Rising Interest Rates: Corporate Treasury's Uncharted Waters
How Bankers can be a Valuable Resource to Corporate Treasury
Corporate finance is constantly in a state of change. For close to four decades, corporate America has ridden a wave of declining interest rates. The mantra seemed clear: borrow inexpensively, reap larger profits. Yet, as the financial winds shift towards a steady incline in interest rates, spearheaded by the Federal Reserve's battle against inflation, the corporate treasury world finds itself navigating an unfamiliar terrain. In this article, we’ll discuss eight factors bankers should be thinking about as they call on their customers in the current financial climate.
1. The Implications on Forecasting
Financial forecasting has always been an amalgamation of art and science. Historically, with interest rates being reasonably predictable in their downward trajectory, forecasting was somewhat simplified. But as rates have risen, treasurers are grappling with increased uncertainties.
Predicting future rates becomes more complex, affecting everything from expected borrowing costs to projected interest income. Additionally, with fluctuating rates, assumptions about economic growth, consumer spending, and business investments require regular recalibration. Many are hoping for a Fed pivot, but what if that doesn’t materialize any time soon?
2. Escalating Borrowing Costs
Low interest rates have historically acted as a catalyst for businesses to leverage debt for growth and expansion. But in this new era of increasing rates, borrowing has become a pricier affair.
Corporates must now re-evaluate their stance on leveraging. Companies that had grown accustomed to refinancing existing debt at lower rates might find themselves cornered, facing higher interest expenses that erode their bottom lines.
Providing more flexible loan products and structures will solidify customer partnerships and grow referrals.
3. Working Capital and Liquidity Concerns
Working capital, the lifeblood of any business operation, will also feel the pinch. With rising interest rates, the cost of carrying inventory can escalate. The same applies to accounts receivables, where extending credit to customers becomes more expensive.
For many corporates, there's an increasing need to optimize inventory levels, re-evaluate credit terms, and perhaps even look at renegotiating terms with customers to ensure quicker payments. Talking through receivables technology becomes more important and a value-add.
Liquidity management, too, becomes pivotal. Treasurers will need to strike a delicate balance between holding cash reserves (which benefit from higher interest rates) and the escalating cost of funding these reserves. Discussing the trade-offs between earnings credit, interest income, and debt retirement (perhaps through a loan sweep) will undoubtedly be a fruitful conversation.
4. Vendor/Supplier Terms
The ripple effect of increasing rates doesn't stop at a company's immediate finances. Vendors and suppliers, also grappling with the impacts of rising rates, might look to renegotiate terms. This could manifest as shorter payment terms, higher prices, or even changes in delivery schedules.
For treasurers, this implies a double-edged sword: managing internal cash flows while concurrently renegotiating external terms. Strong relationships with vendors become more critical than ever, ensuring terms that are mutually beneficial.
5. Fluctuations in Interest Income
While rising interest rates mean higher borrowing costs, they also spell higher interest income on corporate cash reserves. Treasurers must optimize this by diligently managing cash balances, making the most of interest rate hikes, and possibly seeking out more lucrative short-term investment opportunities. Reviewing the company investment policy on a regular basis with leadership can help align the company’s risk tolerance with available investment options.
6. Reimagined Risk Management
In a low-interest-rate environment, the primary concern of risk management was often centered on credit risk. However, with the tide turning, interest rate risk takes center stage.
As many of the banks have bond duration risk, so do corporates. Companies must look at diversifying their debt portfolios, both in terms of maturity and type. The use of financial derivatives, like interest rate swaps, might see a resurgence as companies seek to hedge against volatile rate movements.
7. Increased Fraud Risk
During a recession, people tend to be more financially vulnerable. With increased prices and little-to-no income, the capacity for people to rationalize fraud increases.
Historical data suggests that insurance claims, bank fraud, and other types of corporate fraud skyrocket by as much as 25% during times of economic contractions.
Companies can mitigate the risks by educating their employees to be watchful for fraud risk, reviewing policies and procedures, and adding fraud prevention tools. Bankers can play a pivotal role in leading this charge with their clients.
8. The Transition Away from LIBOR
Amidst all these challenges, companies are also managing a significant shift away from LIBOR (London Interbank Offered Rate) towards alternative reference rates like SOFR (Secured Overnight Financing Rate). This transition isn't merely a switch in benchmarks. It implies re-evaluating and possibly restructuring numerous financial contracts, from loans and bonds to derivatives.
For treasurers, this adds another layer of complexity. The intricacies of transitioning come with both financial and operational challenges, necessitating a clear understanding of the nuances of these new benchmarks.
Guiding Through the Financial Labyrinth
With these multifaceted challenges, the role of financial institutions, commercial lenders, and treasury management advisors becomes invaluable. Bankers must rise to the occasion, guiding corporates through these uncharted waters.
Education: First and foremost, corporates need clarity and understanding. By offering seminars, workshops, and literature on the implications of rising rates, bankers can position themselves as trusted advisors.
Innovative Financing Solutions: In a landscape of escalating borrowing costs, flexible financing solutions will be paramount. Be it revolving credit facilities, bespoke loan structures, or hybrid financing options, financial institutions that can offer innovative solutions and treasury expertise will stand out from competitors.
Relationship-centric Approach: In volatile times, relationships matter. Financial institutions must underscore their commitment to their clients, reinforcing their role as partners in navigating these challenges. This means personalized advice, flexible terms, and perhaps even tailored solutions that consider each client's unique situation.
In Conclusion
The era of easy money might be on the wane, but with every challenge comes an opportunity. Commercial clients demand adaptability, foresight, and robust guidance from their banking partners. Bank lenders and treasury professionals have a pivotal role to play, marking their place as trusted advisors guiding businesses through these financial changes and challenges. With the right guidance, lenders and treasury personnel can best help clients weather any storms and emerge stronger and more resilient in the future.
Does your commercial banking team need to shift to deposit-gathering topics with customers? Oida can partner with you to add value for your customers! Click ‘Connect’ below to contact us today!