“The simple message is: the economy is doing well,” Federal Reserve Chairman Janet Yellen said at a news conference.
The Federal Reserve recently raised the federal funds target rate to 0.75% to 1% and indicated the potential to raise rates twice more this year, depending on inflation and fiscal policies from the Trump administration. This means while mid-market organizations have enjoyed a historically low cost of capital for more than seven years, borrowing costs are about to start rising.
The near-term impacts of a 25-basis point increase are minimal, but longer-term trends have the federal funds rate surpassing 2% percent by the end of 2018. By this point, there would be noticeable increases in the cost of capital for mid-market companies, especially for those seeking to refinance maturing debt.
Greg Thomas, operations director at 375 Park Associates, said that assuming the Fed continues to enact two more 25 basis point hikes throughout 2017, costs for borrowers with AAA ratings would still be near 1% and 1.25%. Yet, he said a BBB company could be near 2% or 2.5%, equating to nearly $200,000 in extra finance costs for a $10 million loan. Thomas said rising rates are still unlikely to have a major impact on direct lending activity as more money may flow into the corporate debt market.
“In addition, a clear rate direction will help middle-market companies more accurately forecast their cost of capital for the next 12 to 18 months, allowing them to make better decisions about what they need to do with their debt portfolio,” said Thomas.
Despite the prospect for rising rates, most mid-market executives have been anticipating it for years. A recent CIT Voice of the Middle Market survey found that mid-market executives expected federal interest rates to start rising, yet they still forecasted an ample supply of capital in 2017.
Nearly 9 in 10 respondents said they were satisfied with their lender, access to financing, the variety of financing alternatives available, and their cost of financing. Forty percent of those said they were using financing to invest in technology while more than 30% said they were using it for working capital or hiring staff.
Should interest rates continue to rise, it could potentially impact the mergers and acquisitions market. Rob White, managing director at the investment banking division of M&T Bank, said cash in the hands of big companies and the evolution of private equity and other institutional capital has fueled the M&A market over the past several years. White expects strong market conditions for selling or raising capital in 2017 and said that while a small bump in interest rates could “increase the cost of capital slightly,” it’s less significant than the availability of capital.
“Assuming banks and non-bank lenders continue to provide senior debt to these transactions, we believe the strong market trends will continue,” said White.
This is only the third time the Fed has raised rates since 2006. The new rate is still low by historical standards but is expected to rise more rapidly in the coming years. The move will filter through the economy, slightly raising rates for everything from business loans to card loans and credit cards.
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