Paul Share: Interest rate hikes impact businesses large and small – Atlanta Business Chronicle
Paul Share wrote an article for the Atlanta Business Chronicle titled “Interest rate hikes impact businesses large and small.”
On June 13, the Federal Reserve raised its benchmark interest rate by 25 basis points. It was the second hike of 2018 and, for the foreseeable future, the Federal Reserve has made it clear that it is in a period of “tightening” or increasing interest rates. Two more increases are expected by the end of the year.
If you are a business leader, you’ll need to understand the ways interest rates influence your company. Interest rates impact every business directly or indirectly. Specifically, when interest rates are on the rise, consumer income decreases, the cost of variable debt increases and greater caution tends to slow business expansion.
Let’s take a look at each of these factors.
For consumers with variable-rate debts, increased interest rates mean they will pay more interest each month to lenders. Households with fixed-rate mortgages won’t feel the impact directly, but those looking for a new mortgage will.
When interest rates rise, home prices typically decrease. However, that translates to less affordability due to higher interest payments and, ultimately, reduced demand (if homeowners can’t trade up and get the house they want, they tend to stay in their current home longer). This can lead to the next housing downturn — but such an outcome can’t be known until after the bust takes place. Home builders and others in the construction industry will feel this impact directly.
Additionally, increasing interest rates have a negative effect on consumer spending habits. When they pay more interest each month to lenders — or more for fuel, with gas pricing rising as well — consumers have less disposable income to spend on products and services. Thus, they may be less likely to go out to out to the movies or a restaurant, or to splurge on larger finance-based purchases like a home or a car.
That impact is felt across the consumer and business spectrum.
Businesses Servicing Debt or Obtaining New Loans
As a turnaround and restructuring expert, I advise businesses working with debt that leverage cuts both ways. Although debt is crucial to help businesses expand, it also can be the water that they can never get out of the boat and eventually causes it to sink. Awareness is critical, because increases in interest rates can overburden even healthy businesses.
Unless a business has a fixed-rate loan, monthly debt payments will increase with rising interest rates. In addition, higher rates make it more expensive to take out new loans to pay for unexpected expenses or to buy new equipment.
For example, a client of mine has a healthy company with $1.6 billion in debt and free cash flow of $80 million after debt service. Every 25 basis point increase in interest rate means the company is paying an additional $4 million on its debt. With interest rate hikes in 2018 and 2019 to total 200 basis points, this client will pay $32 million of incremental interest per year— without any change to the operation of the business! This won’t put the company out of business, but it will impact the cash generated and the willingness of leadership to invest or pay dividends. Furthermore, a downturn in the economy would be incremental to the increase in the interest debt service cost.
The impact on smaller businesses will vary with their structure. If a business holds floating debt (e.g., not a fixed-rate mortgage), it will feel a similar pain from increases in interest rate impacts. The business owner will earn less and, therefore, will likely spend less.
Reduced Business Expansion and Slower Growth
Whether your business is large or small, locking in a lower interest rate when you need capital means your loan will cost you less in the long run. Having cash available through business revolvers (or untapped home equity lines of credit for individuals) creates a good “rainy day” fund for unexpected emergencies. Higher rates will slow business expansion, because economic returns will be lowered as cash is used for the increased interest costs. Many businesses will look to pull back their own spending to offset the increased cash required from higher interest rates to service their debt.
All of these factors will have reverberation effects throughout the economy.
Paul Share, CPA, CIRA, CGMA, is a managing director at Conway MacKenzie Inc., a national consulting and financial-advisory firm. Paul has 15 years of experience in restructuring and interim financial management positions. He can be reached at +1 678-596-8545 or firstname.lastname@example.org.