The laws of physics tell us that what goes up must come down. The reverse is true in today’s interest rate climate. Rates that have stayed low — among the lowest they’ve been in U.S. history — for such an extended period of time will soon begin to climb.
“This is a topic that gets commentary daily in the news,” says Jon Park, chair and bank leader of Westfield Bank. “It’s easy to think that it’s just noise and that things will stay this way forever. But it won’t, and companies should take precautions now against the inevitable increases in interest rates.”
The impact rate increases will have on borrowing money is obvious. But your company also could be impacted in other, more unexpected ways.
Smart Business spoke with Park about what you should expect from the coming rate increases, and how you should prepare.
When will rates start to rise and how large might the increases be?
Experts have predicted stable rates for now, with increases beginning in 2015. Once the Federal Reserve begins increasing short-term interest rates, they will likely climb at least 2 percent over a period of 18 to 24 months.
Interest rates work in cycles. The current 0.17 percent short-term rate (one month LIBOR) is considerably lower than its 20 year average of 3.27 percent. When rates have been artificially held low for too long, they will go up. It’s like tension in a spring that has to release.
Are there ways a rate hike can impact businesses that they might not expect?
Increases in interest rates will reduce the profitability of businesses in general. Though new borrowing will still occur, loans will be more expensive. Some companies are able to pass on these costs as price increases, like utilities and other businesses that are equipment-intensive. Many businesses will need to prepare for the increased cost, as the rising rates squeeze the profit margin for themselves, and their clients or vendors.
Another unexpected consequence is that the market value of commercial real estate could slowly begin to decline. The formulas used to determine a property’s worth are based on the positive cash flow the property generates, and interest rates are one of the biggest components of the formula.
What should businesses do to prepare?
Ask your bank to convert variable-rate term and real estate loans into fixed-rate loans. Many businesses have been borrowing at variable rates because it has been cheaper. Converting to a fixed rate will cost more in the short term, but will protect against future interest rate increases.
Approach your bank about re-pricing your fixed rate commercial real estate loan. Normally these loans are re-priced at five-year intervals. You may have several years before hitting the re-pricing threshold. Negotiating to re-price the loan now could secure that fixed interest rate for another five years.
You can also purchase an interest rate swap that will allow you to convert from a variable-rate loan to a fixed-rate loan. Ask your banker about the cost and terms involved to swap rates.
Finally, consider extending the term and/or renewal extension options of any real estate lease. Higher interest rates will eventually translate into higher rent payments, since interest expense is one of the largest cost components for real estate investors and landlords.
Are there other ways companies should prepare themselves from an operational perspective?
Finance your expansion now. If you need to buy a new drilling machine or update your computer system, take advantage of these low interest rates prior to the expected rise.
It is a prudent time to consider your process for accounts receivable. When interest rates are low, many companies aren’t as strict about payment terms. But as interest rates rise, it will be more important to collect your cash quicker and extend your payables longer. Plan ahead and implement the right strategy now.
This is a good time to make sure you have trusted financial advisers on your side to help you prepare for the coming interest rate hikes. ●
Jon Park is chair, bank leader, at Westfield Bank. Reach him at (800) 368-8930 or [email protected].
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