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 firstname.lastname@example.org.