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With a potential recession on the horizon, we know you want resources to help your business master the moment. We've put together our Agility & Excellence Resource Center to bring you strategies and solutions with a finger on the pulse of what's ahead.
As the first quarter of 2023 comes to a close, it's becoming increasingly evident that the cost of doing business is rising. The ever-increasing difficulty of obtaining funds to expand operations or survive has become a critical component of an organization's financial capabilities, especially as a recession looms. Major banks have responded to this by tightening their credit standards, resulting in tighter liquidity in the marketplace. To add to the challenge, interest rates are rising, and regulatory standards are changing.
In this article, we'll explore three things CFOs need to know to navigate the challenging financial landscape and keep their organizations afloat amidst the changing tides.
Explore Alternative Lending Options
In times of economic downturn, it's not uncommon for banks to tighten their credit standards, leading to a more rigorous lending process. Banks often request more information from borrowers, and some key ratios used to evaluate loans may shift in favor of the bank. For example, a company that may have received a loan-to-value ratio of 75% pre-recession may now only receive a 70% or 65% ratio, leading to reduced borrowing capacity. This can be especially problematic for interest-only loans, where the value of the loan may not have increased, and a new appraisal sets the maximum borrowing amount.
Additionally, debt service coverage ratios may increase, leading to further challenges if interest rates have increased and are affecting the overall debt service. As such, it's crucial for borrowers to be prepared for a more stringent lending process and to fully evaluate their options before moving forward with any new loans.
If a CFO finds that their organization doesn't meet the credit standards of its bank, it's time to consider other lending options. With the lending landscape in a state of flux, the key is to start the process early and determine whether anything has changed regarding the organization's eligibility for financing from its existing bank. If it becomes clear that they no longer meet the bank's criteria, it's important to explore alternative options beyond traditional lenders. For example, a CFO may consider approaching an asset-based lender or factoring for their accounts receivable instead of seeking a revolver for working capital. Alternatively, they may consider non-bank lenders for real estate and other hard assets.
It's worth noting that finding an alternative lender can be a challenging process, especially if the organization is used to working with a traditional bank. CFOs should be prepared to put in some legwork and research to identify lenders that fit their organization's unique needs well. It may also be helpful for organizations to turn to professional finance experts with extensive knowledge and reputable contacts within the marketplace. These experts can help CFOs explore financing opportunities that make sense for their unique situation, considering their risk tolerance, liquidity needs, and overall financial capabilities.
Take Advantage of Interest Rate Swaps (or Not?)
If financing is secured through a traditional bank, there are still challenges that must be navigated. In this current financial landscape, it's clear that the interest rate environment is on the rise. While it's likely that we will continue to see rate increases in the near future, the possibility of a recession could ultimately lead to a reversal in this trend. For CFOs, this creates a critical decision point when considering long-term financing options: should you pursue an interest rate swap or not?
While the appeal of a fixed-rate loan is understandable — providing a level of stability and predictability — it's important to recognize that there is a cost to locking in that rate. By doing so, borrowing costs are inevitably higher, which can significantly impact overall financial performance. Additionally, there is the risk that a fixed-rate option could cost more in the long run if interest rates fall.
When considering an interest rate swap, CFOs must assess their risk appetite to make an informed decision. If they believe rates will continue to rise, then locking into a fixed-rate swap might be the more conservative choice. Conversely, if they anticipate that rate increases will be temporary, a more flexible approach might be more appealing. Ultimately, the decision requires a certain level of trust in one's own instincts, and CFOs need to weigh the potential rewards and risks accordingly.
On the one hand, playing it safe may offer peace of mind, but on the other hand, more aggressive tactics could lead to more significant savings if the market behaves as expected. As with any financial decision, it's crucial for CFOs to thoroughly analyze the economics of an interest rate swap, including the potential costs and benefits, before moving forward. Ultimately, this careful evaluation will help them make the most informed decision and implement the right strategy for their organization.
Prepare for the LIBOR to SOFR Switch
As June 30, 2023, inches closer, the deadline for one of the most significant transitions in market history approaches with it. After this date, the FCA has announced that the USD LIBOR will cease to be available as a benchmark interest rate.
It is important to note that the deadline for the transition away from LIBOR does not mean that all financial contracts based on LIBOR will cease to exist or become invalid. Instead, financial contracts that currently reference LIBOR will need to be amended or replaced with alternative benchmark rates, such as SOFR, which have been identified as the successor rates to LIBOR. Therefore, CFOs and other financial leaders must plan for the transition from LIBOR before the deadline to ensure a smooth transition and avoid any potential legal or financial risks.
To prepare for the switch, CFOs should also:
- Review financial instruments to identify those which need to be transitioned
- Evaluate the impact of the transition on their company's risk management strategy
- Assess accounting and financial reporting practices to ensure they are capable of handling the new benchmark
- Update legal and contractual agreements
At CBIZ, our business consulting team is dedicated to delivering multidisciplinary, agile financial advisory solutions that effectively respond to the intricate and diverse needs of your business today while simultaneously pursuing new opportunities that drive future growth. Contact us today.
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