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Preparing for Rising Interest Rates

Businesses Should Consider Pitfalls and Opportunities in New Environment

It may be hard to fathom, but there are legions of business people today that have no knowledge or experience with rising interest rates.

“That may be the most concerning thing about a rising rate environment,” said David B. Smith, chief investment officer in Rockland Trust’s Investment Management Group. “There are a lot of people out there who have no appreciation for the risks of rising rates.”

“We’ve never seen an era like this, so if that’s all you know it could be problematic,” Smith added.

FedReserveFederal Reserve headquarters in Washington, D.C.

The expected increase in interest rates will probably not have a huge immediate impact on business. But experts warn this will likely be the first of several moves by the Fed to keep the economy clicking and inflation in check. Therefore, it will indeed be vital that businesses consider the pitfalls and opportunities that this new environment will bring.

“Companies watch the cycles in interest rates just like consumers watch for sales in stores,” said Victoria Duff, an investment manager and business writer.

But businesses haven’t really had to pay much attention because interest rates have been at fire-sale levels for nearly a decade.

“Many businesses got comfortable taking on debt because money has been so cheap,” said Gerard Nadeau, Rockland Trust’s executive vice president and head of commercial lending. “So it may be time to check in and think about if that’s going to be the right strategy going forward.”

2000px-US-FederalReserveSystem-Seal.svgA checklist for businesses pondering the new world of rising interest rates reads like this, according to experts:

  • Evaluate your balance sheet for how much debt you’re carrying and how much in financing costs can be tolerated. Companies with fluctuating rate loans could suddenly find it more difficult to repay them. Higher loan payments by businesses could lead to a reduction in profitability, which can make securing future funding more difficult. Without those loans, businesses may have to divert resources away from innovation and reinvestment.
  • Convert all or some flexible rate loans to fixed rate, depending on how much you think interest rates will rise. “If you think interest rates are going up a little, you may convert only some loans to fixed rates,” said Nadeau. “If you think rates are headed up a lot, you may want to move all debt to fixed rate.” He notes, however, that an increase in just a quarter of a percent, which is expected, will nearly double the one-month LIBOR rate which has already been trending up for about a year.  Said Smith, “There are ways to hedge by moving variable loans to fixed rates, by entering into interest rate swap agreements.”
  • Look at all other aspects of your business that could be affected by rate swings.  It’s not just financing costs that are impacted by fluctuating interest rates. “Commercial mortgage rates will rise, obviously, but plant and office rentals could as well if the landlord’s mortgage costs go up,” said Nadeau. “Leases on equipment and autos are traditionally tied to interest rates so those expenses could change.”
  • Audit your company’s cash flow history and your customer spending habits. Companies with limited cash flow could find additional funds needed to repay loans suddenly scarce. As a result, they may have to delay paying receivables, or put off investment and expansion plans, which can further slow growth. A change in customer spending habits triggered by rising interest rates may also reduce cash flow. When consumers have to pay higher interest on personal loans, including mortgages and auto loans, they have less disposable income to buy goods and services. In addition, higher interest rates make it more attractive for both consumers and businesses to save excess cash rather than spend it.
  • Consider how a stronger U.S. dollar will impact your business. The value of the U.S. dollar rises as interest rates rise, so global companies must contend with the negative trade aspects of a strong dollar. “It’s not just selling internationally, but competing internationally, as most companies do today,” Nadeau said. “So those companies might want to talk to their banks about foreign currency exchanges and ways to protect themselves against the impact of a rising U.S. dollar.”

All aspects of business must now be looked at in the context of a changing rate environment, Nadeau added. “And what’s really incredible is, this hasn’t been a part of business conversation or consideration for years.”

Big business has had years of opportunity to borrow freely in the bond markets, locking in long-term, low-cost financing that should have, under normal conditions, led to job creation, investment and expansion binges.

But these have not been normal times. Many of the Fed’s recent actions, or inactions, were in response to a financial crisis, and what was supposed to have been temporary emergency measures became the new normal. Whether the Fed even achieved its desired results is debatable.

“The economy doesn’t require emergency treatment anymore,” Federal Reserve Bank of Atlanta President Dennis Lockhart said in a recent address.

He considers a rate increase a “vote of confidence” that should encourage consumers and businesses to spend, hire, and invest.

“The economy is growing at a solid pace in spite of ongoing headwinds coming from global conditions and the strong dollar,” Lockhart said in remarks before the Broward Workshop in Fort Lauderdale, Florida. “I think a moderate pace of growth should be sustainable.”

16014261694_e1838cff29_oJanet Yellen, Federal Reserve Chair

Fed Chairwoman Janet L. Yellen told U.S. lawmakers earlier this month that an increase was a “live option” given that the economy is “doing well.”

But it still won’t come without some anxiety, experts say.

Smith and many other experts believe commercial development is the first sector to be impacted by rising rates.

“Single family housing developers will retract,” Smith said. “If you’re borrowing money for construction it will have an effect. Mortgage rates will go up and you might be disproportionally impacted if you’re highly leveraged.”

Others think fears that rising rates could diminish growth, halt expansion and increase costs are overblown.

A report by UOB Kay Hian Holdings, a global investment firm, said that since financing costs normally account for less than 10 percent of total development costs, there would be minimal negative effects. Concerns that home buyer demand will drop as interest rates rise are also exaggerated, the report said.

Most business executives and consultants join the large chorus of those who believe there’s more good than bad in a rising rate environment. The Fed, after all, boosts rates when it feels the economy is robust, which overall is the best news for businesses.

But there are naysayers – and some credible ones. Economist Paul Krugman thinks the Fed is making a mistake by raising rates, but wearily concedes it may be time.

“The fact that hiking rates is even halfway defensible is a sign that the U.S. economy isn’t doing too badly,” Krugman wrote last week in The Economist.

But, he adds, the Fed could be wrong.

“A rate hike could end the run of good economic news,” he said. “And this would be much more serious than a modest uptick in inflation, because it’s not at all clear what the Fed could do to fix its mistake.”

This content was produced by Boston Globe Media's Studio/B in collaboration with the advertiser. The news and editorial departments of The Boston Globe had no role in its production or display.