With Inflation Rearing Its Head, Now Is a Good Time for Nonprofits to Consider Locking in Fixed Interest Rates

May 24, 2021

Mike Batts, CPA

If anything they teach you in a basic college macroeconomics class is true, the U.S. economy is headed for some inflation…something we haven’t seen much in at least a couple of decades. In macroeconomics class, we learn that two big things cause prices of goods and services to rise…when demand exceeds supply and when government spends significant money that it doesn’t have. You don’t have to do any research to know that both of those conditions are highly present in our economy today. You can combine with those conditions the fact that employers are unable to hire enough workers across the country despite record levels of reported unemployment. (The hiring challenge may be, at least in part, an example of the supply and demand principle at work.)

When general inflation arises in our economy, a few notable effects also arise. Investors generally expect higher returns on their investments in order to outpace inflation, and the Federal Reserve (Fed) typically raises short-term interest rates related to inter-bank borrowing. The Fed raises these short-term rates in order to cause banks to charge higher interest rates on their loans to customers…which, in turn, causes the lending process to slow down. The Fed’s purpose in slowing down the lending process is to cool the economy…and hopefully, rein in inflationary pressures.

The point of this greatly simplistic visit back to our college economics class is to say that current economic indicators should cause reasonable observers to believe that interest rates for borrowing are likely headed higher in the relatively near future. And that makes now a good time for borrowers to assess the interest rates on their debt positions.

Longer-term interest rates have not yet spiked significantly (in terms of historical comparisons), but they could do so relatively soon. Accordingly, nonprofit organizations with long-term debt should evaluate the interest rates on their debt and possibly take action. For borrowers with variable/floating interest rates, or with interest rates that will “reprice” to market rates in the next few years, this is a good time to try to lock in a low, fixed, longer-term interest rate. Some lenders offer fixed-rate loans for various durations. Bond underwriters offer truly long-term, fixed-rate debt…typically with fairly high up-front costs than can be rolled into the debt. And some lenders (typically through their investment banking divisions) offer interest-rate hedging tools like “swaps” to effectively create longer-term fixed interest rates for debt. [For more information about debt terms, including bond underwriting and interest-rate swaps, see one of my books – Church Finance or Nonprofit Finance.]

Even though market conditions point to inflationary pressures, it is possible that inflation may not become a significant reality in the near future. It is also possible that interest rates may not spike. It is unlikely, though, that taking action now to fix interest rates on long-term debt would be hurtful to an organization economically. Even if interest rates do not spike significantly, it is unlikely in the current environment that interest rates will decrease significantly. Thus, the opportunity to save money in the long-term by fixing interest rates now would seem to outweigh the possible risk of having a long-term fixed interest rate in a declining rate environment. Nonprofit leaders should consider these risks, including the unique risks (and opportunities) associated with hedging instruments like swaps, before taking action.

For clients of our firm, we would be glad to talk with you about these options. We can also assist you in connecting with lenders and other professionals in the lending environment that may be helpful to you as you consider options for your organization.

Let Us Know If We Can Help

If you are a BMWL client and would like assistance addressing the information described in this Nonprofit Special Alert℠, we would be glad to help! Please email our team at [email protected]. It is our pleasure and privilege to serve you.

The contents of this publication do not constitute legal, financial, accounting, tax, or any other type of professional advice. For professional advice regarding the subject matter addressed herein, the services of a competent professional should be obtained.