The company, a commercial electrical contractor, purchases copper wire, aluminum wire and electrical contacts that are primarily composed of silver. In mid-2016, the company engaged their Fifth Third Bank relationship manager to discuss commodity hedging. Fifth Third had recently executed a commodity hedge with another client in the region, and the relationship manager thought a financial hedge might serve as an appropriate risk management tool for fluctuations in metals prices.
The relationship manager referred the customer for an introductory call with Fifth Third’s Capital Markets team who worked to understand their customer base, how they purchase and pain points in their business. The company builds residential apartment buildings and student housing that are typically 24-36 months in duration. Therefore, they are exposed to fluctuating metal prices from the inception of the bid until the completion of the project. To protect against rising prices they build in a price cushion on all of their bids. However, this only offered a minimal level of protection and still left them exposed to a sudden, sharp spike that increased prices above their cushion level.
Copper is by far their largest line item, so they wanted to focus on hedging that product first. Fifth Third proposed the idea of a zero-premium collar, with a cap strike set at their contracted bid level. If prices went above the rate they factored into their bid, the financial hedge would kick in and reimburse them for any additional costs they incurred. Because of the long term nature of their projects, they entered into a 36 month copper collar, for 60% of their annual volume. Since this was their first hedge they wanted to start small and understand the mechanics of financial hedging to make sure it fit in their business. Now that they have experience with the product, they’ve since executed a 24-month zero-premium silver collar and they are working an order for an aluminum hedge.
The Fifth Third Bank team took the time to fully understand the customer’s risks and educate them on the different financial hedging solutions that would help, ultimately leading to an effective approach to capping costs.