What to do in the current interest environment

As of the 7th of June, the Reserve Bank of Australia (RBA) has increased the cash rate by 50 basis points, bringing the current cash rate to 0.85%. This marks the second rate rise in as many months breaking the rate rise drought with the last target cash rate increase back in May 2010. What will happen next?

The consensus amongst institutional economists is that the RBA target cash rate will rise several times over the next 12 months.  Whilst the view of economists varies, the ASX publishes 30-day Interbank Cash Rate Futures which is an indicator of market expectations of a change in the official cash rate. As at market close on 7 June, the implied cash rate in September 2022 is 1.98% and March 2023 is 3.58%, the full schedule can be seen here.  

The Target Cash Rate set by the RBA is a way of implementing Monetary Policy which is used to influence the economy at a macro level. Unfortunately, for business and consumer borrowers now that the outlook for interest rates is rising there are not may levers to pull at this point in time to avoid the consequences. In these times however, it is important to understand all of your options as a business owner and consider the range of hedging tools on offer by many banks and lenders.

It is not doom and gloom

It is worthwhile putting the current interest rate environment in perspective, Australia is coming off a record low cash rate of 0.10 percent.  By comparison, in 1990 it was 17.50%, which is still over 13% higher than the interest rate expectations for the end of 2023.  

Whilst we are unlikely to see a repeat of the Monetary Policy setting of 1990, the forecast rate rises for 2023/24 may still cause some pain for borrowers.  This is because the level of borrowing is likely to be far higher in businesses today than it was back in the 90’s due to the low interest rate assessment levels used to determine serviceability by banks. 

So how will the anticipated rate rises directly impact your business?

  • Interest repayments on loans are likely to increase;
  • Borrowing capacity may decrease as lending guidelines tighten with greater debt servicing requirements;
  • Discretionary income in the economy will likely shrink as purchasing power decreases with inflation and interest rates rise, decreasing the flow of cash in the Australian economy; and
  • The flip side of higher interest rates are that investors and retirees are likely to get a better return on their cash deposits.

Understanding how rising interest rates will impact the way you do business is crucial in the current times.

Rising Interest rate toolkit

There are a few initial questions you need to ask yourself as interest rates rise: 

Questions

Purpose

Have I been talking to my bank manager and Bank Treasury specialist?

Talking to your bank manager can give a business owner a better understanding of their exposure to rate rises. It also gives the bank the opportunity to present in-bank options to mitigate these risks.

How leveraged is my business? Am I still able to make repayments with rising interest rates?

Looking at your ability to make repayments when the interest rate is 2% above current levels may provide the business with confidence or insights into your level of interest rate sensitivity.

Is asset realisation an option?

There is a weak negative correlation between rising interest rates and declining real asset values. If you find yourself in a position of repayment sensitivity, it may be time to consider realising the value of assets.

Is my business dependent on discretionary spending volumes?

There is a negative correlation between increasing interest rates and declining discretionary spending. If your business is dependent on discretionary spending it may be time to consider how to futureproof your business through diversification.

Do I have adequate working capital to navigate uncertain times?

With interest payments increasing it may put stress on the working capital within the business. If this is likely to be the case a working capital review may be necessary.

 In consideration of the framed questions above there are a number of traditional interest risk mitigation strategies which can provide a level of protection against rising interest rates including:

  • Swaps;
  • Fixed rate loans;
  • Caps and collars; and
  • A combination of any of the above with variable rates.

There are positives and negatives to each of the facilities mentioned, where it all comes down to your risk appetite. Understanding your business and its requirements to continue trading profitably is the most important step. In recent years we have seen a raft of specialist facilities arise, these can be considered in conjunction with traditional banking facilities to focus on areas of concern within your business.

How we can help

Mazars has extensive experience in debt advisory having advised on the placement of over $350 million in commercial lending in the last 2 years. There is particular expertise within the debt advisory team in Agri-business, property and active small to medium enterprises. Our financial advisory experts take a business first approach to all debt advisory engagements, understanding your business needs and ultimately providing structured solutions to futureproof your business.  

If you require assistance or want to know more, please contact your usual Mazars advisor or alternatively our financial advisory experts via the form below or on:

Brisbane - Angela Winton & Owen Dingle

Melbourne - Brad Purvis

Sydney - Zenaida Bilar

+61 7 3218 3900

+61 3 9252 0800

+61 2 9922 1166

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Published: 08/07/2022

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References:

https://tradingeconomics.com/australia/interest-rate#:~:text=Interest%20Rate%20in%20Australia%20averaged,percent%20in%20November%20of%202020.

https://www.rba.gov.au/media-releases/2022/mr-22-12.html

https://www.ampcapital.com/au/en/insights-hub/articles/2022/may/the-rba-starts-raising-rates-how-far-and-how-fast-and-what-does-it-mean-for-investors#:~:text=The%20RBA%20has%20hiked%20the,signalling%20more%20rate%20hikes%20ahead.&text=We%20expect%20the%20cash%20rate,made%20rate%20hikes%20more%20potent.