Business Strategies in a Low-Interest Environment
The Fed has given assurances of extended low rates into 2013. Given that, how should prudent business executives respond?
Interest rates are expected to stay at historic lows on both the short and long end of the curve for the foreseeable future, prompting many executives and board members to consider the implications for their organizations. Interestingly, the most effective strategy for businesses in this low-interest-rate environment is to not let interest rates drive strategy.
The role of financing is to support the strategic initiatives of the organization, and while a low cost of capital is beneficial, it will not be an effective long-term solution to a weak business model. Therefore, management’s first priority is to re-evaluate the corporate strategy. The second priority is to analyze the financial aspects with the single goal of maximizing the financial flexibility that is unique to each entity. There are, however, certain themes that apply to every organization and are particularly relevantin this interest-rate environment.
Liquidity
A fundamental principle in finance, which proved painfully true over the past few years, is that liquidity is critical to an organization’s survival. Organizations may consider certain tactics in this regard:
• Evaluate the treasury function. An effective cash-management structure can accelerate cash flow, thereby freeing up cash trapped in the system. Redeploy this cash to either build up liquidity, pay down debt, or fund capital expenditures. Another option is discuss with your bank how deposit balances can reduce fees (for example, through an Earnings Credit Rate.) Increasing returns on cash do not always need to be centered on monies in the bank.
• Establish an investment strategy. Every organization should have an approved policy that determines a balance between maximizing liquidity and returns. The challenge in today’s interest-rate environment is investing these balances effectively. It is important to avoid the urge to chase yield. The few extra basis points are usually a function of additional duration or increased risk, which could tie up your funds for a longer period of time and reduce your financial flexibility.
• Assess working capital lines of credit. Financial officers should first confirm the lines of credit are committed and structured appropriately. Second, they should make certain they are being used efficiently, to avoid the negative arbitrage between low-interest income on idle excess cash and the interest expense associated with borrowings.
Leverage
Return on equity is enhanced with leverage. However, too much debt and the cost of that debt can be debilitating. Therefore, management should take the time now in this interest rate environment to evaluate its overall capital structure.
• Debt schedule. The first step is to determine the appropriate level of debt (here again, excess cash can be used to reduce debt and increase the returns on the cash), the type of debt (bank, equipment financing, tax exempt, private placements, bonds, etc.) and the balance of short, medium and long-term debt.
• Interest expense. With the remaining debt, executives should work to reduce interest expense either through restructuring the underlying debt or using interest-rate risk management tools such as swaps, caps, etc. to establish a mix of fixed and floating interest-rate costs. For certain organizations, this may also involve an analysis of foreign currency exposures, which by their very nature are a function of interest-rate differentials.
The goal is to find an overall debt load, a diversified debt mix, a smooth debt maturity schedule and a floating/fixed interest-rate strategy that support the corporate strategy.
Planning for Wealth Transfer
While these thoughts are relevant for any organization, family-owned businesses have unique wealth-transfer considerations. Low interest rates and depressed values create a window of opportunity for the transfer of wealth between generations. This may be accomplished through intra-family loans or loans to Grantor Trusts with minimal or no gift taxes. Further, if you believe that future income and appreciation of assets will substantially outperform the low interest rates, this significantly enhances the planning.
Ultimately, each business must decide for itself how to act in this historically low interest-rate environment. The right one for a specific organization should be devised only in consultation with financial partners and advisers. Please do not allow low interest rates to distract your organization from adhering to the corporate strategy. By determining your strategic direction and then evaluating the financial plan for maximizing liquidity and appropriately utilizing leverage, you can set the stage for your organization’s future success. 
Michael Viazzoli is President of the Bank of Kansas City.
P | 913.234.6614
E | mviazzoli@bankofkansascity.com
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