Interest rate hedging is used by companies to mitigate risk, but if performed wrongly, it can cost millions. Recent example of this was seen when the Federal Home Loan Mortgage Corp (OTCBB:FMCC) witnessed a huge decline in net income as well as profit due to interest rate hedge.
Insights On The Matter:
Total amount that was at stake when FMCC exercised the interest rate hedge was $3.4 billion. One wrong step and the entire amount was lost. Not only did it affect FMCC’s financial results for the quarter, but also wiped out a major chunk of its profit. The loss has significantly affected the equity capital of the company. According to reports, FMCC is now left with only $1.8 billion equity capital. The major risk, which has come up after this unexpected loss and reduction in the equity capital is enhanced probability of future losses. There are high chances that FMCC may suffer loss in the coming months as well, and if it happens, then the money of taxpayers is not safe at all.
Because of the interest rate hedging, the net income of the company came down to $227 million in 4Q2014 which was $2.1 billion in 3Q2014, close to 90% down.
Why The Interest Rate Hedging Proved Wrong For FMCC:
FMCC used to hedge the derivatives against the rising interest rate. In 4Q2014, it had to suffer a loss of $3.4 billion on the derivatives. The interest rates of 10-year Treasury Bills were 2.4% on October 1, 2014, which remained only 2.17% on December 31, 2014. Since then, the interest rates have continuously been dropping. The market experts claim that unless the interest rates rise, it is almost next to impossible for the company to recover from the current position. FMCC will have to wait for the right time to get out of this situation.