2017 appears to be a turn-around year for the United States economy. All of the major stock indices have hit record highs with the DOW Jones Industrial Average gaining over 3,000 points in 2017. Unemployment continues to be at record lows throughout the United States and consumer confidence is at its highest point since the summer of 2000. Corporate earnings continue to be strong, but most analysts feel that the current stock market is still somewhat undervalued as Price to Earnings ratios (P/E) continue to show signs of capacity for upward growth. Finally, inflation has stayed in check.
While this is all great news for an economy that has grown sluggishly since the Great Recession that started at the end of 2008 and ran through early 2010, there are some downside risks that all business owners should be aware of. One of those downside risks is regarding interest rates.
The interest rate environment within the United States and across the globe has been business friendly for well over 10 years. With the Great Recession, the United States government tried to spur economic growth through very favorable interest rates to allow businesses to borrow and expand with little to almost no cost of borrowing. This environment, for the most part, has been in place for nearly the last ten years. Starting in 2016, the Federal Reserve has begun to raise interest rates. While the impacts of these rate increases have been, for the most part, unnoticed, with the pace of growth in the economy it is more likely now that interest rates will begin to increase at a much greater pace. The Federal Reserve has already hinted towards a rate hike before the end of 2017 and multiple increases throughout 2018.
As a business owner, now is the time to review your debt structure and the interest rates on your business debt. Here are some suggestions to consider to mitigate short and long term interest rate risk.
- Review carrying cost of excess cash versus debt reduction – Many businesses have been able to or have taken an approach to build up excess cash over the last few years. For many reasons, this has been for purposes of stabilizing the balance sheet and providing liquidity for the business for future expansion or business needs. Many business owners used the excess cash and invested the funds into low risk performing bonds or investments that were yielding higher amounts than the interest carrying cost of debt. With the interest rate market moving upward, now is the time to assess this strategy and determine if moving this excess cash into debt reduction makes sense in order to reduce future interest cost.
- Focus on paying down variable debt – Most business lines of credit (LOCs) are variable rate in nature where the rate is tied to the prime rate plus an additional rate charge (Prime +1% as an example). As the interest rate environment continues to increase, now is the time to focus on paying down this variable rate debt in order to save the interest cost on carrying the debt.
- Consider refinancing to fixed rate loans – Currently, short and long term interest rates are still relatively low. In recent weeks, the interest rate environment has begun to climb but is still at very attractive low rates. Now may be the time to consider refinancing variable rate debt and debt with balloon and arm payments to fixed rate debt. By doing so, business owners can better manage the cost of debt by locking in a fixed rate principal and interest charge. This will help business owners to better manage cash flow in an increasing rate environment.
Now is the time to protect your business against a rising interest rate environment. By taking these steps to review your current interest rates and debt structure, business owners should be able to ensure they take advantage of current interest rates and to protect future cash flow from the rising cost of debt. Take the time to make a phone call to your banker to discuss your options and how to prepare for a rising interest rate environment.
To learn more regarding this post, please contact David B. Blain, Partner-in-Charge of the firm’s Entrepreneurial Services Group (ESG). David can be reached at email@example.com.