbright International (Everbright International) to reassess how it manages interest rate risk.
As a result, the Hong Kong-listed company – that mainly develops environmental energy, water and alternative energy projects – is turning to hedging instruments particularly interest rate swaps (IRS). This is because the company has substantial holdings of US dollar-denominated debt.
“In the past we have not looked at hedging tools, but we now are considering it because with the expected tapering of the Fed’s quantitative easing measure there will be a tendency for US interest rates to increase,” said Raymond Wong, chief financial officer (CFO) of Everbright International. “If favourable, we can consider to enter into IRS to hedge not speculate.”
An IRS can exchange a fixed rate payment for a floating rate payment or vice versa. A company will typically use these instruments to limit or manage exposure to fluctuations in interest rates, or to obtain a lower interest rate than it would have been able to get without the swap.
Everbright International has a variety of dollar debt obligations. In June, the company entered into a loan agreement with International Finance Corperation (IFC), the World Bank Group member focused on private sector development, to secure a 10-year loan of US$70 million.
Also, in November last year, the Asian Development Bank (ADB) and Everbright International signed a 10-year loan of US$100 million for its development of agricultural and municipal waste-to-energy projects.
Clearly, the company is comfortable holding dollar-denominated debt and there are several reasons for this.
“Obtaining foreign currency debt in Hong Kong dollars or US dollars, we can enjoy lower interest rates and secondly, we also enjoy the appreciation of the renminbi,” said Wong. “However, we normally maintain a balance between the US dollar and renminbi because our projects are all denominated in renminbi, making it a natural hedge.”
Additionally, given that Everbright International’s relatively high exposure to the US dollar the group tries its best to mitigate foreign exchange risk by converting the currency into the renminbi, which has been on an appreciating stance compared to the dollar.
So far this year, the renminbi has gained 1.8% against the US dollar, distinguishing itself as the top-performing of Asia’s 11-most traded monetary units that Bloomberg tracks.
“The best way is to remit and inject the Hong Kong or US dollars into our project onshore by converting them into the renminbi as early as possible,” said Wong. “That way we can enjoy the appreciation in renminbi versus the US dollar.”
Ample gearing capacity
Companies involved in the environmental business are able to secure strong support from the central government, unlike China’s property sector which faces difficulty gaining access to funding. This is part of the Chinese government’s long-term commitment to a green agenda, with its leaders promising fresh air, clean water and safe food.
“Our company has not faced any problems in funding, where as mentioned we are the favoured business sector in China,” said Wong. “We enjoy government subsidies, and both commercial and policy banks are willing to offer loan facilities to our group.”
“The economic slowdown actually gives us a good opportunity to rapidly grow our business,” he added. “In the past year, we have secured a number of sizable new projects.”
For example, Everbright International’s Suzhou waste-to-energy project phase III has obtained a Rmb30 million (US$4.9 million) subsidy from the National Development and Reform Commission (NDRC).
Additionally, the group has already completed 40 out of its 70 projects, which leads to a growing amount of recurring cash flow.
For example, its earnings before interest, tax, depreciation and amortisation (Ebitda) on a recurring basis has increased 58% to HKD1.1 billion (US$140 million) in the first six months from HKD681.7 million during the same period last year.
Because of this the Everbright International has plenty of capacity to take on more debt, but it will do so cautiously. The group’s gearing level is currently at 48%, and would be comfortable taking that level up to 66%, notes Wong.
“Opportunities are always there but we are very mindful of our shareholder’s interest and we also take a very conservative view on our financing position,” he said. “Environmental protection involves the signing of concession agreements with the municipal governments for over 25-30 years. So during the operation period we enjoy a very steady cash flow and can always enjoy high gearing."