Taking Advantage of the Low Interest Rate Environment
Now is a good time for companies to lock in bank loans to fund M&A, stock buybacks, and capital investments.
After a few years of regulatory and economic uncertainty, multiple forces have combined to create an ideal environment for CFOs and corporate treasurers to put their capital to work. From an economic perspective, the strong economy should lead to a robust demand in the loan and bond markets. At the same time, the 2017 tax reform law created visibility for CFOs that should provide them with the ability to act with conviction on merger-and-acquisition (M&A) deals, stock buybacks, and capital investments.
Many CFOs and treasurers are looking to capitalize on the combination of the booming economy, tax reform, and historically low interest rates, either by refinancing debt or restructuring their balance sheets. However, they are aware that this opportunity won’t last forever. With headwinds on the horizon in the form of rising rates and inflationary pressures, finance decision-makers should act now.
In light of this unique market opportunity, here are some tips and factors CFOs and treasurers should keep in mind for the remainder of 2018 and beyond:
Lock in Rates
The reduced corporate tax rate and loosened regulatory environment, along with a historically low interest rate environment have made it an advantageous time for finance decision-makers. For example, some corporations are bringing large amounts of capital back from overseas subsidiaries due to changes in tax law. In addition, savvy finance decision-makers are locking in fixed interest rates before additional rate increases. TD economists are predicting the Federal Reserve will continue to move up its policy rate a quarter point once a quarter.
Consider Shorter-Term Loans
Finance executives who currently have floating-rate loans should evaluate shorter-term loans. A shorter term will save money as interest rates increase. In addition, corporations should consider moving to benchmarks that are rising at a slower pace. According to a recent article in the Wall Street Journal, companies are moving toward one-month LIBOR, as opposed to the historically utilized three-month rate. The three-month contract—which is based on the rate banks believe they will be charged to borrow over the course of that time span—has risen 79 basis points (bps), to 2.41 percent, over the past year, according to LIBOR indexes published on Bankrate.com.
Its one-month counterpart also increased, to 2.27 percent, over the same period. The gap between one-month and three-month LIBOR, which reached its peak in April, has shifted the fixed-income marketplace. As of May, more than half of junk-rated corporate loans had interest payments tied to one-month LIBOR, up from less than a quarter at the beginning of 2016, according to data tracked by Wells Fargo.
The difference between the spreads is due to uncertainty in the money markets and questions over U.S. businesses repatriating cash. Issuers have preferred to fund around the three-month level and, as a result, have pushed up the price for that note, presenting an opportunity for corporations to continue to borrow at a low rate.
Be Mindful of Inflation
As treasurers allocate capital and lay out their financial plans, they need to consider rising inflation. Inflation is up 2.7 percent over the past 12 months, according to the US Inflation Calculator, and is expected to continue to rise. Rising inflation ultimately impacts consumer-oriented companies, which at times may notice less demand for goods and services as prices rise. Most concerning is the increase in gas prices, which can limit consumers’ budgets.
Inflation can also hit organizations through rising business expenditures. Price increases for energy and other inputs can impact a company’s growth plan. Fortunately, we have seen many corporations take costs out of their business where appropriate and get more productivity out of their existing workforce. Moving forward, having an efficient employee structure will be imperative to stay ahead of inflation.
CFOs and treasurers have an opportunity to grow their businesses and improve the health of their balance sheets. Debt will not remain affordable for much longer. It’s the perfect time to evaluate your bank loans and speak with your financial partner, which can bring deep industry expertise and product capabilities that support you through every business cycle.