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Point of interest Featured

5:48am EDT March 22, 2005
Interest rates appear to be on a slow ascent, but as with most things in the financial world, you can never be too sure.

A sudden change in the economy, foreign turmoil or a host of other unforeseen circumstances could keep interest rates where they are or even send them back down. Regardless of which direction they go, have you looked at how any changes will affect your business? Is your credit all fixed-rate products? Is it all floating-rate? Some combination? What will happen to your cash flow if rates increase or decrease a percentage point over time?

"Because the future direction of interest rates is uncertain, it is risky to use solely floating-rate or solely fixed-rate loans," says Julie Sabroff, National City's senior vice president of small business banking in Cleveland.

Keeping some of your credit on fixed rates and some on floating rates can help spread your risk no matter which way rates go. A lot also depends on the type of credit facility. For example, a 20-year commercial real estate loan should probably be at a fixed rate, considering how low rates are right now. A line of credit with fluctuating balances will probably require a floating rate.

The bigger the company, the more options it has available for structuring a loan. A mid-sized company may be able to get a rate swap or rate cap in the loan. A rate swap is typically a floating-rate product that can be converted to fixed-rate under certain circumstances. A rate cap is a floating-rate product with which, if interest rates rise beyond a certain threshold, the lender is responsible for future increases.

"It's for people who want to shield themselves from future increases," says Sabroff. "It's effectively buying insurance, if you will."

Talk to your banker about specific concerns because each case is different.

"Everything will be case-specific," says Sabroff. "It depends on how you plan to use the proceeds, the type of business and where the business is in its own industry cycle. There is no one-size-fits-all approach. Interest rate risk is out there and should be understood and managed in all organizations, whether they are small- or medium-sized businesses.

"They should be going through forecasting exercises and understanding their sensitivity to rises in interest rates. What impact would it have on their business income?"

These types of scenarios are exactly what the bank will be looking at when determining your loan applications. You should know in advance exactly what kind of risks a change in interest rates will pose to your operations.

In today's competitive banking environment, you should expect your banker to get to know your business, industry and specific needs. Your banker should be able to explain all of your financing options, which ones would best meet your needs and what risks each poses. More complicated solutions might require product specialists, but you should be comfortable with whatever package you ultimately choose.

"It's about really digging in and understanding what makes their business tick," says Sabroff. "It's about understanding what risks the business faces from both a balance-sheet standpoint and the interest rate risk. It's really about knowing your customer."

But the bank can only do so much. It's ultimately up to the business owner to make sure he or she has fully considered all the possible scenarios regarding changing interest rates.

"They should have an understanding as to how interest rate risk can impact them and really be thinking about that," says Sabroff. "That sensitivity is very important."

How to reach: National City Bank, www.nationalcity.com