You might think that a Federal Reserve interest rate increase of one-fourth of a percentage point isn’t a significant movement, yet the implied message is what means the most for the mergers & acquisitions market.
Over the past eight years, the Federal Reserve interest rate charged for overnight deposits, commonly referred to as the discount rate, at 0% to .25%. A discount rate that low was intended to encourage lenders to lend money, rather than leaving their money parked at the Federal Reserve. Lending money would be more profitable for lenders, but also means taking on more risk. The assumed risk is what kept lenders from aggressively taking funds to the lending market.
Consider how that situation impacts the merger & acquisitions/business broker market in St. Louis.
When lenders don’t want to take risk, the whole system slows down. Only buyers who can afford to insulate the lenders with heavy down payments and additional collateral get funding.
When lenders are in this mindset, the SBA (Small Business Administration) becomes a preferred source to protect lenders against losing a substantial portion of capital due to loan defaults. Other funding sources are also in the market, but the interest and fees they charge reflect the higher level of risk they potentially assume.
So, how does an increase in the discount rate affect the merger & acquisition and business brokerage market?
Two signals are sent to the market with the one-fourth percentage point rate increase:
• Although very small, the change in direction of the Fed – from trying to stimulate the economy with free money to charging those lenders one-fourth percentage point more – is a small step in encouraging lenders to lend. Several more rate increases will be needed to convince lenders to seek a better return on their money through lending, yet the direction of interest rates is the important signal.
The Federal Reserve is signaling their opinion that the economy (business climate) is improving. Charging more to lenders is the Fed’s way of also saying that the market risk of lending is decreasing.
• The other signal is to borrowers, particularly buyers of small businesses. Buyers are now alerted that borrowing will become more expensive, and if you are considering a major acquisition of a competitor or the purchase of a small business, you should ramp up your efforts as the future holds higher interest costs.
On the flip side:
A benefit to the small business buyer is that lenders will become more aggressive in looking for good lending opportunities as the cycle is turning to lend more.
Subtle signals are important to monitor, as they present opportunities for you to evaluate your next strategic move.
How long is this window of opportunity?
Well, if you believe that the Fed will continue to increase interest rates by one-fourth percentage point each quarter for the next eight quarters, that would mean the Federal Fund Rate (the rate the Fed charges to banks to park their money) would be up 2% in two years…placing the Federal Fund Rate around 2.5%. Now may be the right time for you to consider that expansion or acquisition.