The uncertainty surrounding interest rates has been one of the biggest business storylines of the last year, and the topic will not be going away anytime soon. It’s crucial for small businesses to be prepared for these changes in order to successfully plan for the future. BradyRenner CPAs sat down with Greg Baggan, Assistant Vice President and Commercial Relationship Manager at Revere Bank, to discuss some of the most frequently asked questions on this critical topic:
How will rising interest rates impact my company’s current small business loans and forms of credit, such as revolving lines, business credit cards, variable-rate SBA loans, working capital lines of credit, etc.?
When people hear about rising interest rates, they are usually talking about the Federal Reserve increasing the target Fed Funds rate (also known as the overnight rate). This is reflected directly by the Wall Street Journal Prime Rate, a rate that has been determined based on a survey of the 30 largest banks’ rates, which is one of the major indices relied upon for bank financing.
Depending on the type of debt, business owners may feel immediate effects from rising interest rates. Lines of credit are typically variable rates tied to an index – usually the Wall Street Journal Prime Rate. With each Fed Funds rate increase, the cost of lines of credit increase.
While this means more money out of you or your business’ cash flow, the tradeoff is you continue to have access to additional funds that usually only require interest payments, still a lower monthly cash flow requirement than an amortizing loan requiring principal and interest payments each month.
Should business owners consider refinancing or negotiating to lock in current rates and avoid a fixed rate increase? What are the downsides of doing that (such as prepayment penalties or refinancing fees)?
There are a few scenarios this can apply to:
1. If you desire to lock in the interest rate on your line of credit, you are likely going to have to convert to an amortizing loan, which means you will pay towards principal and interest each month. This will stop the rising interest rate risk but require higher fixed monthly payments which also requires a higher cash flow.
2. Another scenario involves existing debt with a fixed rate, but a near-term maturity or balloon. As interest rates generally continue to rise, when your loan matures, the cost of capital could be substantially more than it is now. It may be prudent to try to refinance or modify your current term debt at today’s rate, even at a fee, to eliminate that interest rate risk.
3. If you are considering a purchase in the near future that requires financing, but you want to limit your interest rate risk between now and when the purchase actually occurs, you can try to speed up the time to the purchase to lower this risk. Another option is finding a banker who has some creative ideas to help find the best way to minimize risk, for example, you could be leveraging other assets at today’s rates.
What factors can one focus on to ensure that their small business is eligible for the best and lowest rates? (For example, business credit rating, prior payment history, owner’s personal credit history and score, income-to-debt ratio, etc.)
The best steps a business owner can take, in advance of requesting some sort of credit, is having all of their financial information up-to-date and organized, preferably with input from their CPA. Some key factors that banks consider are:
• The upside potential of providing the financing (purchasing a building instead of renting from a third party or leveraging current assets so the business can pursue a new service contract, etc.).
• The current debt load of the business and its liquidity.
• The personal credit history of the owner.
Are there some silver linings for small business owners if rates go up? (For example, some economists have suggested that as rates rise, banks are more likely to make small loans because the profit on making them is healthier and therefore it should actually open up capital).
Rising rates can be beneficial to certain businesses. As banks can offer higher rates on deposits, cash-rich businesses will reap the benefits. On the lending side, some banks may have an increased appetite for small business loans due to healthier interest rate margins. However, smaller local banks are generally tuned into local small businesses even in lower rate times.
What else can business owners do to make rising interest rates work for their business? For example, should they set aside cash reserves in an interest-bearing account or in securities?
Generally, it’s always a good idea to have meaningful cash reserves. No one can predict the future, so it’s best to be prepared for unexpected cash needs. That said, now is the time to talk with your local banker to see if you can put some of those cash reserves to work for you. This could be CDs, money markets, or other products that provide a meaningful return of interest with minimal downside risk while still maintaining that liquidity for emergencies.
No matter what happens with interest rates in the coming year, it’s important to build a relationship with your banker and financial advisors to work together to come up with the best plan for you and your business.
About the Author:
Greg Baggan is a Vice President and Relationship Manager of Revere Bank. Prior to joining Revere Bank, he was a Relationship Manager at Susquehanna Bank, where he also served as a Commercial Credit Analyst. He also has experience as a Risk Analyst for Euler Hermes ACI. Mr. Baggan was named to the 2017-2018 Maryland Bankers Association “Emerging Leaders Champions” program, a statewide program recognizing the next generation of leaders in the industry. Mr. Baggan graduated from Salisbury University with a Bachelor of Science in Finance and earned a Master of Business Administration from Loyola University. He may be reached at (443) 274-1018 or via email to firstname.lastname@example.org.
Note: This article was cross-posted on the Revere Bank blog at https://www.reverebank.com/how-rising-interest-rates-will-impact-small-business-owners-in-2019/.