A precarious situation Featured

7:00pm EDT January 29, 2008

Companies in industries that have highly leveraged balance sheets should renegotiate interest rates now if they have

not already done so, according to Will Thatcher, vice president and affiliate head of business banking for Fifth Third Bank.

“Your bank should always be willing to review your companies’ financial position, and reviewing interest rates in a reducing rate environment is part of that,” Thatcher says. In times of volatile interest rates, there are several opportunities for both borrowers and depositors to improve their financial situations.

Smart Business spoke with Thatcher about interest rates and what companies can do to combat them in today’s market.

Are banks really happy to renegotiate rates?

Banks are trying to manage the fact that interest rates are moving around. I would always tell people to meet with their banker to take advantage of the situation. The same thing holds true if interest rates are headed up. We know higher rates make it more costly to run a business. In fact, the more capital intensive your business is, the more important it is to meet with your lender — no matter which way rates are going.

Which way are rates going?

There is definite downward pressure on interest rates. There is discussion that at the next Federal Reserve meeting the Federal Funds Rate may fall as much as 50 basis points. The yield curve continues to be inverted. That is, the cost of borrowing money for the short term is greater than that of long term. This will place some stress on companies and individuals that rely on returns on liquid investments for income as banks and other financial institutions reduce the amount of interest paid out. Contrary, the individuals and companies that have large amounts of debt to repay may be able to review their strategies for financing indebtedness and lower their overhead costs.

So, these are strange times?

Everyone who has been in the banking industry for a while agrees we’re in a situation that we’ve not seen for a long time. My advice, if you are looking to borrow money, is to utilize a fixed rate, for the environment is at historical low levels. Do not attempt to time the market for its lowest trough, for interest rates can turn quickly. Rather, make certain that your ROI analysis works for the level of debt and productivity you expect for the asset to be purchased. Also, talk to your banker about performing an interest rate buy-down. Most likely a fee will be incurred to break an existing contract, but the interest rate received may be lower.

What about my other business accounts?

As rates move around, your earnings credit rate (ECR) will adjust. ECR is the interest-like payment banks give customers in lieu of interest. As interest rates fall, the ECR falls, too. So, revisit your depository relationship. Decide which features you need since, in effect, a lower ECR costs you more for each transaction, whether online banking, check writing or ACH activity. When rates go back up, add back the ‘nice to have’ services since you will get a higher ECR. They effectively become free add-ons. It’s like frequent flier miles — use them or lose them.

What about deposits?

If you are a depositor, you may not want to tie your money up long term. Therefore, meet with your banker to review other investment alternatives inside the organization, i.e. brokerage, insurance, commercial paper, other than certificates of deposits.

Is rate volatility good for real estate?

As rates go down, it is quite favorable for real estate. Interest is the most significant cost for most borrowers. A $2 million property will cash flow better at 6 percent than at 7 or 8 percent. If you are selling, look for a price premium, since the cost of the property to the buyer is effectively lower. Since you are likely to find more people interested in buying, it might be a good time to take your gains and move on. If you are building a large building or buying large, expensive equipment, your bank can lock in your rate a year in advance using interest rate hedges or derivatives to manage risk. That way you won’t run into a difficult situation a year from now if rates rise before the building is completed. This is also a good time to look at leasing equipment. The tax advantages inherent in an operating lease are still present, while the overall monthly payment will fall as well.

How long will the topsy-turvy situation last?

I don’t know that we have a pulse on it, but there is certainly a bias towards further rate reductions. A common mistake by business owners is that they try to ride the variable rates down as far as possible and then lock into a fixed rate agreement. My recommendation — don’t be greedy. Pick a target with your banker. When rates creep to that number, lock in your rate. If you fear rates are rising, lock them in fast. Talk to your vendors, too. Low interest rates may have lowered their costs as well. It may be time to revisit the cost of items you buy. But remember, playing interest rates will make you less money than what you do for a living. Manage your interest rate to a target. You may lose if you wait for the lowest rate.

WILL THATCHER is vice president and affiliate head of business banking for Fifth Third Bank’s Cincinnati and Kentucky markets. Reach him at Will.Thatcher@53.com.