Businesses and consumers alike are aware of the current economic pressures with higher interest rates and elevated prices for many goods and services. Right now, most of our business clients are performing well, but recent uncertainty is leading to questions about the near future. What is the economic outlook for businesses? Is it all bad news? Not in our view. We see it as more of an adjustment to a new normal.
This year, we expect an economic slowdown rather than a traditional recession. This slowdown will predominantly impact two areas—employment and consumer spending. As of now, it’s expected that employment will waver, but not completely crash. Labor availability has improved but is still tight, and wage inflation continues to be a challenge. However, we’re advising clients that higher interest rates could remain for the rest of the year, making purchases and borrowing more expensive, so it is important to recognize and plan for it.
For businesses, operational costs continue to be more expensive than before the pandemic. For example, three years ago, three pieces of equipment could be purchased at 3% interest each, but now, one piece of equipment is available at 7% interest. That’s going to change the way businesses behave, and it’s going to affect the economy because it will price people out of the purchasing practices they were accustomed to. In turn, businesses will be more limited in their choices.
To best navigate the “new normal”, we advise our business clients to adhere to the following strategies:
Cash is king. Right now, there is a window where cash is worth more when paying down debt – and that won’t last. Debt is going to cost more in the future, and how business owners utilize cash right now matters. We are advising business clients in most cases that it is best to act now on debt and nail down capital structure from the debt side. Pay off debt before it is repriced, or even pay off half to keep some liquidity. This is especially important for newer business owners. For young businesses, cash is critical, so the focus should be on cash optimization and reviewing debt versus capital reserves for the future.
Consider interest rate swaps. One option to work through is an interest rate swap. When used correctly, interest rate swaps can be an extremely beneficial tool for companies managing long-term debt. Its proven effectiveness has resulted in a significant uptick in interest rate swap requests over the past year, and this is expected to continue over the next 12 to 18 months.
Essentially, an interest rate swap is a way for a company to lock in a fixed interest rate rather than have a floating rate on its loans. By locking in business loan rates for an extended period, the company reduces its exposure to fluctuations from rising interest rates. This is most effective for companies that take out long-term loans – think five, seven or 10 years – in large amounts, usually more than $3 million.
This being said, interest rate swaps are not appropriate for all situations. The first step for any business is to understand what an interest rate swap is, and then evaluate it against the company’s specific needs. This will help determine if it strategically fits within the overall financial plan, and whether it will positively affect the bottom line.
Turn to your bank partner: Communication is key. Your banking partner can help you identify and utilize the right products and strategies to adjust your business as needed to operate in this environment of high interest rates, a predicted recession, and other economic pressures. By staying in close contact with your banker, business owners can navigate these waters with expertise and increased confidence.
For businesses, there is no need to panic; I don’t think the nightmare scenario is here, but there is a “new normal” we all need to recognize. The adjustments businesses make in the short term to account for the rising costs of debt and how they utilize cash during these fluctuations are keys to success during these evolving times.
Author: Peter Blumeyer is market president of UMB Bank in St. Louis