The Impact of Rising Interest Rates on Borrower Cash Flow
Credit conditions in the US for both commercial and industrial firms have remained accommodative, with the banking community willing to extend funding to corporate borrowers. However, many years of “easy credit” have led to increasingly high debt levels for non-financial corporations. According to Reuters, global non-financial corporate debt has reached all-time-highs. Some have begun to fear the impact of this in the case of an economic downturn.
John Budyak, Managing Director, reveals his take on the current and future state of the C&I loan market in the US, through his experiences with clients in the private debt industry.
The overall spread between short-term and long-term interest rates has been narrowing since 2010. Between December 2017 and December 2018, the spread fell from 1.08% to 0.45%. This narrowing spread is due, in large part, to the Fed’s increase of short-term rates.
“It’s still unclear to me whether the trend in the interest rate spread will continue, but historically, a declining yield spread moving towards a negative spread often suggests that a recession is forthcoming.
“In general,” he explains, “I’m starting to hear a bit more concern about continued increases in interest rates and their ultimate effect on borrower cash flow. Adding to that concern, many express the belief that an economic slowdown is getting closer, but are just not sure when and how severe it will be. Overall, I would say our clients’ risk tolerance remains flat but has begun to decline modestly.”
A rise in interest rates can have rippling effects. According to John, “When interest rates rise, consumer disposable income declines as a higher percentage of credit payments for cars, credit cards and mortgages go to paying interest, thus reducing overall buying power. From a corporate standpoint, the rise can also mean lower profits, lower dividends and ultimately lower stock prices. Long and short term investing may be affected as investors move money to higher yield short-term and long-term bonds and other debt instruments and possibly away from the equity markets.
“During an economic slowdown, and especially in the case of a recession- which may also be compounded by higher interest rates-, there will undoubtedly be more distress in the credit markets with more loans going to non-performing or under-performing status. At Cortland, we’ve seen this scenario play out in the past. During the last recession, for instance, our Special Asset Management group (“SAM”) was involved in the management, restructuring and litigation of over $800 million in defaulted loans.
“Many of our lender and regulator clients chose to outsource their non-performing loans to seasoned asset managers within our Credit Services team for multiple reasons. In some cases, they came to realize that they lacked the necessary in-house expertise. In others, the volume of loans that became distressed was simply too large for them to manage internally.
“In the case of an economic slowdown, we expect to see much of the same that we’ve seen in the past, where our lender clients, especially relationship lenders, see their loans move to a distressed state and understand that they’re in a very compromising position of trying to collect on a defaulted loan. Third-party special asset servicers often have much more experience with efficiently moving that non-performing loan through the workout process. The outcome is often faster and more economical with less disruption to the lender client’s base. It’s important for lenders to understand that if and when the markets do take a dip, there are options available to them that will help ease the shock.”
John Budyak will be speaking on the “C&I Loans Market Review and Outlook” panel at IMN’s Bank Special Assets and Credit Officers forum in Miami on February 12th at 11:45am. If you would like to meet with John during the two-day event to discuss C&I loans or any other topic, feel free to reach out to him directly.