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The ABC’s of Interest Rate Hikes

May 09, 2017, 07:00 AM

Commercial finance firms like asset-based lenders may be at a crossroads as interest rates ticked up for the second time in a decade last month. While the increase of a quarter of one percent is nominal, it has sent a wake-up call through the asset-based financing community as it potentially signals the end of an era of historically low rates. While banks are usually seen as the immediate beneficiaries of higher rates, commercial finance companies can also leverage the rebounding economy through a careful examination of current and future clients.

The vast majority of business owners have grown accustomed to a low-rate environment as rates have remained artificially low since the financial crisis of 2008. As a result, some are not ready for the obstacles they may face or the changes they’ll need to make to their operations as rates are expected to gradually increase over the next few years. Asset-based lenders are in a unique position to help their clients prepare for these challenges and to continue to grow their own client base by following the ABC’s of interest rate hikes: Anticipate, Be Prepared and Communicate. Adopting this approach will prepare commercial finance firms for future rate hikes and provide concrete steps any business development officer or account manager can employ with prospects and clients.

Anticipate: First, asset-based finance executives should anticipate where they see the greatest risks and identify the clients that will need the most support to weather the interest rate storm. In the current environment, the two types of companies likely to feel the effects from interest rate hikes first are those in low-margin industries and those that are highly leveraged.

Companies in industries like commodities or food service operate under slim margins with many depending on higher volume and lower overhead to make a profit. Those that are not well capitalized and do not have the revenue history to cope with increasing costs are going to face greater difficulties as interest rates rise. At the same time, companies with high amounts of debt or carrying costs will also see an increase in overhead and any existing issues will be exacerbated by rising interest rates. Building products companies in the construction industry may be a prime example. Potential home buyers may reconsider purchases with home mortgage interest rates rising. Construction firms may see the cost of doing business rise as it becomes more expensive to hold real estate assets. In the midst of these hindrances, home builders and others serving the construction industry may find it challenging to get new business, while perhaps those focused on home improvements may be poised for growth.

Be Prepared: Second, be prepared for change and adjust business strategies to mitigate risks associated with rate hikes. It’s not enough to casually advise clients of the potential impact. Both commercial finance firms and their customers must recognize the vulnerabilities they face and take steps to strengthen their future outlook.

From the lender’s side, it’s important to evaluate existing client lists and understand which customers may see cash flow dwindle or could have difficulty making repayments or keeping vendors paid on time. This requires taking a global look at client portfolios and adjusting projections to account for more rate hikes in the coming years. Identify the types of companies that could face adversity as financing costs increase and companies are forced to cut overhead in order to prepare for potential shortfalls and stay ahead of the competition. Some clients, particularly those backed by private equity firms, may need to alter their approach and reevaluate potential acquisitions. Private equity deals could dry up if the cost of funding gets too high and using excess capital for equity becomes more of a requirement.

Communicate: Finally, create an open line of communication so clients feel comfortable alerting their financing partner to any difficulties they may face down the road. The last thing any commercial finance firm wants is a surprise because it represents a heightened risk exposure and could signal further issues in the future. A customer-centric approach distinguishes commercial finance from the impersonal solutions provided by online lenders and some traditional banks. Business development officers, sales teams and account managers have the opportunity to develop close working relationships and act as a resource that connects clients with the advice and guidance they need to manage in a changing marketplace.

Many factors drive the success or failure of a business. No one can say for sure which specific industry or company will struggle with higher rates. What is happening now isn’t like the early 1980s when interest rates skyrocketed to 20%. A quarter of a point here and there won’t move the needle much. In fact, these small increases signal that the economy is improving. But if the pace accelerates too quickly, then business owners will have to adjust their operating model, given how the market has adapted to the low interest rate environment.

Start looking for the opportunities to expand your business now, through relationships with existing customers. Currently, competition is fierce and growing from online lenders and traditional banks. However, that may change if the risks grow too great for conservative financial institutions to bear and as companies see their business challenges can be solved more easily through a personalized, customer-centric approach. Commercial finance firms can position themselves to take advantage of these developments by using the ABC’s of interest rate hikes. Anticipate the potential risks, be prepared for the changes commercial finance firms and their clients’ businesses could face, and keep communicating with current clients and prospects.

Barry Kastner
EVP, Head of Asset Based Lending | Bibby Financial Services
Barry Kastner is Executive Vice President and Head of Asset Based Lending at Bibby Financial Services with more than 40 years of experience in the commercial finance industry.
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