Mention derivatives, hedging, LIBOR
(London Interbank Bank Offered
Rate), and similar finance and investment terms to business owners looking for
capital market services and the reaction is
understandable: What are they and how can
they help me manage my business? That is
because business owners are more familiar
with conventional loan and investment management products and services offered by
banks.
Now, banks are offering business owners
seeking comprehensive capital market services a wider variety of alternative products
that offer significant benefits. Granted, there
is a learning curve associated with them, but
that education is a part of the process.
Smart Business spoke with Todd Rifkin
of MB Financial Capital Markets to learn
more about the innovative financial and
investment products being offered to business owners and how they can benefit
from them.
Why would companies become involved in
hedging strategies?
These are financial products that help companies when they are seeking fixed-rate
loans to finance their typical operations, such
as purchasing inventory or building a new
plant. Often, commercial loans are subject to
floating rates, but borrowers frequently prefer fixed-rate loans to avoid being impacted
by swings in interest rates. In such cases,
banks might create opportunities for synthetic fixed rates through derivatives or hedges.
What about investment alternatives?
When a company has excess liquidity,
even for a relatively short period, it should
maximize the return on those funds. This is
especially true for corporations that have a
large tax burden. Tax-exempt investments
may help a client outperform comparable
interest-bearing vehicles.
Are these products complex?
They are not. They are fairly typical offerings among bank-based broker-dealers of
varying sizes nowadays. There are strategic partners with whom the banks work to make
these kinds of transactions competitive and
effortless.
When would business owners want to use
these alternative products?
The main factor to consider is a client’s goal
regarding capital requirements. Individual
companies have varying uses for specific
products, so different strategies regarding liquidity and risk tolerance apply to each of
them. Those strategies can be defined by
individual business owners with their capital
market representatives.
How do business owners learn about derivatives, hedging strategies and similar products?
Generally, they learn about them when
they discuss their capital requirements
with their bankers. It is prudent for business owners and their bankers to discuss
their ongoing financial needs for normal
long-term and working-capital operations
on a routine basis. These innovative products are generally customizable and are
likely to come up as solutions during these
discussions.
The products might be introduced when the subject of loan rates comes up. For
example, the bank typically ties the rate on
the loan to the prime rate or LIBOR, and the
business owners want to mitigate their exposure to rising rates. Another situation would
be when a corporation has excess funds that
it can invest for a predetermined period of
time. To make the appropriate recommendation, the bank ascertains liquidity needs,
risk tolerance and tax status of its clients.
How do such products benefit business owners?
One benefit can be to help clients minimize exposure to interest-rate fluctuations.
By synthetically fixing the rate at which
they borrow, clients can focus on the operational aspect of their business. On the
investment side of the equation, banks can
offer a universe of alternatives that typically enable their clients to earn a superior
return over bank products, without sacrificing credit quality.
Both of these concepts give clients exposure to products and services that typically
have not been offered in the past by some
smaller financial institutions. Technology
has allowed smaller banks to efficiently
offer these products, which can lead to
improved financial performance for their
clients.
What criteria would a business owner apply
when choosing a bank that offers products
such as derivatives and hedging strategies?
Look for investment specialists who have
considerable expertise in this area; are willing to educate clients about their advantages and disadvantages; who have a flexible approach to their products and services; and who are able to build and maintain
relationships with clients. The bank’s capital markets representatives must have a
familiarity with the products and the market, an understanding of the clients’ businesses, and the ability to discuss the products knowledgeably with business owners
and their financial associates.
TODD RIFKIN is vice president of MB Financial Capital Markets.
Reach him at (847) 653-0311 or [email protected].
