“Preaching to the choir”. In this case, the choir is me. It seems that every commercial banker I meet, tells me to advise my clients, or anyone who’ll listen, to lock in today’s low interest rates.
When I ask, “what’s the risk?”, I get a lecture that we’re in an interest rate bubble and that despite the Fed’s announcement about the Fed Funds rate, business loan rates will likely rise, especially after the election.
The bankers cite macro issues like the supply and demand for business loans or micro issues like a deterioration of company’s credit conditions as factors triggering a rise in interest rates.
When I confess that I not only believe them but share their concern, I ask “what should a company do to lock in these low rates?”.
Since most companies have floating rate business loans, the bankers’ most common recommendation is to enter into a swap arrangement to fix the rate.
The cost of the swap, especially after tax, is considered very low cost insurance relative to the risk of a rise in interest rates.
Even if a company’s floating rate debt varies over time because of seasonality or whatever, a company can still obtain a swap to fix the rate on that portion of the debt which is essentially always outstanding, that base debt portion.
A swap is not the only way, however. Some bankers recommended fixed rate term loans or even public bond issues if the financing is large enough.
One of my clients raised its first high yield bond last week so I’m doing my best to help companies to reduce interest rate risk. My banker friends would be pleased that their preaching paid off.
Dennis McCarthy specializes in helping companies to consider all the actions described above in a timely and cost efficient manner. He can be contacted here for more information.
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