INDUSTRY FOCUS: FINANCE
The Rise in Long-Term Interest Rates and Its Effect on the Apparel Industry
The recent jump in long-term mortgage rates and bond rates means that short-term interest rates will be seeing their own increases down the road as the economy improves.
The question is how much more will manufacturers and retailers be paying to borrow money, and when will that happen?
California Apparel News Senior Editor Deborah Belgum quizzed several financial experts and lenders in Southern California about what the future will bring and how to prepare for it.
Sydnee Breuer, Senior Vice President, Business Development, Rosenthal & Rosenthal
Certain interest rates (those tied to real estate/mortgage rates) have risen. However, others have remained steady. The prime rate and LIBOR (the London Interbank Offered Rate) have remained constant, and these two are the interest rates on which the asset-based and/or factoring/lending community typically bases its lending rates. In fact, Federal Reserve Chairman Ben Bernanke has repeatedly indicated he does not expect the prime rate (currently at 3.25 percent) to increase until early 2015. So it seems that manufacturers and retailers will have ample time to prepare for increases in their base-lending rates.
Having said that, when the rates do rise (as I can guarantee they will rise—I am just not sure when) manufacturers and retailers will need to make provisions within their expenses and cost structures as they do with rising prices on other items (such as raw materials, employee benefits, etc.).
With the continued gains in technology, other efficiencies and the ability to do more with fewer employees, the borrowers may not feel much of an impact to the bottom line.
Mitch Cohen, Western Regional Manager, CIT Trade Group
We have seen a steepening of the curve with long-term rates rising. Short-term rates have not increased as dramatically.
Generally, short-term rates would have a more profound impact on manufacturers and retailers. Hence, we have not seen an impact to the bottom line of manufacturers and retailers.
Whether factors' lending rates are affected this year are tied to short-term interest rates. So it would really depend on what happens to short-term rates from here.
Ron Garber, Executive Vice President and Regional Manager, First Capital Western Region
The recent rise of interest rates primarily isolated to long-term instruments (mortgages) hasn't really trickled down to short-term rates as yet, so, in general, short-term working-capital lending costs have stayed relatively low.
I believe there is still skepticism on the part of the Fed that, at the current rate and spottiness of our recovery, the economy could sustain the shock of any meaningful rise in short-term rates now.
If short-term rates eventually start to edge up later this year or next—because the Fed becomes uneasy with the inflation index or determines the unemployment rate has dropped sufficiently—I believe the adjustment(s) will be negligible—perhaps in the one-eighth to one-quarter range. An uptick of this magnitude, I don't believe, would have any material impact on manufacturers' or retailers' bottom line—certainly not significant enough so that a slight adjustment in their operating efficiencies would adequately neutralize the negative effects of such a price increase.
To a greater extent, I think what will influence factors' lending rates in 2013 will continue to be the competitive environment in the marketplace. Business in general is soft, and all factors—as well as lending institutions—are being aggressive in offering attractive pricing packages to grow their book.
In the past, lenders would couple this with looser credit requirements as well, but the memory of the recent financial crises and the regulators' more stringent credit policies have put the brakes on that strategy. So financial institutions are only left with one arrow in their quiver to attract new business—that being pricing their services and product at the lower end of the spectrum.
Therefore, any well-financed and managed manufacturer/retailer looking to lower their borrowing costs anywhere from 100 to 200 basis points (1 percent to 2 percent) is well-positioned to negotiate successfully better terms when their current agreement is up for renewal with either their current or future lender.
Rob Greenspan, President and Chief Executive, Greenspan Consult Inc.
When interest rates rise, the related cost of borrowing money goes up. With increases in interest rates, manufacturers and retailers need to be prepared that this will have a negative effect on their bottom line. Most manufacturers and retailers have variable interest-rate lines of credit. If interest rates keep rising and the amount the company is borrowing doesn't go down, then your cost of funds will increase, which is to your detriment.
What manufacturers and retailers can do to minimize the rate increases is to lower the amount of money that is borrowed. There are various strategic ways to do this, but to me, first and foremost, is to get more liquidity in your company.
If the company can reduce its inventory levels, this will create more liquidity. Also, being able to generate more profits—by either getting a better gross-profit margin, lowering overhead or a combination of both—will increase profitability and should increase the liquidity in the company.
Financially stronger companies will always get the best and most competitive interest rates. Companies that are considered to have too much leverage and are more difficult to finance will continue to have to pay higher interests. That is just a fact of life in business.
Sunnie Kim, President and Chief Executive, Hana Financial
As interest rates rise, manufacturers' and retailers' interest expense will rise as well, theoretically reducing profitability, assuming they are unable to pass that cost on to their customers.
Although typically rising interest rates portend a healthier economy, this may not be the case now. Since our industry is ultimately consumer driven, rising rates will also mean potentially less disposable income for consumers due to higher credit-card rates, increasing rates on mortgages and lines of credit.
In addition, as the value of real estate improves, individuals will be socked with higher property taxes. This does not take into consideration that the unemployment rate, although improved, is still hovering around 8 percent nationally.
