By Corey Henriksen
Yes, there are opportunities for you as a Borrower to use your bank financing to actually make money for your business, but you must think about your bank financing differently and you must prepare now.
If it makes sense for you to borrow money in order to make a greater profit for your business, then don’t just focus on obtaining the least liability cost of your financing. Instead, refocus your thinking in order to treat your bank financing as a separate profit center that in reality makes money for your business. How? Let’s walk through the analysis.
First, does it make sense to obtain bank financing for your business?
Put simply, if you make a greater profit using bank financing than if you don’t, it is sensible to use bank financing. Why? Because even though you pay out more in expenses, you obtain a greater overall profit. So, if it is reasonable and sensible to borrow money in order to utilize assets to obtain a greater profit for your business, then you are going to be consistently borrowing money. If this is the case, then you have to take a very hard look at how you manage your bank financing. You must structure your bank financing as a separate profit center and then look for every benefit that you can obtain and monetize.
Second, how can you structure your bank financing to take advantage of a rising interest rate environment?
Interest rates have been historically low for a number of years now. This will not go on forever. Sooner or later, we will be in a rising interest rate environment. The question on every Marketer’s mind is… when will interest rates start rising, how fast and how much? Short answer: no one really knows. But it could be very soon. So, be prepared. But be prepared by structuring your bank financing to take advantage of the rising interest rate environment.
The traditional mindset is: Don’t be caught in debt when interest rates rise. However, there are ways to mitigate rising interest rates, and even take advantage of them.
One method is to lock in low fixed rates long-term on your loans with your Lender. This makes good business sense in a rising interest rate environment. As interest rates rise, you are paying the locked-in lower rate for your loan payments as compared to the higher rates that will be offered as rates rise. You are therefore making money on that differential. The higher interest rates rise, the more you would be paying if you had not locked in low fixed rates. That money instead stays in your pocket.
Okay. Structure your loans with your lender utilizing his fixed rate financing terms. Fair statement. Unfortunately, most lenders have specific guidelines on the “products” (read loans) that they can offer Borrowers. You have to fit in their box and take the fixed rate product that they present you, or not at all. Good for the lender. Not so good for you.
An alternative to accepting a lender’s fixed rate terms that makes sense in a rising interest rate environment is to enter into an interest rate swap. As always, the devil is in the details; however, the basics are pretty straightforward.
For purposes of this article, we’re going to discuss a plain vanilla swap. The Borrower enters into a variable rate loan with the Lender. The Borrower then executes a separate financial contract with the Lender (or a thirdparty) to convert all or part of his variable rate debt to fixed rate debt. Thus the Borrower in essence ends up with a fixed rate loan with the benefits described above. It is important to note that an interest rate swap is not a loan from the Lender, but rather a contract to “swap” interest rates with a swap party (here the Lender).
A swap can be terminated at any time during the loan. For example, let’s assume: (a) a 10- year loan term and 10-year swap on a piece of collateral, (b) the Borrower sells the collateral at the end of year three, and (c) that interest rates have been rising for the past three years and will continue to rise for the next seven years. Under this scenario and with a properly structured swap, the Borrower could transfer the swap to another piece of collateral (and maintain the low interest rate on the new collateral) or, terminate the swap with a small breakage fee and a cash return. Since interest rates have risen, the swap contract (with its lower interest rate) has value that will enable the Borrower to receive additional money (cash) on the termination of the swap (hence make even more money on his financing by monetizing the asset value of the swap at termination).
Why have some Marketers had bad experiences in the past with interest rate swaps? Bad guesswork and possibly bad advice. You don’t lock in interest rates for a long time with an interest rate swap if you are going to be in a declining interest rate environment. For example, if we were in Jimmy Carter days where interest rates were 18% and higher, you would not lock in interest rates for a long time because of the distinct probability that interest rates would be declining sooner rather than later. In this example, because interest rates are high and moving down over time, the swap contract is a liability, not an asset. The cost for terminating the swap contract is prohibitively expensive because of the necessity to terminate the swap contract for the previously higher rate.
If you’re going to utilize an interest rate swap at any time, the question that you would ask yourself is… are interest rates going to go any lower or are they going to go higher? If interest rates are not going to go lower, but rather go higher; then your swap contract will be an asset and you could make additional money on it. If it’s the opposite, then it’s going to cost you.
Customizing your financing for your specific needs both long-term and short-term is a necessity. Long gone are the days when you had a relationship with your banker for 20-30 years and he would take care of you. With the recent upheaval, many bankers have been laid off, or transferred to other lenders. Many banks have been purchased by other banks. Corporate policies in banks have changed drastically. Specialty Lenders providing financing to the petroleum industry have been sold off multiple times to different lenders.
Why look at your financing from the perspective of making your business money? Because Marketers make their money with thin margins—cents per gallon—you can’t afford to leave big dollars on the table because of an improper financing structure. Your financing has to be scrutinized and managed as a separate profit center. Look for every benefit that you can obtain and monetize.
Corey Henriksen is Managing Director of Acquisition and Refinance Capital, Inc., a firm founded for the sole purpose of obtaining numerous capital alternatives for wholesale and retail owners and operators in the petroleum industry. Corey is a member of NACS, SIGMA, CIOMA and WPMA and is a regular speaker on financing for petroleum retailers and wholesalers. Corey can be reached at 949.481.8500 or www.AcqRefCap.com.
