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Apollo Global Management has taken a haircut on profits thanks to derivative trades it entered to hedge interest rate risk as the Federal Reserve looks set to start lowering rates in the months ahead.
The firm entered a large number of interest rate swaps starting in March, at a time when the US central bank signalled confidence in its view that inflation was cooling and that it would lower its benchmark interest rate this year. But the Fed has been slower to act than previously expected; though the market now expects up to three quarter-point cuts this year, with the first in September, rates have remained locked in place at a 23-year high for more than a year.
Apollo has been paying out on the swaps at a cost of up to $230mn per year, but they have yet to generate anything in return. The firm acknowledged in its second-quarter earnings announcement on Thursday that the hedging costs are weighing on current and future earnings.
“The disagreement over the direction of interest rates towards the beginning of the quarter provided us opportunities to do additional hedging, which we did,” Marc Rowan, Apollo’s chief executive, said in a call with analysts on Thursday. The decision “cost us growth for the quarter and will cost us growth for [the third quarter],” he added.
The move by Apollo signals how uncertainty over US rate policy this year has surprised even some of the world’s most sophisticated financiers.
Fed chair Jay Powell said earlier this week that interest rate cuts were “on the table” when policymakers meet in September.
Apollo’s hedges were put on to manage its interest rate risk within a company it owns called Athene, an insurer that sells annuities and other financial products for retirement planning. Athene is one of Apollo’s fastest-growing businesses and a cornerstone of its profitability.
Athene holds a $45 billion portfolio of floating-rate financial instruments to generate revenue that it uses to make payments on the financial products it sells, and its returns on the portfolio fluctuate with the benchmark interest rate. As the Fed begins to lower rates, those instruments will generate lower revenue for Athene. The swaps allow Athene to receive fixed payouts on its portfolio while transferring the risk of the floating rate to its counterparties, in exchange for a fee.
Apollo’s chief financial officer Martin Kelly estimated the hedges would lop about 5 per cent off profit growth in so-called spread-related earnings, which were Apollo’s biggest profit driver last year. Still, the firm expects the contracts to eventually move in its favour as rates come down — particularly if they remain low for an extended period.
Disclosures indicate the firm is paying between $115mn and $230mn for the hedges a year, according to calculations by the Financial Times. The costs of the swaps disclosed in the first quarter also included other expenses, making it difficult to pin down an exact figure.
The firm pointed to the hedging costs as one reason for a drop in Athene’s profitability and Apollo’s flat earnings overall. Firmwide, Apollo reported adjusted net income of $1.01bn, or $1.64 a share, falling short of Wall Street expectations. Spread earnings fell 11 per cent from a year earlier to $710mn in the quarter.
