Business Guidance

Hedge Against Rising Interest Rates

Several times in my career, I have been asked by a client to provide a long-term fixed-interest rate for a commercial real estate purchase or refinance. Clients have asked why they are able to obtain a 30-year fixed-rate loan on a residential home purchase, but are limited to a 5- or 7-year fixed-rate loan for commercial real estate financing. The simple answer to this is interest rate risk.

For a bank, there is risk associated with providing long-term fixed-rate financing on a loan with variable-funding costs (deposits). Consider this example, a bank provides a commercial loan with an interest rate fixed for 15 years at 6%. During the next five years, interest rates increase steadily and the bank is now offering 3-year CDs at 6.25%. If this were to occur, the bank would be paying out more in interest on a deposit than it is bringing in on a loan.

When it comes to residential mortgages, the vast majority are sold in the secondary market through Fannie Mae or Freddie Mac to investors such as insurance companies and pension funds. This allows the originating bank, such as Univest, to provide a long-term interest rate without holding the loan on the banks’ balance sheet for 30 years. Commercial loans on the other hand, are typically held by the originating bank for the duration of the loan. In a rising rate environment, as seen in the example above, a long-term fixed-rate can be problematic for the bank.

For businesses wanting a fixed-rate, an “interest rate swap” is a possible solution. In the simplest terms, an interest rate swap allows a client to essentially receive a “fixed” rate for a period of time, while the bank is receiving a variable rate over that same period. In some cases, the borrower is able to receive a 10- or even 15-year “fixed” interest rate. This option eliminates the interest rate risk for both the bank and the borrower.

Interest rate swaps can be a valuable tool for businesses to hedge their exposure to changes in interest rates and manage cash flow. This option is best suited for business that are fairly certain they will own the property for the entire duration of the swap period. This product is not ideal for a borrower interested in prepaying the loan during this time. Also, there are additional qualifications a borrower must meet to be eligible for an interest rate swap which is typically reserved for loans in excess of $3 million.

Your banking partner is best prepared to determine if this option may be right for your business. To learn more, contact a Univest Relationship Manager at 877-723-5571 to get a conversation started.

 

Univest Bank and Trust Co. is Member FDIC, Preferred SBA and Equal Opportunity Lender and Equal Housing Lender.


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