Work Matters: Finance - interest on loans
Ian Murchie, relationships director in the Barclays Bank Healthcare Team
Tuesday, July 20, 2010
While interest rates are low, nurseries may want to consider fixed or capped rates on their borrowing. Ian Murchie, relationships director in the Barclays Bank Healthcare Team outlines the different options and their implications
For any borrowing that has been provided against variable interest rate terms, assumptions need to be made about future interest rates, for financial forecasting. If these assumptions are too optimistic, the capacity of the borrower to service its loan may come under a degree of strain.
To reduce this risk and provide more certainty on future interest costs, nursery businesses may be thinking of fixing the interest rates on their loans. Alternatively, hedging instruments such as interest rate swaps, caps, and collars can be considered as tools for managing interest rate risk.
Interest rate swap arrangements exchange interest payment obligations between two parties, without exchanging the underlying obligation to make principle repayments. For example, a nursery will pay its bank a fixed rate of interest on each payment date, while the bank will pay the corresponding floating rate of interest as at that date.
Interest rate caps provide insurance against rising interest rates, while letting the borrower to fully benefit from a fall in rates. In other words, interest costs can be managed within a certain range in return for an upfront premium. Those looking to reduce the upfront costs associated with a cap may consider entering into an interest rate collar arrangement, which provides a cap on interest rates but also includes an interest rate floor - that is, a minimum level of rates that the borrower is committed to pay. For example, if the market interest rates track above the cap rate, then the borrower will benefit from only having to pay at that capped rate. However, if market interest rates fall below the floor rate the borrower is required to still pay its bank at that floor level.
Before entering into any form of interest rate protection, you should be fully aware of the potential costs/benefits of that particular product. For example, borrowers in a swap arrangement may face market gains or losses if they exit it early.
- Next month sees the start of a new series examining the implications of the 15-hour free entitlement for different types of settings.
