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Why Hedging Tools Are Smart In Today's Economic And Interest Rate Environment

Start using hedging tools to navigate your business investment especially given today's Economic Interest Rate Environment. Learn more via Fresh Insights.

In an effort to jumpstart economic growth, the Federal Reserve has kept the benchmark Federal Funds Rates at or near zero for going on eight years now. After a quarter-point increase in the rate late last year, the Fed has hesitated to make any further rate hikes so far in 2016 as the economy continues to grow slowly.
Fed watching has almost become a sport as pundits try to guess when the nation’s central bank will raise rates again. While no one knows for sure when this will be, one thing is fairly certain: Higher interest rates aren’t a matter of if, but when.

Upside Interest Rate Risk

 This is important for businesses with floating-rate debt to understand, says Cadence Bank Executive Vice President Barry Kelly. “There’s a lot of upside risk for interest rates to go up substantially,” he says. “And when rates spike, they can rise fast and by a lot.”
For example, during the last Fed rate hike cycle, interest rates rose 425 basis points between April of 2004 and June of 2006. “Middle-market companies with $20 million or more in floating rate debt are making a big bet on rates staying low,” says Derek Beitzel, a principal with B&F Capital Markets.
According to Beitzel, the best way to protect your business from rising rates is to use interest rate hedging products such as caps, swaps and collars. “With these, you can take some of your interest rate risk off the table,” he says.
Kelly says business owners sometimes think that using hedging products is “speculating,” but the opposite is actually true. “Interest rates can only go in one direction right now, and that’s up,” he says. “Swapping helps reduce the risk of rising rates by converting floating rate debt to a fixed rate that’s very low by historical standards.”
“There’s a balance involved in hedging strategies,” Beitzel adds. “We usually don’t recommend that companies hedge all of their debt, just some of it. Not hedging any floating-rate debt is essentially 100 percent interest rate speculation.”

Cash Flow and Credit

 There are cash flow and credit considerations involved in hedging decisions. “If rates go up and your debt isn’t hedged, this is going to increase your costs and thus decrease your cash flow,” says Kelly. “That’s one reason why lenders often like to see businesses hedge at least a portion of their floating-rate debt.”
Hedging products are especially attractive right now due to the flat yield curve. Beitzel explains why: “The one-month LIBOR rate is currently around 50 basis points while the five-year rate is just over one percent. Therefore, the difference between floating rates and a fixed swap rate is the lowest it has been since 2007.”
Beitzel says this is an unusual development in the current economic environment. “In the past, we’ve typically seen a flat yield curve when the economy was slowing down or headed into recession. Even though current economic growth isn’t where we’d like to see it, few economists are predicting a recession. So right now businesses can buy hedging products at a low premium.”
For more cash flow advice, read: Seven Ways to Strengthen Cash Flow.
Given the current interest rate and economic environment, now is the time to talk to your bank about hedging tools like caps, swaps and collars. Cadence Bank offers hedging tools that can help you reduce interest rate risk, which can boost cash flow and improve your credit standing. To learn more, please contact a Cadence Bank Treasury Management specialist today.

This article is provided as a free service to you and is for general informational purposes only. Cadence Bank makes no representations or warranties as to the accuracy, completeness or timeliness of the content in the article. The article is not intended to provide legal, accounting or tax advice and should not be relied upon for such purposes.

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