Lenders generally charge interest based upon an index such as the prime rate or LIBOR. So as those rates increase, the increases to their customers are already factored in. The major takeaway is how the various financial organizations compete with rising rates.
The major banks and their affiliates are able to access funds at cheaper rates than independent organizations, and, therefore, as rates rise, the disparity becomes greater.
Don Nunnari, Executive Vice President/Regional Manager, Merchant Factors Corp.
Long-term fixed rates—10 years and more—have risen. There has been no movement on short-term floating rates at this point. Most apparel manufacturers are borrowing short-term with floating rates.
If short-term rates increased, it would increase the borrowers' financing costs and impact their income. Factoring contracts' lending rates are tied to prime rate or LIBOR and would automatically adjust if short-term rates changed. Competition in the factoring arena has kept interest rates low for borrowers for the near term.
Dave Reza, Senior Vice President, Western Region, Milberg Factors Inc.
Companies that utilize short-term revolving credit facilities—whether from a bank, factor or asset-based lender—typically have rates tied to the prime rate or LIBOR.
When these key indexes rise or fall, the effective interest rate on borrowing follows suit. If interest rates rise, then there will be a corresponding increase in the cost of debt.
As noted above, factoring advances are charged to clients at a rate based on the prime rate or LIBOR. As these rates go up, the interest rate charged to the clients will rise concurrently.
When possible, manufacturers, importers and retailers will try to pass along these rising costs to their customers. However, it is not always possible to build these increased money costs into pricing.
Until they can price the change into their costs, some companies will have to absorb/accept higher costs/lower profits. As always, operators that anticipate and quickly respond to changing cost dynamics will find it easier to make better and more profitable decisions.
Tri Sciarra, Executive Vice President, Capital Business Credit
The rise of interest rates is a hot topic in the lending sector right now. Since 2008, while the lending market tightened, those who were able to secure financing did so cheaply as the prime rate dropped from 8.25 percent at their peak to 3.25 percent.
Now, faced with the fact that interest rates will begin a slow ascent, many businesses are wondering how this will affect their bottom line.
First, it's important to remember that interest rates are not expected to climb rapidly. Each 1 percent increase in the prime rate for a company that borrows $1 million will cost $10,000 per annum. While the cost of money will rise, a company that is running a profitable operation will not see a material impact to its business.
However, it's important to acknowledge that rising interest rates are just one of many cost increases for importers, manufacturers and retailers. Margins are already being squeezed by other elements, such as the rising cost of manufacturing, shipping and raw materials. Over the next several years, the challenge will be for businesses to find a way to increase sales to offset some of these incremental costs. Additionally, increases in interest rates may impact consumer spending, especially at the lower tier.
Kevin Sullivan, Executive Vice President, Wells Fargo Capital Finance
Interest rates charged by factors are generally floating rates tied to a standard benchmark such as LIBOR or the prime rate. In an environment where interest rates begin to rise, certainly the interest rate charged by most factors would also increase.
It's important to note, however, that the spread charged by a factor (meaning the amount above the benchmark rate used) isn't really impacted by a rising interest-rate environment. The overall rate might increase because the benchmark rate increases, but this certainly isn't a function of factors raising rates in any way.
We've been in an unprecedented period of low interest rates for some time now, and I think most companies within the manufacturing and retail sectors understand that the current rate environment won't last forever.
Fortunately, we've also seen clients become much more efficient operationally since the most recent economic crisis, which should enable most to continue operating profitably should rates continue to rise.
Ken Wengrod, President, FTC Commercial
The interest rates that are rising are the long-term mortgage rates and bonds but not short-term rates. I don't think it is going to have a significant impact on manufacturers but more on the psychological side for consumers.
The people who benefit from the rise in bond rates are senior people with a fixed-rate income because they are now getting a higher return. Short-term interest rates have a much greater impact on borrowers or manufacturers.
Right now, interest rates have been kept artificially depressed by the federal government. There is a lot of confusion in the market right now because people are wondering if the economy is worse off than the feds are saying. There is still 7.6 percent unemployment nationwide, and I don't think the market is that strong.
At the manufacturing level, apparel is doing well. Luxury brands are doing well because people who have money will buy something if they see newness.
In the contemporary market, it is somewhat overcrowded.
Paul Zaffaroni, Director of Investment Banking, Roth Capital Partners
Interest rates have been rising since May, which will increase borrowing costs for manufacturers and retailers for the remainder of 2013.
The collapse of the economy in 2008 forced many manufacturers and retailers to rationalize their costs structures, making them more resistant to future shocks, including higher interest rates. While higher borrowing costs have a negative impact on profitability, the current increase in interest rates is being driven by an improved outlook for the economy, which should result in increased consumer spending offsetting the higher borrowing costs.
Publicly traded retail and discretionary companies continue to outperform the stock market, and M&A (mergers and acquisitions) activity has remained strong. Higher-income consumers have been doing most of the spending in 2013, benefiting publicly traded companies such as Michael Kors, Restoration Hardware and Tumi.
A lower unemployment rate in the second half of the year should help bring middle-income consumers into the mix, improving revenue growth for a broader group of manufacturers and retailers while offsetting their higher borrowing costs.