Companies do not fully feel the effects of interest rate hikes until after five quarters

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5 quarters. That’s the time it will likely take for the interest rate hikes by the U.S. Federal Reserve to fully impact the interest expenses of companies, according to a new study by the Federal Reserve Bank of Boston (see the study in English here). This is the reason why, after a year and a half of implementing anti-inflationary measures, only now are companies starting to experience an increase in the financial cost of their debt.

The graph shows the historical evolution of the interest rate of the American Federal Reserve (light blue line) and the non-immediate effect on the financial cost for companies (red line).

This delayed effect of restrictive monetary policies is also likely to be seen in the European realm. Since March 2022, both the U.S. Federal Reserve (the Fed) and the European Central Bank (ECB) began raising reference rates in an effort to curb inflation. Since then, the Fed has raised its rate from nearly zero to 5.25%, and the ECB has raised its main reference rate to 4.5% following the recent 0.25% increase on September 14th.

When central banks raise their interest rates, companies must pay higher rates on any variable interest debt they have, and on any debt they refinance. This leads to the need to offset this increased cost by reducing expenses and, in severe cases, by containing wages or laying off some of their employees. The rising cost of debt can also cause treasury difficulties and loan defaults.

The researchers of the mentioned study state that “regarding the current cycle, this finding suggests that most of the interest rate hikes have not yet been fully transferred to companies’ interest expenses.” They add that “it’s possible that the initial rate hike of 0.25 percentage points in March 2022 has fully impacted the interest expense ratio of companies, but they have not yet felt the full impact of the subsequent 5 percentage point hikes.” This contrasts with other parts of the economy, such as the real estate market and the banking system, where the high interest rates have already had an impact.

For companies, it is time to prepare for this rate hike which, in a deferred manner, will have an impact on their operating accounts and their treasury in the coming months. As always, Altria Corpo will be there to assist these companies in finding the best financial solution for these situations.

The Bank of Spain alerts banks to the complex situation and urges them to increase their provisions.

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The Governor of the Banco de España, Pablo Hernández de Cos, gave a presentation on 4 October entitled “The new economic scenario for banks”. After reviewing the various economic indicators, the Governor stated that “the potential impact of the current climate of uncertainty on the banking sector calls for extreme prudence“. For Hernández de Cos, while gross margin will increase in the short term due to the rise in interest rates on both new and existing variable-rate loans, funding costs (deposits and debt instruments issued in the financial markets) will also be pushed up.

The Governor warned that “the adverse effects of the current and foreseeable environment on the ability of households and firms to meet their financial obligations will manifest themselves mainly over a longer horizon (one to two years ahead)”. As a consequence, banks will have to increase their provisions to cover potential losses.

The latest Financial Stability Report, published in May 2022, includes simulations of the impact on banks of a scenario in which some of the current risks materialise: additional energy price hikes and more persistent bottlenecks in global trade, leading to further spikes in inflation and a further tightening of monetary policy, together with a deterioration in agents’ confidence and increased risk aversion. The results show that the sum of the different transmission channels in these stressed scenarios would generate a negative impact on bank solvency of between 1.8 percent and 3 percent for Spanish banks as a whole. By component, while net interest income would increase, the deterioration in the credit quality of loans to the private sector would lead to greater losses. Moreover, the simulated rise in interest rates entails a slight reduction in the value of bond holdings on banks’ balance sheets.

Hernández de Cos concludes that we are in the midst of a very complex macro-financial situation, characterised by high inflation, tighter financing conditions and heightened uncertainty, which has already led to a slowdown in economic activity in the third quarter and a general downward revision of growth prospects for the coming quarters. In this context, although the starting point for the banking sector is positive, extreme caution is needed and risks, which can worsen rapidly, need to be closely monitored and new stress scenarios need to be envisaged. All this leads the Governor to recommend banks to be very careful in their provisioning policy and capital planning in the coming quarters.

The consequence for companies seems clear: further credit tightening by banks and a rise in the financial cost of their debt. Expanding the number of non-bank financial providers and seeking more liquidity in anticipation of this tighter scenario seem sensible advice at this point in time.

ESG strategy, key for medium-sized companies

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The Sustainable Development Goals (SDGs), adopted by the United Nations in 2015, cover areas such as responding to the threat of climate change, eradicating poverty, promoting gender equality and social inclusion, among others. The SDGs propose a plan to move towards a global economy that is much more responsible and inclusive of people and the planet.

The investment world, with funds that invest in companies at the forefront, is aware that it must collaborate decisively in the achievement of these SDG objectives, and it does so by applying the so-called ESG principles (E for Environmental, S for Social and G for Governance). These are non-financial criteria divided into three main groups:

  • The environmental ones, which encompass aspects such as climate change, toxic emissions or renewable energies;
  • Social criteria, such as the achievement of human rights, decent working conditions, equal diversity and access to information;
  • Corporate governance, such as putting an end to corruption, promoting business ethics or fostering transparency.
ESG criteria. Source: Rankia

Increasingly, pressure from the investment world and society in general will mean that companies will have to submit to these ESG principles if they want to obtain financing from the markets and their agents (banks, funds and investors in general). The Next Generation funds, for example, will have a strong ESG component, and more and more funds with which we collaborate at Altria Corpo are setting ESG criteria for financing medium-sized companies.

The ESG strategy is therefore absolutely crucial for companies in the coming years and is transformational in all areas of the company, so the responsibility for implementing it lies with the general management and governing bodies, and is not a matter that should be left to the marketing and communications department alone.

Altria Corpo, through its partnership with the leading PKF Attest group, can help companies to undertake the necessary ESG transformation processes from all sides:

  • Definition of the ESG strategy, with the help of specialist strategic consultants.
  • Participation in the implementation of the plans that have been defined: emission control plans, compliance, equality, conciliation, supplier management, etc.
  • Measurement of the company’s progress over time based on objective ESG indicators, and benchmarking with companies in the sector.
  • Support in obtaining an ESG certificate such as the B Corp certificate, among others.
  • Implementation of Business Intelligence solutions to measure and track ESG KPIs.
  • ESG audits